Day-trading in the age of coronavirus

Amateur pseudoscience

Suppose, during a TV weather broadcast, that the reporter presented “forecasts” from several private persons, wholly unqualified in meteorology, who base their forecasts on eyeballing a handful of charts and graphs. Most of us would never rely on such clearly amateurish methods ourselves, and would reject outright any such forecasts presented by others. If anyone took such forecasts seriously, when a severe storm was approaching, rather than relying on the consensus of qualified government scientists assisted by state-of-the-art supercomputer models, they would risk disaster, including the potential loss of their homes.

Similarly, suppose that after an examination at a clinic for a significant medical condition, that the attending physician offered some health advice shared with him or her by some drinking friends, wholly unqualified in the medical field, who base their comments on informal notes exchanged on Facebook and Twitter. Again, most of us would never employ such quackery in our own personal health, and would be repelled that a medical professional would recommend such quackery to others. In fact, were a medical professional to routinely proffer such unscientific advice, his or her license might be revoked.

So why does the financial community still tacitly encourage day-trading?

Day-trading in the age of coronavirus

“Day-trading” refers to speculation (yes, “speculation” is the entirely appropriate term here) in financial securities, typically performed by amateur investors who buy and sell various securities multiple times within a trading day and, in many cases, close their positions before the end of the trading day.

Day-trading has become very popular worldwide since the onset of the Covid-19 pandemic. TD Ameritrade reports that visits to its website giving instructions on trading stocks has nearly quadrupled since January 2020. Robinhood reports three million new accounts in the first quarter of 2020. Other discount brokerages, such as Charles Schwab, have reported similar increases in activity.

Some factors in the recent rise of day-trading include (see this Washington Post article, this Traders Magazine article and this Vox article):

  1. Millions of bored, millennial, white-collar workers sitting at home with lots of time and money on their hands.
  2. Closure of many sports betting operations due to the suspension of almost all professional and collegiate sports.
  3. Zero-interest monetary policies by the U.S. Federal Reserve and its equivalents in other major nations, making it cheap to borrow money.
  4. Government stimulus checks burning holes in recipients’ pockets.
  5. Recent promotion of day-trading by celebrities such as Barstool Sports CEO Dave Portnoy.
  6. The recent rapid rise of stock markets worldwide after the February crash, which has given many individual traders a false sense of invincibility.
  7. The rise of new, zero-fee trading platforms such as Robinhood, specifically targeted to young millennial customers.

Why day-trading does not work

But the grim truth is that day-trading does not work. As Burton Malkiel (author of A Random Walk Down Wall Street and other books) explains,

To go and day trade and think that you are investing, that’s what I think is absolutely wrong and is likely to be simply disastrous for people. … It’s not that they can’t make money in gambling, … but over the long run, this is a losing proposition.

How can one be so sure that day-trading doesn’t really work? Let us count the ways:

  1. In July 2000, the manager of a day-trading operation acknowledged in a U.S. government hearing that between 80% and 90% of their customers lost their funds and quit within six months.
  2. A large 2004 study of Taiwan day-traders found that more than 80% lost money, and only 0.03% consistently earned significant profits.
  3. A more recent 2017 study by U.C. Berkeley and Peking University researchers found that even the most experienced day-traders lose money, and nearly 75% of day-trading activity is by traders with a history of losses.
  4. A 2019 study of Brazilian day-traders found that 97% of all individual traders who persisted for more than 300 days lost money in their trading. Only 1.1% earned more than the current Brazilian minimum wage, and only 0.5% earned more than the current starting salary of a bank teller.
  5. A 2019 study by Crestmont Research found that from 1950 through 2019, U.S. large-cap stocks go up on a day-to-day basis only slightly more than 50% of the time, whereas, say, holding onto a U.S. stock for a 10-year period produces a profit 94% of the time.
  6. A 2019 study of trading using “contract for differences” confirmed that only about 20% of individual traders actually made money.
  7. A 2019 study of foreign exchange traders found that over 90% of individuals who trade in these securities lose money and quit.
  8. Many day-traders rely on technical analysis methods. But as we have discussed at length in this forum and elsewhere, the blunt, unvarnished truth is that technical analysis does not work, particularly given that trading in modern financial markets is now dominated by hedge funds and other organizations utilizing very sophisticated, highly computerized, big-data-based, machine learning methods, together with sub-millisecond trading operations, all of which are far beyond the realm of technical analysis in general and amateur day-trading in particular.

Consequences

Many amateur investors who have tried day-trading have suffered severe losses. For example, Richard Dobatse, a San Diego Navy medic, used Robinhood’s platform to ply $15,000 from a credit card advance, later augmented by home-equity loans, into over $1,000,000. But then he suffered severe losses, and his account fell to less than $7,000.

Day-trading can have more than financial consequences. In June 2020, a University of Nebraska student named Alexander Kearns took his own life after (mistakenly) thinking that he had racked up a $730,000 loss on his Robinhood trading account. In a note that he had left on his computer, later posted by his cousin-in-law, he asked, plaintively, “How was a 20-year-old with no income able to get assigned almost a million dollars’ worth of leverage?”

There is further concern that the injection of this much speculative buying into financial markets may be creating a bubble, as in the 1999-2001 dot-com crash. As Forbes columnist Donna Fuscaldo writes,

Kearns is an extreme example of what can go wrong with day trading as this way of investing grows in popularity again during the pandemic. Thanks to commission-free trading, mobile apps, and low barriers to entry, the recent day trading boom is creating stock market euphoria not seen in almost twenty years. … That’s spooking institutional investors, raising concerns a stock market bust is coming.

Who is promoting day-trading?

All of this raises the question, why does day-trading persist? And who is promoting day-trading in today’s financial markets?

Sadly, basically all major brokerages and financial news media are involved — after all, they clearly profit from frequent trading and a fixation on minute-to-minute market activity. In a previous blog, we listed numerous brokerages and financial news venues that promote technical analysis methods; basically all members of this same list implicitly acknowledge (or, at the least, certainly do not actively discourage) frequent trading in general and day-trading in particular.

In part because of this implicit promotion, coupled with the undisputed power of the Internet to spread widely the meme of amateur market trading, millions of individual investors have been convinced that day-trading, together with related methods such as technical analysis, are the way that “smart” investors win in today’s market.

However, as we have seen, this notion is utterly, woefully, disastrously false.

But day-trading will remain popular unless more of us in the mathematical finance community, who recognize well the technical futility of chasing ephemeral statistical quirks, as in amateur day-trading, speak up for scientific reality. As the present author and colleagues argued in a 2014 paper, Our silence is consent, making us accomplices in these abuses.

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