Does the average active stock trader make very little money? Do you even need to ask?
11-Jan-2022 •Dhirendra Kumar
A few days back, Nithin Kamath, the CEO of Zerodha, a large online stockbroker, said that over a period of three years, no more than one per cent of active stock traders made returns that were better than a bank fixed deposit. Predictably, there was a huge reaction on social media with multitudes of people saying, basically, that they were shocked or scandalised or disillusioned and so on. However, there was another set of (non) reactions, which boiled down to 'So, what's new?'
I firmly belong to the latter camp. That almost all active traders do quite poorly is something that I have consistently observed over decades. Not just that, I think that Mr Kamath might have overstated the success percentage. One per cent is obviously a figure of speech, a general impression. It's not actual data. The number could be significantly smaller. Notably, his initial comment was about the practice of pasting screenshots on Twitter showing enormous returns from investments. That doesn't prove anything of course. Life on social media and reality is markedly different. Everyone has some trades or the other that make money and taking screenshots of those trade reports and showing them off to the world is normal behaviour.
There are many other things I'm curious about but I doubt if the answers to these questions could be determined beyond impressions and anecdotes. Why do investors do badly? Do they buy the wrong stocks? Or do they buy good ones but transact at the wrong time? Is there some pattern as to old vs new investors, young vs old, full-time vs part-time?
Most importantly, what happens after a few years of doing badly. It's hard to imagine people going on trading for years and years only to lose money or make minimal returns. Either they would quit or they would get better at it. How many quit in time and how many get ruined? How many shift to long-term investing, either through stocks themselves or thorough mutual funds?
These are not irrelevant questions. If you are in this situation - you are trying out active investing and doing badly, you should think about them. These are the possible paths that are open to you. A little bit of introspection would make it clear to you as to what is the most likely one that your investing experience will lead you towards. It's not that hard to make a course correction early enough.
In all the public discussions about the original comment, no one has commented on the loaded meaning of the word 'active'. The more active you are, the more you trade, the worse you will do. Why do people trade too much? The answer often is that they feel that stock investing, as an activity, consists of monitoring news and other events and reacting to them by making appropriate trades. This concept is sustained by the daily news (noise?) in the business media which seeks to map every single day's news events to that day's stock moves. For someone who starts off investing and then starts watching business TV channels, it is impossible to avoid coming to the conclusion that this is what investing is - absorbing news and then, as fast as possible, reacting to it by trading.
The first thing that active investors should do is to try and become less active by breaking this news fixation. The people who bring you news are not doing it because they are in the business of showing you how to make money from investments. There is a huge misalignment of incentives here. News is a product and especially with digital delivery, the more someone produces and the more you consume, the more the producer makes money. It's like any other product. It's not there to increase the returns you get from your investments, that is something that you will have to figure out yourself. The fact that the more newsworthy events are supposedly happening does not mean that more intense, more active trading is justified. Far from it.