How often to trade stocks, according to investment experts
If you ever want to feel really old, tell a young investor what trading stocks were like.
First you had to call a broker on the phone. You usually had to buy in round lots, like 100 shares. And all of this came with high fees, which chipped away at any potential profits.
These days, on the other hand, trading stocks is a snap – you can often do it free of charge, from the comfort of your smartphone.
But just because you can trade all the time doesn’t mean you should.
âThere is nothing wrong with actively trading,â says Randy Frederick, vice president of trading and derivatives for Charles Schwab & Co. value brokerage.
In the past, it was very difficult for frequent retailers to establish themselves. A famous study by academics Brad Barber and Terrance Odean, “Trading Is Hazardous To Your Wealth,” quantified it: They found that those who traded the most underperformed the market by 6.5 percentage points each year. .
This was in large part because of the high commissions: If every trade you make comes with some sort of sales charge, it’s a high mountain to climb.
You can also show the buy and sell price differentials, or the difference at a given point in time between what you would pay to buy a stock and how much you would receive to sell it. This is part of the natural âfrictionâ of trading, and over time even small spreads build up.
But what about these days, now that commissions and spreads have gone down?
As it turns out, Barber, a professor at the University of California at Davis, is currently calculating the numbers on an updated look. âRetail investors are still losing [trading], but the losses are less because the spreads and the commissions have gone down, âhe told Money. âTrading is a zero-sum game: if institutional investors profit from trading, then individual investors will lose. “
In other words, the underperformance of trading these days is due less to fees and more to broader issues such as emotion and skills: family investors are generally just not very good. in this domain.
We are very sensitive to a number of different emotional biases, which have been exacerbated by the sheer ease of the modern negotiating process.
Maybe you are “scared of missing out” as some tech stocks reach new heights. Perhaps you have an overconfidence bias, making you think that you are a much better trader than you actually are. Perhaps you have a “loss aversion”, forcing you to abandon your underperforming stocks at the worst possible time.
In the old days, there were a number of barriers to taking action with your wallet. These days, if an idea pops into your head because of a social media post or CNBC panic article, a few clicks on your smartphone could lock in a transaction with devastating long-term consequences.
Note: Another recent article co-authored by Barber, “Attention Induced Trading and Returns,” outlined the dangers of quick and easy trading. “We link periods of heavy buying by retail investors at Robinhood to future negative returns,” the authors wrote.
Whenever family investors rushed to buy a particular stock, it led to a decline the following month. Partly to blame: handy lists like âTop Moversâ and âMost Popular,â which draw investors’ attention to stocks that might be trigger-happy and inexperienced.
Of course, there is no general prescription on which number of transactions is the ârightâ number for investors. One person may be comfortable and successful in making hundreds of transactions per year, while another may be perfectly happy with none.
But whatever type of investor you are, here are a few things to keep in mind:
It always pays to buy and keep
For most retail investors, who are not good at synchronizing the market, frequent trading is not the right way to manage your hard-earned savings. After all, as investment legend Warren Buffett once said, “our favorite holding period is forever.”
Frankly, if we’re talking about long-term holdings, most investors shouldn’t be getting into individual stocks anyway. Even big, familiar names can go to zero at times, as we have seen in times of market turmoil like the 2008-09 financial crisis.
For this reason, focus on large baskets of securities that protect your losses. âIn general, I recommend investors to use an index mutual fund or a low-cost ETF for their long-term core investment,â says Barber.
Of course, buying and holding doesn’t mean completely âforgettingâ about your investments, advises Frederick. You can always think about trading once or twice a year in the interest of rebalancing, as your asset allocation may have become out of balance in the normal course of market fluctuations.
Think how much, not how often
Trading per se is not inherently good or bad, especially if we are talking about zero cost brokerage. Better to consider what part of your overall portfolio we’re talking about, according to Frederick.
For example, a good place to start might be to keep at least 80% of your holdings in long-term buckets that you leave on their own to grow. With stock market averages approaching 10% per year, this should be compounded over decades into a tidy retirement sum.
But with the remaining 20%, you might consider trading with more speculative investments like individual stocks, suggests Frederick. Even if these transactions don’t work – which is certainly possible – you should have enough cushion that your financial future isn’t too badly affected.
When to trade stocks
Before clicking that button to buy or sell, take a break and think about your motivations for making a trade. If it’s largely because of emotion, like euphoria or panic – a stock soars or collapses on any given day – then you should catch your breath. Any trading decision should be based on a more sober assessment of fundamentals.
Or maybe your desire to trade is based on how easy it is to do so. Maybe your investing app has put a list of the top 10 prominent stocks in your sight. Is that what made me think of this profession in particular?
If so, then you are part of the herd – and generally speaking, that is not the smart way to invest. âNew evidence shows that the way information is presented to investors affects the way they trade,â says Barber. “Apps with a large number of subscribers have the potential to generate collective action.”
You can even give up what is called “action bias” – the idea that doing anything, anything, is better than sitting still.
It can make you feel good in the moment and give you a sense of control, but trading just for the sake of trading is not wise. Doing nothing is also an investment strategy – and often a very smart one.
âOver-trading can definitely be a problem,â says Frederick. âThe S&P 500 is up about 70% from its March low. If you sold early to take profit, you’ve missed the next higher shot – while you’re sitting in cash and earning nothing.
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