Transcript: Segment 2
Paul Winkler: So one of the things we’re going to talk about this hour, I’m going to talk a little bit about some day trading. This is something that many people are engaging in. It’s not unlike other times in past history where people have engaged in this process. And we’re going to talk a little bit about that. Some really fascinating statistics regarding day trading.
I have people ask me all the time, you know, what stocks do you think to be doing right now? You know, based on what’s going on with coronavirus, who’s going to benefit from this? What’s going to be happening as the election nears? What areas of the market, what companies do you think are going to be benefiting? And people will try to day trade and they’ll try to “catch the wave” as stocks go up in value and try to get out before they go down in value.
And the belief is many times that maybe that they have an advantage because they’re so small versus the big fund managers. So we’ll talk a little bit about that. I also talk a little bit about some hidden risks: indexing. Now, many times when somebody goes on the other side of that and says, “You know what day trading is a really bad idea. You ought to just buy into the stock market and just hang onto it and not try to figure out where it’s going to go next. Now, try to figure out which company is better than others. You ought to just index.” Well, these are two very different extremes from each other. So we’re going to cover both of those extremes and talk a little bit about those right now. Now let me talk a little bit about day trading. What is it?
Day trading is “easy”
Well, you might set up an investment account and you’ve seen these commercials online where they say, “Hey, you can do these trades and it might be seven bucks a trade. It might be $5 a trade, very, very inexpensive.” And you think, Wow, you know, I, I don’t have to pay hardly anything to do this. And this is really fun. I can do this in my pajamas. And you see these commercials on TV with the guy that is the psychiatrist, I guess, is what they’re trying to make him out to be. And they have these shows on TV, talking about different companies, which companies are doing, what, what’s happening right now, which companies are on the move. They have the heat map that you can watch on TV. And the heat map is something where you can see the green or the red.
And the green is where the stocks are the areas of the market that are actually performing well, and the red are the areas that are actually performing poorly and the top performers in a given day. So you think about the media is really priming you to do a lot of this type of trading, which companies should you be investing in right now? Oh, this new announcement just came out and this company, look at the stock price or look at the year-to-date performance. And they’ll pull up the companies that had the top year-to-date performance. And that’s what you need to be looking at right now. These are the companies, “on the move.” That’s the idea what is on the move because they’re appealing to our greed, our desire to get rich and get more money because more money is going to make you, what? More secure.
Day trading makes you “happier”
It’s going to make you happier, right? That’s what people believe. Now you always hear people say, “Well, money doesn’t make happiness”. It doesn’t buy happiness. The Beatles said money can’t buy love. Right. But somehow in the back of my mind, I really don’t I believe that. I believe it is going to make me happy. I do believe it’s going to make me much, much more well adjusted psychologically, and I want to be more well adjusted. So give me more money and give me more security because I feel insecure. I feel scared about the future. I have a fear of the future. What is going to help me overcome that fear of the future? More money. And the funny thing is there never seems to be enough. And then funny thing about it, it’s like the eye is never satisfied.
We’ve heard that before. Right? Well, it’s, it’s true, but I think I’ll be happier. So I go after that. Well, how can I get the most amount of money? Well, I am impatient, so I don’t want to wait for the market to deliver returns. Oh yes. I’ve heard, I’ve heard that the market historically large US stocks historically, the rate of return is about 10%. Well, that means it takes me a full seven years for money to double that’s a long time and it takes me 14 years for it to quadruple. But yeah. Yeah, that sounds great in theory. But what if it doesn’t, you know, we go through the dead decade and you got no return. You go through the dead double decade, which is ’66 to ’82 for large US stocks, that’s no return. That’s a really long period of time.
Retired? Want to try day trading?
And so there’s that aspect of things. I can’t deal with that. Now, by the way, during that dead double decade, there were a lot of areas in the market that did quite well. So you, if you were diversified, you didn’t go through that. But I’m just talking about the data that you might look at. Okay. So if we look at day trading, man, I could double my money in a day. Would that be way better than seven years? So it’s very, very appealing. Now there’s an article written about this in market watch. It was entitled, Retired? Want to try day trading? Well, why do I want— I’m retired already? Why do I want to try it? Well, maybe because I’m starting to worry about my health going bad and I need more money to cover my healthcare expenses later on. Maybe I don’t want to be a burden to my kids, or whatever motivates you.
