Active Trading: Speculative Animal Spirits on the Rise

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Vince Lombardi once said, “Winning is a habit. Unfortunately, so is losing.” One thing is for sure: day traders have a habit of losing. Like a hamster on a spinning wheel, day traders spend a lot of energy creating loads of activity, but end up getting nowhere in the process. This subject is important because the animal — or, hamster — spirits are on the rise as evidenced by the 22 percent and 17 percent increase in average client trades per day reported last month by TD Ameritrade (NYSE:AMTD) and Charles Schwab (NYSE:SCHW), respectively.

The statistics speak for themselves, and the numbers are not pretty. An often cited study by Terrence Odeon (U.C. Berkely) and Brad Barber (U.C. Davis) showed that 80 percent of active traders lose money. The duo came to this conclusion over six years of research by studying 66,465 accounts. More importantly, they “found that if you were to look at the past performance of these traders, only 1 percent of them could be called predictably profitable.” Ugh!

How can this horrendous performance be true? Especially when we are continually bombarded with the endless commercials of talking babies and perpetual software bells and whistles that shamelessly promote a simple path to prosperity. The answer to why active trading fails for the overwhelming masses is the following:

  • Taxes/capital gains
  • Transactions costs/commissions
  • Research costs/software
  • Lack of institutional advantages (speed, beneficial rates, I.T./automation, execution, etc.)
  • Impact costs (buying handicaps returns by pushing purchase prices higher, and selling handicaps returns by pushing sale prices lower)
  • Absence from participation in long-term upward drift in equity prices

After considering the horrible odds stacked against the active trader, the atrocious results are not surprising.

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