By: Ryan P. Dolan
“We’re going to need a bigger boat.”
Chief Brody, “Jaws”
I worked as a stock trader at a technology-focused investment bank in the late 1990s. Though I didn’t fully appreciate it at the time, I was sitting at ground zero of a full-scale investment mania. It was an incredible, wild and manic time in financial history, with large fortunes being minted at an almost unprecedented pace. And like moths drawn to the flame, a large wave of individual stock day traders rushed into the chaos, desperate to grab a piece. While there have always been day traders in the market, a few factors conspired to lure an unprecedented number of these small, inexperienced, short-term “investors” into the market in the late 1990s.
First, the stock market had been in a 15 year bull market, with tech stocks entering a full scale euphoric bubble. Late stage bull markets and bubbles, those times when investing seems easiest and profits the most certain, are the perfect enticement to the uninitiated investor. What was unique to the late 1990s, however, and what ultimately sparked such a mass invasion of day traders, was the proliferation of cheap, online discount brokers and widespread internet access. People could trade stocks at home in their pajamas. This combination of a high risk environment and widespread access to the market was the equivalent of handing a 15 year old a bottle of whiskey and the car keys.
And initially, many of these investing neophytes were making large and consistent trading profits, dancing in and out of stocks multiple times a day. Anecdotal success stories were everywhere. A college buddy, with no investment experience, who had supposedly made close to a million dollars trading stocks in a year while in business school. Or a friend of a friend who quit his job as a realtor to day trade stocks full time. Who had time to show a house when there was big money to be made in the market? The sense of easy riches, of a new economy with new rules, drew more and more traders into the market, further exacerbating the bubble. Anyone not participating simply didn’t get it and would miss the gold rush. By early 2000, it seemed everyone, even the early critics, had capitulated and grabbed a seat in the casino.
Fast forward a year, and the day trader, the market and technology stocks lay in smoldering ruins. The bubble had turned to bust; the clock had struck midnight. The day trader went over the falls and the pain was relentless and never-ending. By the end of the long bear market in 2003, you no longer heard about day trading. All those who had been crowing about their success a few years earlier were conspicuously silent and clearly licking their financial wounds. The very term “day trader” became synonymous with greed, foolishness and ignominy.
It’s taken almost twenty years later, but the day trader is back, amidst echoes of that prior golden era. Once again, we’ve had a long bull market with technology stocks the stars. Now, rock bottom interest rates have pushed many out on the risk curve looking for yield and growth. Conveniently, those low rates allow brokerage accounts to be leveraged cheaply, magnifying gains (and losses). Discount brokerage firms have slashed commissions (to zero in some cases), and new robo advisors like Robinhood have increasingly “gamified” investing for millennials.
While the number of day traders has been picking up quietly for years, the onset of the Coronavirus has turned this trickle into a tsunami. People are stuck at home, maybe out of work, bored and unable to gamble on sports or in a casino. The stock market has become the speculative vehicle of choice. The number of new brokerage and robo accounts opened in the last 3 months has been unprecedented.
I can say, with categorical conviction, that this will end badly. I could list dozens of reasons why day trading, even with a small portion of your portfolio, will negatively impact your long-term financial health. I’ll focus here on just a few reasons why you should avoid it:
-Jumping into a shark tank with a bloody nose: Day traders, in the search for consistent, short-term profits, are unwittingly and naively, entering a very dangerous competitive arena. These are treacherous waters, stocked with apex predators. The amount of human, financial and technological capital that a day trader is competing with today, whether he knows it or not, is mind-boggling. As the saying goes, if you don’t know who the mark is at a poker table-it’s you. You need to have a realistic view of your competitive advantages and disadvantages, and focus on fishing in the right pond. Short-term trading is not the pond. Trust me.
-Getting a good result with a bad process/the typical life-cycle of a day trader: The day trader starts out hesitatingly and cautiously, by betting small. Then he starts making money. This positive feedback builds confidence and conviction. Over time, the bet sizes increase. The trader thinks he is getting a good result, so by default he must have a sound process. Unfortunately, he most likely has simply gotten lucky. Just when the day trader has the most confidence in what is inherently a bad process, he is most exposed financially to a turn in his luck. When his process gets exposed, the trader often has a desperate desire to “get back to even” before he gets out, which tends to magnify the losses.
-Day trading is a bad use of your human capital: Day trading is a distraction-it’s all short-term dopamine hits and adrenaline that ultimately doesn’t serve you financially. Resist this siren song. You have two forms of capital: human and financial. Your human capital is your future income stream. We work primarily with high-earning professionals in mid-career. They have a lot of human capital left, and considerable control over it. They are FAR better served focused on developing and maximizing their human capital, then dissipating their focus on trading. Day trading ultimately serves to dilute your human and financial capital.
-The financial double-whammy: When the day trader has suffered a devastating reversal there is the immediate financial pain of the money lost trading. That’s obvious. More insidious is the long-term financial damage from this ill-advised foray. The typical busted day trader spends years licking his wounds, refusing to even look at the stock market again. The lesson often learned is “stocks are bad” instead of reinvesting with a sound investment methodology. This considerable opportunity cost often dwarfs the actual amount lost day trading.
A lot of success in life boils down to avoiding mistakes. All too often we learn by making mistakes ourselves. Hopefully then we can, internalize the lesson, and adjust our behavior in the future. A far better approach is to learn vicariously from others' mistakes. You would be far better off completely avoiding day trading altogether. You don’t need to make this mistake yourself. I get it-the lure of quick and “easy” money is tempting. It’s a mirage. All successful financial planning and investment is about making slow, steady, relentless progress and letting that compound over decades.
Stay dry-and safe-on the beach.
About Dolan Partners:
Dolan Partners is a holistic financial life planning and investment management firm, working hand in hand with professionals and business owners. We dive deeply into clients' financial lives, working to align their money with their unique vision, values and goals.
We offer complimentary introductory calls with prospective clients, which are always completely confidential and judgment-free.
Learn more at www.dolanpartners.com
Ryan P. Dolan
Managing Partner
Dolan Partners LLC
100 School St.
Danville, CA 94526