A few years ago I wanted to be a day trader, a pirate on the high seas, a Gordon Gekko-lite that raided the holds of the slow moving freighters. So I bought subscriptions, I bought software, I bought accounts, I believed it was the beginning of the end of he slavery, the beginning of the glory. It was so easy to see myself making all the right investments, picking the exact winners among the gazillions of losers, timing the trades to the perfect picoseconds, that I somehow forgot that I am after all one single speck of dust in an beach full of pebbles.
And all this was after a pretty grounding talk by a professor at school who had studied individual traders over years in Taiwan and in the end concluded that individuals lose an average of 5% over their trading lifetime (found the paper, here it is). If that were true, shouldn’t the losses of most day traders be a deterrent to new entrants? Yet, there are still hoards of new traders who are getting into the market thinking that they have that extra sauce that nobody else inherited. In reality, I believe that this attitude is no different than that of gamblers who are clearly aware of the advantage the house always has, and yet are so immensely confident in their skill that they are willing to let their emotion blind the simple truth and risk it all anyway.
Lets not get caught up in metaphors, lets see the underlying economics. Day traders are betting on short-term volatility, that they are going to be on the right side when the prices move. However, there is a problem with short-term bets – first, short term movements are not based on infinitesimally small chunks of new information that can be exploited, instead they are based on the collective impact of the thousands of trading actions undertaken by the hundreds of thousands of larger market players, and subsequently, short term trend based trading is on an average random at best. Second, if there were delays in the assimilation of new information into the price of a financial instrument, there is absolutely no way on earth, an individual investor will be the one making that correction. Simply, there are too many more resourceful human and machine participants with near-infinite computational and analytical resources that are trading on not just every iota of new information but also based on every possible correlation that new information might have with any pre-existing knowledge.
Finally, the question that I really asked myself was, what is the economic value of a day trader? I understand the economic value of financial institutions, that is to help in the efficient allocation of capital among the deserving firms in the market. But what of the individuals, are their day to day trading activities helping in this efficient allocation process? Maybe. One one hand, there is a possibility that individual traders as a group are simply fine tuning this allocation process that is largely done by the larger institutions. But on the other hand, there is a fairly strong academic opinion that day traders, because of their non-collective decision making are simply creating random noise as a whole that simply does not add any economic value to the market. I know for a fact that there are several stars in the day trading world, the ones that made millions out of nothing, and somehow end up selling their so-called secrets in deceptively overpriced seminars and tapes that are advertised in the wee hours of the night. They are there, and the worst part is that they make a difference, just like there are those few that strike the progressive jackpots in Reno and raise the hopes of everyone around them. And while I have nothing against people who make a living in this profession, it is only my personal perspective that individuals involved in short-term trading are no different than professional gamblers, who are trying to get a small cut from an extremely profitable industry. However, I do believe that long and medium term investment based on fundamental analysis, even by individuals, does create economic value and actually influences market prices.
At the end of the day, I like to remind myself that there is no free ride, there is no sense of satisfaction to be had in a profession that is driven solely by personal greed, and a job that possibly adds zero economic value to society. Philosophy aside, why would I waste my money betting in a random and fickle market, where my overall chances of making money are less than 1%, when the odds of winning by playing black or red in roulette is a solid 48.5%.
