Image: The Spinoff/Getty Images
Image: The Spinoff/Getty Images

MoneyOctober 28, 2020

Day trading has surged in popularity. Should we be worried?

Image: The Spinoff/Getty Images
Image: The Spinoff/Getty Images

Many new investors in the US have started frantically buying and selling shares without considering the risks involved. Hatch GM Kristen Lunman explores the reasons for such behaviour and whether we’re seeing it happen in New Zealand. 

A share market rollercoaster, record low interest rates, and more free time on our hands have inspired a new generation of investors to put their money to work. Investing platforms around the globe have seen a huge spike in the volume of trading activity. At the same time, interest in risky options like day trading has surged, too. 

As huge advocates of putting your money to work with investing, we feel a responsibility to stem a growing trend of share picking in a potentially dangerous way leading to losses. So let’s address the day-trading elephant in the room.

What is day trading?

Day trading is the act of buying and selling shares quickly. Actual day trading can happen in seconds, but the term also refers to people who buy and sell shares in companies they might not understand to sell them quickly for a profit. 

You’ve probably seen day trading in films like The Wolf of Wall Street and The Big Short where it looks fun and exciting, but the perception isn’t always reality. Studies have repeatedly shown that actively trading shares results in worse investment outcomes.  Research out of the University of California found that only about 1% of active traders grow their money more than people who simply put it into an S&P 500 fund (a fund that tracks the 500 biggest companies listed on the US share markets). When the study analysed the active trading accounts of the discount broker Charles Schwab over six years, it found that the more frequently people trade, the worse they do. 

That truth doesn’t make for an exciting narrative at the flicks, but it should come as good news for anyone who wants an easier way to put their money to work. We’ve already seen the rise of platforms like Robinhood, a longtime fintech darling of Silicon Valley which has lured in 13 million new investors and led the way for zero-commission-fee trading. Its simple “gamified” user experience quickly captured the hearts and minds of young, first-time share traders. 

Robinhood has revolutionised investing in the US

Tempted to start trading more? You’re not alone

The Covid-19 pandemic has created an environment which has seen a surge in the number of people who are day trading. Heaps of newcomers have started frantically buying and selling shares without considering the risks involved. Let’s bring in Warren Buffett’s ominous yet truthful analogy: “It’s only when the tide goes out that you learn who’s been swimming naked.” 

Despite the “Coronavirus Crash” in March, this year has been relatively kind to investors. Thanks to the trillions of dollars that have been pumped into economies by governments around the world, by August share markets had quickly recovered. The stimulus has been like a shot of adrenaline to share markets and, as any trader will know, it’s a lot easier to make money speculating and taking bigger risks when markets are going up.

Then there are the jocks. Many commentators have pointed to a shift caused by bored, locked-down sports fans who couldn’t gamble their money on sports, so they’re betting it on the share markets instead. Do you blame them? Pandemics are boring, and even those of us diligently trying to save money can feel tempted to jack up our returns with a short stint in shares, especially when the pitiful interest on savings accounts isn’t exactly tempting. 

Finally, there’s the fear of missing out, or “fomo”. Investing fomo is when you watch a share price soar to new highs and you realise you’ve missed an opportunity. The market recovery in August, which saw the S&P 500 back up to its pre-coronavirus crash February highs has also been attributed to fomo. As share prices climbed steadily higher in July and August, more and more investors believed blindly buying on the rise was their best shot to avoid missing out altogether. 

The above factors combine to create a perfect storm, or rather, a deadly cocktail. Mix these ingredients with a rise in low-cost share trading platforms, add a splash of lime, and it’s never been easier to speculate on the price of publicly listed businesses. Mind the hangover, though: it’s got a bite.

Beware the bear

Markets have been rising, but what goes up can come down.

A share price fall of 10% or more is called a correction, and the S&P 500 Index has, on average, recorded a drop like this every 16 months. A fall of 20% or more is known as a bear market. Bear markets are a normal part of investing in shares and usually occur around once every seven years. 

So, what do we know about bears? They’re always lurking around the corner. As good as things are today, it’s still important to think about the risks of short term investing, in comparison to long-term investing. To build long-lasting wealth, long-term investing wins hands down.

Roll the dice

According to data scientist Nick Maggiulli, across all one-day periods since 1915, the Dow has returned a positive return roughly 52.3% of the time. That’s not much better than a roulette wheel at the casino. However, holding shares for a longer period can significantly increase those odds. 

The Dow Jones is a group of 30 big, established companies like Johnson & Johnson, Microsoft and Apple. Over one year, the probability of a positive return extends to almost 70%. Over 20 years, the likelihood of a positive return jumps to a solid 96%.

Not only do our odds improve by investing for longer periods, but studies show that we make terrible traders anyway! Time and time again, research has shown that individual investors lose money or underperform the average market return when trading.

Is day trading happening in New Zealand?

We created Hatch for new investors as well as seasoned pros, and we’re chuffed to see Kiwis getting off the sidelines. Our goal has always been to meet you wherever you’re at on your investing journey, but also to encourage you to adopt healthy investing behaviours and a long term approach. Why? Because investing strategies that have stood the test of time have the best outcomes.

We were curious about our loyal Hatchlings’ investing behaviours and strategies, so we put together our first annual survey to assess if we were in the Robinhood camp. Almost half of Hatch investors said they joined the platform to build long-term wealth, while another 50% said they started with Hatch as an investment in their financial education. Almost 80% of our investors indicated that they expected to hold their shares for years or decades. 

An overwhelming 97% took the time to research, with 59% analysing the share price to determine value; 54% read analyst opinions and 49% indicated they also read up on companies in financial blogs and news sites. Many more of them read annual reports, financial reports, and every bit of information they could find on companies they were interested in to make sure their investment was a good idea. 

Building healthy investing habits is the best way to avoid making high-risk bets. They’ll also give you the confidence you need to ride out the ups and downs of the markets. Some good habits to take on board:

  • Think long term. Remember, you’re buying a slice of a business, and it needs time to grow.
  • Invest mindfully. Be deliberate about why you’re investing and what you’re investing in. 
  • Be a sceptic. Avoid getting swept up in investing fads and speculative hype. 
  • Focus more on avoiding investing mistakes, rather than making the perfect move.

Thinking about shares as owning part of a company and taking a long term approach to investing gives you a much stronger chance of growing your wealth. When those bear attacks come along, you can check those emotions at the door and keep calm and invest on.

Kristen Lunman is the general manager of Hatch, a digital investment platform that gives New Zealanders access to the US share markets. This article is of a general nature and is not personalised financial advice. 

Mad Chapman, Editor
Aotearoa continues to adapt to a new reality and The Spinoff is right there, sorting fact from fiction to bring you the latest updates and biggest stories. Help us continue this coverage, and so much more, by supporting The Spinoff Members.Madeleine Chapman, EditorJoin Members

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