Trading It All Away

by Tom Cock

Just when it seemed that the “average” investor was coming around to accepting indexing, we received this news: Day trading is back.  Hey, I’m serious.  The idea that you can make money, lots of money, perhaps even enough to quit your day job, is once again receiving serious consideration by many, many investors.

The evidence comes from recent reports of sharply higher trading volume at firms such as E*Trade Financial Corp, and TD Ameritrade.  According to a recent report in The Wall Street Journal, average daily client trades at E*Trade increased about 25 percent in the 4th quarter when compared to one year earlier.  TD Ameritrade customers made 414,000 trades per day, a 24 percent jump, while those who trade at Charles Schwab also increased their activity nearly 10 percent.

On top of that, there has been a boost in advertising for stock trading programs and classes.  Reportedly, these classes are filled, and students can’t wait to “graduate” and start trading stocks, and make their first gazillion dollars!

Hey, if that’s not enough, there’s even more great news: it’s easier that ever to trade stocks.  You can do it from your phone, and E*Trade confirms that it's growing in popularity!  Now, almost 10 percent of trades at E*Trade are made from mobile devices.  

If you detect a note of cynicism, let me explain why.  A preponderance of academic research shows that “professionals” (that is hedge funds, actively managed mutual funds, and large brokerages) earn less, and in some instances, far less, than indexes.  Given their amateur status, day traders are likely to fare far worse than the “pros.” 

A number of studies back up this assertion. The most compelling of which was a 2011 study (1) ( from the University of California, Berkley and Taiwan’s National Chengchi University that calculated all of the day trading activity on the Taiwan Stock Exchange from 1992-2006 and found that, in any six-month period, 80% of day traders lost money. Those who made money almost universally had any meager profits wiped out by high trading costs.

One of the study’s author, Professor Brad Barber from Cal-Berkley told the New York Times (2), “There are slivers of [active traders] out there who are quite good. And everyone thinks they will be in that group of 1 percent [who make a net profit]”

My sense is that the return of day trading has a lot to do with the long running bull market (especially last year’s big gains), the success of recent initial public offerings, and the growing belief that “everyone” is making money in stocks, so I need to “get mine.”

If you are tempted by the siren songs of stock trading schools, or the allure of easy money promised by a broker or actively managed mutual fund, take a breath and close your eyes.  Let your mind drift back to 2001 or 2008.  Perhaps those harrowing times will remind you that a gold rush usually doesn’t end well for the bulk of participants.  Indexing, low costs, tax efficiency and discipline have created the best long term investment returns.  Anyone who promises anything else is selling you fools gold.

The decision to day trade comes down to a simple question: Are you willing to work at a difficult job that requires constant vigilance (and a pretty hefty initial investment) for a 1% chance that you will be paid for your efforts?

(1) Barber, Brad M., Yi-Tsung Lee, Yu-Jane Liu, and Terrance Odean (2011), “The Cross-Section of Speculator Skill Evidence from Day Trading”, University of California

(2) David Segal, “Day Traders 2.0”, New York Times, March 27, 2010