Daytrading fever is sweeping the world.
Thousands of first time traders are signing up to apps like Robinhood in the U.S. and others in the hope of shortcutting their way to riches. A combination of the sharp share market bounce, a surge in at-home workers, cash government handouts and a lack of sports betting options have all been said to have contributed to this surge in share market participation.
Though they might not know it, most people who try share trading are just participating in a socially acceptable form of gambling. Like poker machines, trading apps know you’re playing against the odds.
The research shows that almost all aspiring day traders lose money. There have been numerous studies that show how badly traders actually perform. The results in the U.S., Taiwan and even Brazil all show that between 80-97% of day traders lose money.
The websites and apps offering trading to newbies know this and have built platforms that are as addictive as slot machines in orchestrating your slow release of dopamine though their flashing lights, sounds, charts and updating profit numbers.
Trading apps try and hook you in for as long as possible by creating the false impression that you are doing better than random chance, fostering the false impression of skill. This can last a while, especially if share market conditions remain favourable.
Eventually, most daytraders will take on more risk or leverage than they should due to being overconfident in their skill – or their luck simply runs out. Then the trading apps simply move onto the next generation of suckers.
I fell into the same trap of confusing trading luck for skill during the 1990s tech boom. On reflection here are 5 tips I wish I’d been told when I started trading tech stocks as a teen in the 1990s.
1. Don’t confuse trading for investing
An investor is someone who buys reasonably expecting a predictable long-term return.
A speculator is someone who buys to try and profit from a short-term change in price.
If you want to try trading with some of your money, that’s fine but keep it small and separate from your investments. And don’t forget that just because it’s typically an ‘investment’ asset like a large company like Afterpay or ETF doesn’t mean you’re not speculating.
It’s possible to be a speculator in large ‘safe’ shares just as it’s possible to be an investor in small volatile shares. It’s not about what you’ve bought but why you’ve bought it that matters! The studies show the more you trade, the worse you do.
Less than 1% of speculators consistently beat the returns from a low-cost market tracking ETF.
2. Forget yesterday’s news, it’s already in the price
Jumping onto yesterday’s news is a sure fire way to lose money trading. In most cases information you read is already reflected in share prices so there’s no point buying after the fact. More often than not it’s too late and you’ll be left a bag holder (someone who stubbornly holds onto a falling share) as others sell out.
Of course that’s not the impression you’ll get from trading websites or newsletters promising a better formula for picking the right shares and getting onto new information early.
For every trading success story you see there will be thousands of others who walked away with less than they started with due to costs, interest and the mathematics of the market which is geared against you when you trade. The only real winners are the ones selling their stock trading tips, subscriptions, courses and broking services.
3. Trading is all about risk management
Any good trader will tell you that risk management is critical. Not every trade will go your way so it’s important to not risk too much on any one position.
Rule #1: You should only risk 2% of your capital per trade, because that means you need to have 50 losing trades in a row to be ‘out of the game’ which is much less likely than getting a few trades wrong.
Rule #2: All of your individual trades shouldn’t be the same big trade that will move in the same direction (i.e. shares in the same industry). The market has a habit of causing the most possible pain to the most possible people, which is why risk management is important. Negative surprises happen a lot more often than you might expect.
4. What’s your edge?
In order to be a successful trader (and not just a lucky one), you need to have an edge over other traders. You need to have some unique knowledge or insights that others in the market don’t have.
Edge is what gives you a higher probability of a trade working than not working. Your edge also needs to be publicly available information, unless of course, you want to go to gaol. Having a unique, publicly available insight is rare these days since trading is so competitive and thousands of others are reading the same information as you. Most edges are discovered and exploited by others quickly… something this video explains perfectly…
5. Bank some profits
It can be tempting to keep increasing your trading position sizes after a few wins. Resist the temptation! What you’re feeling is overconfidence bias and it will quickly take away any profits you’ve made. Just ask this bitcoin trader who, at the peak of the frenzy in 2017, decided not to sell anything after making millions of dollars…
The crypto-assets he mentions in this video went on to fall by 95%.
If you have success trading, consider that it may, at least in part, be due to luck and not skill. Bank some profits or invest them into a lower risk diversified portfolio so you have something to fall back on if your day-trading career doesn’t work out.
Shift the odds back in your favour
It’s great to see that the new generation is taking an interest in the share market, but it concerns me that most have fallen into the alluring trap of daytrading.
Having traded both for myself and then professionally I can confirm that the odds are stacked wildly against you.
For 99% of people looking build wealth from the share market, you should be focused on shifting the odds back in your favour – by not trading!
Experience has taught me that successful investing is about having a disciplined approach to asset allocation, keeping your costs (like brokerage) low, not overextending yourself with leverage and automating your investing decisions to remove emotion.
That’s why I started Stockspot.