Trying to pick stocks can be risky. Especially these days.
Tatsiana Volkava | iStock | Getty Images
Bored at home, many people are turning to the stock market and dabbling in day trading for entertainment and profits.
However, most individual investors do not have the wealth, the time, or the temperament to make money and to sustain the losses that day trading can bring, according to financial experts.
Day trading has become very popular worldwide since the onset of the pandemic. Activity has “increased dramatically” in the first quarter of 2020 compared to 2019, according to data analyzed by Cerulli Associates. TD Ameritrade reports that visits to its website giving instructions on trading stocks has nearly quadrupled since January. Meanwhile, trading apps like Robinhood are seeing a surge in business.
Lawrence Sprung, a certified financial planner and the president of Mitlin Financial, based in Hauppauge, New York, believes day trading is up for a few different reasons.
Millions of unemployed Americans “feel it is a method they can use to replace the lost income,” he said. In addition, he said, people are doing things they normally wouldn’t because of all the additional time they have on their hands.
Another reason? “There are a lot of ads on day-trading for beginners,” wrote Barbara Roper, director of investor protection at the Consumer Federation of America, in an e-mail.
But trying to make a profit by buying and selling individual companies over a short period of time can backfire, financial experts say.
“People are obviously attracted by the promise of big gains,” Roper said. “But they are just as likely, maybe more likely, to suffer big losses.”
To that point, during the pandemic there have been stark winners and losers. Between the middle of March and the end of August, computer game company Nvidia was up nearly 95%, according to Morningstar Direct. Delta Air Lines, meanwhile, plunged by more than a third.
“No one likes to hear from their buddy that they’ve just tripled their money on Zoom and they didn’t,” said certified financial planner Douglas Boneparth, founder and president of Bone Fide Wealth in New York.
Yet no one has a crystal ball to be able to tell which companies will go up and which ones will go down, said CFP Carolyn McClanahan, director of financial planning at Life Planning Partners.
“We spend too much time trying to predict a future that’s not predictable,” McClanahan said.
“Not too long ago, GM and Eastman Kodak were two of the most valuable companies on the planet,” said Allan Roth, founder of financial advisory firm Wealth Logic in Colorado Springs, Colorado.
“Both still exist but shareholders were wiped out.”
And with day trading, not only do you have to be able to predict a company’s performance. You also have to be able to make your moves at “just the right moment to capitalize on fluctuations in price,” Roper said.
“It’s gambling,” she added. “Not investing. Losses are particularly likely in an economy that is as rife with unprecedented and unpredictable risks of the kind we face in a global pandemic that has decimated certain industries.”
Even before the health crisis, the average retail day trader lost money, according to a 2014 study.
That’s because they “tend to be a little late to the party,” said Andreas Park, associate professor of finance at the University of Toronto and a co-author of the research.
For example, they might buy and sell stocks based on a news report that a company is filing for bankruptcy, whereas hedge funds and other larger investors have technology that allow them to trade on that information before most people have time to read it.
Park said this year’s “explosion in day trading” is due in part to the financial desperation many are facing in the U.S.
“People have aspirations, but working hard isn’t cutting it,” Park said.
The good news? You don’t need to be prophetic to reap decent returns.
You can simply invest in passive funds that track an index, like the Dow Jones U.S. Total Stock Market Index.
In the long-run, those who’ve selected and own around 30 stocks only have a 40% chance of doing as well as the overall market anyway, Roth said.
Over the last 31 years through 2017, the overall market was up more than 2000%, he said. The median stock? Just 7%.
“The only way to make sure you own the winners is to own everything,” Roth said. “I hadn’t heard of Zoom, and yet I owned it.”
That doesn’t mean you can’t take any chances.
In fact, people may up their odds of staying invested in index funds over a long period of time if they allow themselves a little, limited fun with stocks, Boneparth said.
He recommends some investors set up an “opportunity portfolio,” between 5% and 10% of their overall holdings. With that money, they can invest in individual companies.
“It decreases the fear of missing out,” Boneparth said. ”And you prevent yourself from doing too much damage.”