That might be the motivation to try day trading. Now, there may be another reason to try day trading that has nothing to do with more money. It’s just the thrill of it because our brain kicks out chemicals, endorphins when we’re gambling with our money. Well, it also kicks out those same chemicals when we’re day trading. And that’s a really good feel good chemical, and maybe I’m retired and I’m little bit bored. And I don’t feel that same charge that I got when I was working for a company. You know, when I worked for a company, I was out there, I was going out there and I was killing and eating. I was the caveman right out of the cave or the cave woman running out of the cave and going and hunting and gathering. And that kicked off endorphins maybe. And I just don’t feel them anymore.
So I’m going to try day trading because I want that, that feeling again. I want that feeling of power control. And so often what happens is day trading gives us that feeling of power and control that we crave. So the article in MarketWatch says, read this first. And it happens to be written by a guy that does a day trading or a market timing newsletter. So you might want to listen up this guy. That’s all he does is he studies this particular thing. Now it says, this question would be unthinkable, and that is: Retired? Want to try day trading? That question would be unthinkable up to a couple months ago. Day trading is risky. That’s the last thing you should be incurring with your retirement portfolios. Nevertheless, no doubt, because many of you have lots of time on your hands during this pandemic. It recalls a stick song too much time on my hands day trading has mushroomed in popularity.
Day trading is “simple”
So this is getting to be a big deal right now. Lots of time. I’m a little bit fearful because, Hey, let’s say that the future is looking pretty uncertain in order to overcome that uncertainty, I’ve got to do something to build up more money. One of the more extreme—so what happens is this people are jumping into day trading, setting up these online brokerage accounts. They’re seeing a lot of commercials about it. You know, it’s just like the late nineties. There were ton of commercials on day trading. Oh my goodness. Tons of them. And the fear of missing out—FOMO—has been intensified by a rash of recent news stories making day trading appear to be easy. This is simple. Anybody can do it.
And you think it even worse. There are some people that have had some say successful with it, right? And you won’t ever hear when somebody fails at something, you always hear successes because our human desire is to look good. I want to look successful. I want to look good. I will only share my successes with you. I won’t share my failures with you. That’s normal. That’s human behavior. One of the more extreme of these stories was a claim by a day trader that he’s a better investor than Warren Buffett. And that day trading is the easiest game that there is number one. I don’t know if you looked at Warren Buffett’s net worth recently, but I’m guessing it’s probably more than this day trader. Just saying. “I have one word of advice,” he says in the article, “if you’re tempted by such posts don’t or at least read this column first.”
Is everybody average?
So what is going on? He says, “I say this, not to say, because day traders never make any money.” And this is the trap folks. They do that. Some of them do, many of them do at least temporarily, but the overwhelming pattern is for them to eventually lose much of their winnings. It’s the latter point that too often gets missed. And wait we’ll you hear these statistics. It’s the latter point that often gets missed. The usual response from day trading skeptics is to point out that day traders on average, don’t beat the market. And that’s normally what you hear. Well, they don’t get a higher return than the market on average, but who amongst you wants to think of themselves as being average? We have this exercise that we would do for years and we would get a whole—the more people in the room—the better.
If you’re getting a couple hundred people in a room, this is really fun. And what we do is we say, “Okay, everybody stand up, everybody stand up.” If you’re driving, don’t try standing up. “Now what we want you to do, if you are a below average driver, please sit down.” Now, of course, how many people do you think sit down? And then there’s a jokester, always in the room. They sit down, they make a big fuss of them sitting down, but most people don’t sit down. And then my next line to them is this: “Now you can’t be all above average. Some of you have got to be below average, but we don’t want to think of ourselves that way.” So most people will remain standing. So what happens with day traders? On average, they don’t beat the market, but nobody wants to think of themselves as average.
So they go, “Well, yeah, yeah, I get it. Most people lose, but you know, I’m not below average.” And he says in the article, he says, “but that doesn’t speak to whether any individual day traders are beating the market consistently.” If they can, then you couldn’t care less whether the average day trader was a market lagger, right? That’s who cares? I don’t care what the average person’s doing. I care what I’m doing. And that is why they anti-day trading diatribes, it’s just, nobody listens to them. And it falls on deaf ears because I’m not average.
