It’s easy to get swept up in the rush of day trading and the ability to trade money at the tip of your fingers. And over the course of the last few months, we’ve seen “TikTok” investing and day trading increase in popularity, especially amongst young investors. But according to a CNBC article, despite what some might think, in reality day traders often have terrible track records. While we think investments and long term ownership is a great way to build wealth, we want to raise light to be careful when day trading and understand the tax implications and risk tolerance there.
Academics who study stock pickers have long observed that the vast majority of professional money managers – about 85% – underperform their benchmarks over a multiyear period.
Now those professionals are turning their sights on retail day traders, warning that the same poor results apply to them as well.
“I don’t confuse day traders with serious investors,” Princeton professor Burton Malkiel, author of “A Random Walk Down Wall Street.” “Serious investing involves broad diversification, rebalancing, active tax management, avoiding market timing, staying the course, and the use of investment instruments such as ETFs, with rock bottom fees. Don’t be misled with false claims of easy profits from day trading.” He also added, “Large increases in Robinhood users are often accompanied by large price spikes and are followed by reliably negative returns.”
Why did that happen? The authors noted that most Robinhood investors are inexperienced, so they tend to chase performance. The layout of the app, which draws attention to the most active stocks, also causes traders to buy stocks “more aggressively than other retail investors.”
Finally, the ease of use of the site, and the fact that it is commission-free, may also encourage trading. “As evidenced by turnover rates many times higher than at other brokerage firms, Robinhood users are more likely to be trading speculatively and less likely to be trading for reasons such as investing their retirement savings, liquidity demands, tax-loss selling, and rebalancing.”
As young and inexperienced individuals begin day trading more and more, it’s important to spread the message about behavioral and investment biases that are present in investment management and financial planning, and oftentimes persuade one’s decisions about when and what to purchase and sell. Day trading may or may not have a piece in your portfolio, but if it does make sure to understand the whole picture and take your risk tolerance into consideration. Long term stock ownership and appreciation is a great way to build wealth but it’s important to be aware of the biases that are hidden within day trading.