The Illogic of Active Trading
Individual investors have been busy the last few months. TD Ameritrade saw a 30 percent jump in daily trading volume compared with the same period last year. Other discount brokers reported a similar increase in daily trading volume.
I spoke to TD Ameritrade, and it said this number represented a broad-based increase in trading. The number of people trading in their accounts also increased, and over all, they were trading more.
Frederic Tomczyk, TD Ameritrade’s president and chief executive, referenced all of these trades in a news release announcing a 35 percent increase in company earnings. According to Mr. Tomczyk, the earnings increase was “driven by record trades per day as retail investor engagement continued to improve. In fact, our quarterly activity rate was the highest we’ve seen in a decade.”
While we don’t know exactly why people are trading, Joe Kinahan, chief strategist at TD Ameritrade, made it pretty clear in an earlier news release: “Our clients have been dialing up equity market exposure and participating in the rally every step of the way.” In addition to all this trading activity, many of the online brokerage firms are seeing cash levels at their lowest point in years.
But wait! Isn’t trading bad?
We’ve known trading is bad for a very long time. A series of academic studies done by Terrance Odean and Brad Barber found conclusively that investors who trade a lot experience reduced returns. In fact, the more they trade the worse their return is likely to be. Based on the activity we’re seeing today, it’s worth noting what Mr. Barber and Mr. Odean wrote in 2000: “It is difficult to reconcile the volume of trading observed in equity markets with the trading needs of rational investors.”
So why are people doing it?
After the best year we have seen from the markets in more than 15 years, a rise from the panic-inducing levels of 2009 and in the face of pretty conclusive evidence that trading leads to lower returns, why are we trading more?
Maybe we’re confused. It’s reasonable to think that activity will equal results. Because our money is so important to us, it can also be very hard to accept that just buying boring things and holding on to them for a very long time is all there is to investing. So it’s easy to buy into the story that we need to be trading. After all, that’s how they do it on TV.
Then there’s the case of Gabe Mercer. The Wall Street Journal highlighted his story in its coverage of the jump in trading numbers. Mr. Mercer is a 22-year-old student who “stumbled” onto the stock market in March while reading Twitter and watching YouTube videos. From that base of experience, he has concluded that “it seems like a great time to be in the market.”
It’s possible that he doesn’t know what has happened to all those who have walked this lonely road before him. Maybe he and other would-be traders haven’t seen the research that shows that not only does trading hurt our returns but that we’re also really bad at deciding when it’s a good or bad time to get in and out of the markets.
Those who have tried before have almost always failed. Last week, Ron Lieber shared one such story in his Your Money column for The Times. At the age of 30, Randy Kurtz thought he could successfully trade individual stocks, and he started an investment firm around the idea. Now, he mostly buys index and exchange-traded funds for clients. While there was no endorsement of Mr. Kurtz or his portfolios, Mr. Lieber does write that we can learn something from Mr. Kurtz’s change of heart: “Taking gonzo risks on individual stocks or specialized funds just isn’t prudent anymore.”
We could chalk up trading’s popularity to people being confused or inexperienced, but I suspect the more likely culprit is that we think we know better. In other words, we’re overconfident. It’s an very easy mistake to make. After all, trading sounds so easy. Just buy things that are going up and sell them before they go down. How hard can it be?
The easy-to-use tools and readily available information about individual stocks make it very appealing to try. But this all comes down to one very important question: Do you want more money? The data argue that trading won’t get you there.
This commentary originally appeared April 28 on NYTimes.com
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