The Difference Between Trading & Investing
The stock market is filled with individuals who know the price of everything, but the value of nothing.
Earlier in the year, the Wall Street Journal profiled one novice trader who made a tidy sum of money after following advice from an internet forum. Hearing such stories would often cause many others to want to jump in, in the hopes of such a “game winning trade” to try and change their lives.
You probably hear more stories of success than failure. After all, it is unlikely that a peer might tell a story about how they foolishly lost their life savings betting on something that their friend mentioned over a pint of beer.
In Singapore, the rise of trading amongst younger investors using online platforms has people urging for more “healthy trading”. But what exactly does healthy trading look like? By and large, trading isn’t healthy for your emotional state and your bank balance. Let’s look at the data.
Research on day traders in Taiwan over a 15 year period from 1992 to 2006 showed even the most experienced day traders lost money. Overall, these investors performed worse than the market by an average of -3.8% annually. A lot of these losses were chalked up to their aggressive order placement. Interestingly, traders who lost consistently still continued to trade despite suffering losses, which showed an inability to learn from their own mistakes and is reminiscent of social patterns we see in those who gamble.
A study on the futures market in Brazil (the third largest in the world) showed that 97% of the traders lost money, 1.1% generated profits just above the minimum wage, and 0.5% earned more than the starting salary of a bank teller.
Another study by the US Securities and Exchange Commission (SEC) found that retail Forex traders do extremely poorly. A staggering 70% of such traders lose money every quarter and they lose their entire investment in the span of a year. That’s a very poor outcome.
An analysis of trade data from eToro (an online brokerage platform) found that an enormous majority (80%) of investors lost money over a 12 month period with a median loss of -36%.
It appears that the odds are really stacked against the day trader. But are there people who managed to make decent returns? Absolutely — otherwise there wouldn’t be such legendary stories abound. However, the stats do not lie — these people are the outliers.
Nobel Laureate, Robert Merton, commented on the difficulty of market timing and trading; “Suppose I could verify that I’m a .700 baseball average hitter in calling the market turns. That’s pretty good; you’d hire me right away. But to be a good market timer, you’ve got to do it twice. What if the chances of me getting it right were independent each time? They’re not, but if they were, that’s 0.7 times 0.7. That’s less than 50-50. So, market timing is horribly difficult to do.” The diagram below shows exactly what he means.
If you’re thinking that professionals at are any better at trading, think again. Admittedly, with the wealth of information at their disposal and experience in the markets, some market forecasters do come close to the 70% accuracy mark, but the majority of them do way worse (see diagram below).
We can learn from this humble janitor who left behind an estate of $8 Million through careful investing and the power of compounding. Gathering high quality stocks over the years, he allowed the returns to compound and grew his wealth substantially and consistently; most important of all, he did not trade.
Our role as advisors is not to force anyone to invest their money in a certain way. People are free to trade as much or as little as they please. But our role is to lay out all the facts, showing you where the weight of the evidence points toward. This way you can go into it with your eyes open. If you need a second opinion on whether you are doing the right things or whether you are on the right track, come and speak with us.