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Statistics
Now there was, you know, Burton, Malkiel, Princeton professor, he likes to write about this stuff. And he had some fascinating stuff that he talked about. He said, “This behavior, isn’t anything new. We can go back to the 1600s.
We can look back at the tulip bulb craze. And we see where people were trading tulip bulbs and got their heads handed to them. We can look at the sixties “tronics” phase where you know, all you had to do to get a bump in your stock price is add the suffix to your company’s name, “tronics.” And you got a bump in the stock price. You know? So these go on all the time, but he often talks about day trading and he cited two studies in his work. He says, “One found that day traders at Charles Schwab had an average lag behind the market over a six-year period. And the other, which found that there were three only 3% of Brazilian day traders turned a profit. 3%. And you know why we have to go all the way to Brazil to find data like that?
Do you know why? Now this isn’t in the article, but I’ll tell you because I’ve seen the studies before investment companies that allow day trading online trading will not release data on the actual returns of their investors, because they know what I’m telling you to be true. Isn’t that funny? It’s anti-good business for them to release that data to you. Because if they released that data to you, you probably might just stop setting up accounts with them is really what’s going on. Now these are indeed sobering statistics, but notice that they enable true believers to continue to have hope, because I am not average. I will be part of the elite subset that consistently makes money. But there’s a recent study that eliminates that hope. And here’s how it goes. The study is entitled to follow or not to follow an empirical analysis of the returns of actors on social trading platforms.
An experiment
So it was conducted by six researchers. It’s a university in Germany and here’s what they found. They said the study focused on day traders on two of these platforms and because the platforms published each user’s performance. And I actually talk about a study like this in my book, Confident Investing. Very, very similar, it was actually a gentlemen that had had a very, very similar result. So this is even outside of the studies I published in my book, same stuff, same results because the platforms publish each user’s performance. The researchers were able to simulate the returns of a day trader who followed the others with the best track records. So what they did is they said, we understand that most people aren’t very good at this, but how about the ones with the best returns? They apparently have some skill. They got mad skills.
You’ve heard that in some commercials, “you got mad skills going on right now.” Consider a strategy that each month followed the five portfolios with the best lifetime returns up to that point on a particular social trading platform. These people must be really good. Let’s follow them. In one, in the case of one of the platforms analyzed, to follow the winner’s strategy produced how much of a gain? Okay. No, a 79% loss. Ouch. According to researchers, in the case of the other platform, how much of a gain did they get? Oh, no. A loss of 92%. 92% loss. The research, not enough. They go even further. They next looked at progressively more sophisticated strategies for mimicking other day traders. These included, well, that’s just to unsophisticated to go with past performance winners. Let’s get a little bit more complicated in our study, shall we?
These included focusing on day traders with the highest risk-adjusted performances. Let’s add another thing, because maybe these people that had really really high returns had super, super high risk. So there’s something called sharp ratio that you may, if you’re really in the know about investing, you might be familiar with. So you take the return of the portfolio minus the risk-free rate—just doing this from memory—divided by the standard deviation. That’s how you get a sharp ratio. And it’s a sophisticated way of determining if this person really has mad skills, because we want to see if they’re getting high risk adjusted returns. So they eliminated the person that might be employing margin. Which that’s where you borrow money to try to actually magnify your returns a little bit. It’s super, super risky.
And matter of fact, if you look back at the Great Depression and you look at the people that lost all the money, you hear people losing all their money in the Great Depression. A lot of them was due to margin investing where they borrowed money. So now, not only have you invested your own money, but you’ve actually invested borrowed money to magnify the gains. If you really have mad skills, that’s a great way to do it. But the only problem was that it didn’t work so well in the Depression and it doesn’t work now. But here’s what happened. They looked at sharp ratio and after transaction costs—which is, remember, that’s how the investment firm makes money, transaction costs. None, none of these more sophisticated strategies beat their benchmarks, not a one of them. So, so much for following the leader. So much for day trading.
And if you know somebody engaging in this, maybe this is an article, well, maybe a radio segment you have them go listen to because this is, this is not only crazy sauce, but it is really a good formula for losing your financial security. It may be fun. It may get some chemicals going in your brain, but it’s not necessarily good for your financial livelihood.
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