With the emergence of platforms like Robinhood (robinhood.com), many Millennials (and older Gen Z’ers) are speculating with their savings by day-trading. Some are posting on social media the incredible profits they’ve made buying stocks hit hard by the COVID-19 crisis, increasing others’ anxiety about missing out.
The spike in day-trading may in part be due to the interruption of sports betting during the COVID-19 lockdowns. At the same time Millennials may also be turning to day trading as an alternative to traditional financial industry services, which the majority of Americans don’t happen to trust. Rarely in the industry is anyone held accountable for negligence. There are no consequences for taking on too much risk with investors’ savings. The industry seems entrenched with greed and cost-generating gimmicks.
“Here’s why forecasting is so difficult…nobody knows what tomorrow will bring.”
In their short lifetimes, younger Millennials are also struggling through yet another economic crisis, navigating a jobs market that’s been stagnated in terms of real income for decades, as well as competing in a system that unfairly hordes wealth and opportunities with the few–all this while managing debilitating student loan debt. They not only have every right to be fed up and the good sense to be suspicious, but most Millennials don’t even have enough in savings to meet the minimum in assets required by legitimate financial advisors. Instead, they end up with commissioned brokers/advisors who tout expensive investment and insurance products that drain wealth.
The good news is that there do happen to be independent advisors who genuinely look out for investors’ “best interest.” These advisors are registered as fiduciaries, which means that they are legally accountable to always act in the utmost good faith and care, to avoid conflicts of interest, to disclose all material facts, and to control investment expenses.
Unfortunately, this is in stark contrast to the majority in the industry, who are held against the much lower “suitability” standard. Suitability essentially means the best interest may be for the commissioned brokers and advisors as long as the products they sell are at least suitable for their clients. And now that the courts have upheld the Regulation Best Interest ruling, commissioned brokers can sell advice (not just products) based on the suitability standard as well.
“Clearly we are led to believe the hype that trading generates wealth.”
To make matters worse, by signing client agreements, investors give up their right to file complaints in a public court. Instead, they are forced to agree to arbitration facilitated by financial industry insiders. This helps explain why rarely anyone in the financial services industry is held accountable and why investors have little protection against negligence.
Nobody Knows What Tomorrow Will Bring
The question then is whether Millennials are better off trading. There are two ways to think about this.
First, the odds of success picking winning stocks for investors are as good as the odds are for those in the financial services industry. This means that Millennials need not waste their savings paying transaction fees and commissions to brokers who tout their supposed trading skills (since their skill is no better than yours). They don’t provide much value by speculating (indeed, net of fees, the value to investors is negative). The good news then is that if you decide to day-trade, you should minimize your expenses and trade directly on retail platforms.
What’s the bad news? Well, that has to do with the second, more rational way to think about this. The bad news is that your odds of outguessing the market are just as terrible as they are for financial brokers and advisors. Here’s why forecasting is so difficult…nobody knows what tomorrow will bring.
Certainly, commissioned financial brokers and advisors dismiss the obstacles stacked against forecasting because they depend mostly on speculation strategies to drain your wealth. Either they ignore the data and evidence, or they don’t understand it. If speculation is based on a false premise (the ability to predict what happens tomorrow), then the financial services industry would lose the biggest chunk of their revenue: the fees and transaction costs from picking individual stocks, timing the markets, and coaxing you into overpriced securities. The book written by Fred Schwed, “Where Are The Customer’s Yachts?”, takes a deeper look at the financial services industry and why the advisors are the ones with the yachts (rather than the clients). It’s been a staple for over 50 years.
When I traded professionally for a proprietary trading firm, I understood the fundamentals and technicals. I could explain what happened yesterday and historically in detail and within different contexts. Unfortunately, charts are always backward looking, they don’t predict the future. And for all practical purposes, markets are efficient, which means that fundamentals and market participants’ expectations are pretty much priced in. Since that’s proven to be the case (by Nobel Prize-winning ideas, peer-reviewed research, and empirical evidence), then the only information that is not priced in is tomorrow’s news. To predict that you need a crystal ball or some magical powers.
“Professional traders are sophisticated, systematic, and have access to all of the advantages. You are relying on luck.”
So, if not by accurately and persistently predicting the markets, then how do most professionals make so much money trading? Well, it helps this myth propagate when it’s mostly the successes that anyone hears about. Most professional traders can’t earn a comfortable living wage over the longer term. Of course, the financial news media still touts financial industry insiders and hedge fund managers for ratings. The conveyor belt of these market “gurus” on the financial news channels is meant to enforce your anxiety about being left out of the game. It seems that every day is full of opportunities to transact and make profits. Of course, this has nothing to do with your best interest. It’s simply about encouraging transactions (to generate fees for the industry) and drawing eyeballs (to increase ratings for the networks).
