Majority of ALL Investors/Traders Lose Money

It is a sad truth that most day traders fail and lose money over time. That’s right, the majority of ALL investors/traders lose money… The University of California study covered millions of trades and every account on the Taiwan exchange. From memory 70+% of all accounts lost money, 15% made money and the rest were around break even. This is the most compelling paragraph in the report imo:

But if I remember correctly the percentage success rate of all traders/investors regardless of timescale is pretty dire too, it being a zero sum game and all that. 80/20 failure/success rate has a ring to it so you really to be smart to make money spread betting.

In a paper titled “Trading Is Hazardous to Your Wealth” they showed that, on average, the most active traders had the poorest results, while the investors who traded the least earned the highest returns.

Many individual investors lose consistently by trading. The first demonstration of this startling conclusion was collected by Terry Odean, a finance professor at University of California Berkeley.

Odean began by studying the trading records of 10,000 brokerage accounts of individual investors spanning a seven-year period. He was able to analyse every transaction the investors executed through that firm, nearly 163,000 trades. This rich set of data allowed Odean to identify all instances in which an investor sold some of his holdings in one stock and soon afterward bought another stock. By these actions the investor revealed that he (most of the investors were men) had a definite idea about the future of the two stocks: he expected the stock that he chose to buy to do better than the stock he chose to sell.

To determine whether those ideas were well founded, Odean compared the returns of the two stocks over the course of one year after the transaction. The results were unequivocally bad. On average, the shares that individual traders sold did better than those they bought, by a very substantial margin: 3.2 percentage points per year, above and beyond the significant costs of executing the two trades.

Further research by Barber and Odean has shed light on these mistakes. Individual investors like to lock in their gains by selling “winners”, stocks that have appreciated since they were purchased, and they hang on to their losers. Unfortunately for them, recent winners tend to do better than recent losers in the short run, so individuals sell the wrong stocks. They also buy the wrong stocks. This sounds very much like skill and discipline to me.

Just How Much Do Individual Investors Lose by Trading?

“We record that individual investor trading results in systematic order and, more crucially, financially big losses. Using a complete trading history of all investors in Taiwan, we document that the aggregate portfolio of individual investors suffers an annual performance penalty of 3.8 percentage points. Individual investor losses are equivalent to 2.2 percent of Taiwan’s GDP or 2.8 percent of total personal income – nearly as much as the total private expenditure on clothing and footwear in Taiwan. Using orders underlying trade, we document that virtually all of individual trading losses can be traced to their aggressive orders; passive orders placed by individuals are profitable at short horizons and suffer modest losses at longer horizons. In contrast, institutions enjoy an annual performance boost of 1.5 percentage points (after commissions and taxes, but before other costs). Both the aggressive and passive trades of institutions are profitable.”

In John Bogle’s Little Book of Common Sense Investing he concludes that for the majority it’s a mugs game to try to beat the market and that the only way to ensure maximum returns from the earnings of businesses – earnings growth + dividends – over time is to own all of the market with minimum expenses. (This was largely a slight on the fund management industry and their excessive fees but could also apply to over active private investors).Further, that the failure to take the full return from the market plus the ravages of inflation will, over the long term, destroy investment returns. He therefore recommends a very low cost index fund like he began as founder of the Vanguard Group.

I realise that the Bogle’s view is at complete odds with modern online personal investors trading culture. Further, I’m not completely convinced by all of his arguments as market timing is still necessary to succeed with an index fund. However, it’s still worth saying for both short and longer term investors who have ambitions to ‘beat’ the market year after year especially if 80% will ultimately lose!