Clearly we are led to believe the hype that trading generates wealth. What you won’t hear often is that most hedge fund managers can’t even keep up with the S&P500. And private equity funds, net of fees, turn out to simply match market returns. Unfortunately, average investors are not sophisticated enough to understand the quality and relative performance of their holdings (not just for hedge funds and private equity funds, but also for 401ks and traditional IRAs), and whether they are instead better off with a simple, globally diversified portfolio of low-cost index funds.
“Even with all of their advantages, most professional traders don’t make it.”
The more complicated investing seems, the more you are willing to pay the financial services industry for their understanding. Clients put up 100% of the capital and take 100% of the risk. Then brokers, advisors, and managers earn fees and commissions regardless of how much value they provide investors. Obviously, this business model has been incredibly lucrative and is fiercely guarded, even if it’s at the expense of investors’ best interest.
What Are Your Chances Day-Trading?
I had the most success by swing trading yield-curve spreads. Back then, bidding, offering, and active trading were executed with keyboards. Of course, this was before computer-aided trading took over. For a long while now, professional traders have been relying on state-of-the-art technology and immediate news aggregation services. Algorithms are competing in the milli- and micro-second time frames. In the split second of time that it takes to click a key (or blink), a history of trades can take place.
My trading keyboards (on left for eSpeed, on right for Btec).When you day trade, you are competing against the professional traders and the aggregate knowledge of all market participants. You won’t have an edge in technology (like automated spread-treading), connectivity, data, news, or information that you need to develop, test, and implement a strategy. It’ll also be very likely that an institution, like Goldman Sachs, Citadel, or DRW, will be on the other side of your trade. What makes you so sure that you–or your broker–know more than they do? That you can react faster to news than they can, that they missed an actionable piece of information that you somehow came across instead. Or that you just happen to simply be smarter than they all are. They are sophisticated, systematic, and have access to all of the advantages. You are relying on luck.
Of course, you will get lucky sometimes and maybe for a short while by buying stocks hit hard by the crisis or by following some mindless mean-reversion or cross-over strategy in the intermediate term, but the odds of your continued success over the longer run are virtually zero. Here are some of the reasons why the odds are stacked against you (and against your broker):
- You will be going up against professional traders and institutions, who are much more sophisticated than you are and have unlimited technological and information-gathering resources.
- You can’t compete in speed, where most of the edge is. Actionable information that reaches you is outdated, already priced in the markets by the professionals. Algorithms filter news headlines for actionable word triggers, then instantaneously begin to price that information into the markets. The broadcasts on CNBC and FOX Business are just background noise.
- The conveyor belt of “market-gurus” and talking heads in the financial news media make predictions that on average turn out to be worse than a flip of a coin. Why would you listen to them for guidance? Or, what makes you so much better than they are?
- Technical and fundamental analysis is useless as a trading edge. Mindless strategies like mean reversion work until you suffer a blow-out. Fundamentals and expectations are priced in.
- The success from backtested or paper trading strategies doesn’t translate to live markets. It’s easy to develop strategies that backtest with high sharpe ratios.
- Behavioral biases are detrimental to your odds.
Then consider this. Even with all of their advantages, most professional traders don’t make it. There’s a high turnover in the business. Do you still like your odds when they are stacked against even the professionals?
Increasing the Odds of Your Investment Success
It turns out that you don’t have to try to outguess or outwit the markets to be successful. Over the long term, disciplined investors tend to perform much better than those who try to beat the markets. It’s the time in the markets that makes the difference, not timing the markets.
“It’s the time in the market that makes the difference, not timing the markets.”
Investing is all about the probabilities of cost- and risk-adjusted expected returns. Over the long term, the success of your investment depends on the actions that you take to help improve these odds. And like any other discipline that has behind it decades of data, research, and evidence, we know what improves those odds and what doesn’t. It turns out that speculation, like stock-picking and market-timing, is a losing strategy over the long run. Instead, what helps your odds are the following:
- Minimizing costs (this is a big one)
- Focusing on asset allocation
- The amount of time your savings are invested in the market (not how well you time the market)
- Diversification
Millennials have the most valuable commodity of all, time. However, time is only an advantage when you know what to do with it. Trading, speculating, and frequently transacting diminishes the value of your available time. In other words, you will be squandering the most powerful commodity that can help the odds of your success.
To maximize the power of your time, invest with discipline in a globally diversified portfolio of low-cost index funds. It’s the most efficient, practical way to help you focus only on those actions that add value. Index funds minimize your costs, help you pay attention to your asset allocation, keep you disciplined (by maximizing your time in the market, rather than timing the market), and help you diversify. You’ll not only be more rational and relaxed about investing, you’ll also end up doing better than the majority of your peers–and trading professionals–over the long term. It’s anything but “passive” when it comes to the odds of your investment success.
Good luck.