Don't trade stocks, kids.
I'm biased, of course – I contribute to a company that promotes long term buy-and-hold investing. But there are a couple of very good reasons why I think all beginning investors should be wary of trading stocks. Here are 4 of the biggest:
- You might not know how
Do you know what price action is? Do you have a mental list of all the upcoming events (e.g. RBA or US Fed interest rate meetings) that might move stocks? Can you read a balance sheet and predict when, for example, that G8 Education Ltd (ASX: GEM) might want to raise more capital to fund its ongoing acquisitions?
- You have worse access to information
Can you compete with a bunch of people with Bloomberg terminals (this is a subscription service that provides the most comprehensive financial information in the world) and an extensive Twitter network? Blue Sky Alternative Investments Ltd (ASX: BLA) is not exactly a trader's stock, but the stock fell heavily last week before entering into trading halt. By following Glaucus, which released a negative report on the company, some investors were aware of the publication of the short report well before the rest of the market – and indeed, before the company itself.
If you aren't a) financially sophisticated and b) able to sit in front of a computer all day (i.e., if you are gainfully employed), in my opinion day trading isn't for you. Some traders like to hold positions longer, over 3-12 months, but that comes with its own risks:
- It's like picking up pennies in front of steamrollers
Unless you have a large amount of your own capital to play with, you may need to use 'leverage' (debt) to enhance your returns. This can take the form of contracts for difference (CFDs), a margin loan, or options. Each has substantial risks and it is possible to lose a lot of money (in some cases more than your initial investment) very quickly if you are wrong. You can use stop losses as well, but there are circumstances in which those can be ineffective, especially if you hold positions more than a few days.
- Potential for long term underperformance
There are a number of studies that show that no trading strategy works all of the time, and that traders often achieve sub-market returns especially once fees are considered.
I am sure that there are a few traders out there outraged by my comments, especially given that I am not a trader myself. This is a tricky area because even a large number of successful fund managers make short term trades. I even had a discussion with a colleague a few years ago where we discussed how there appeared to be a good trade in A2 Milk Company Ltd (ASX: A2M) which at the time looked very cheap relative to then-champion Bellamy's Australia Ltd (ASX: BAL).
So I'm not saying you should never trade, but if you are a beginner or part time investor thinking that you should start trading your stocks to earn a little extra return, I would suggest that you reconsider – unless you are willing to invest a substantial amount of time and money (in potential losses) to learn the hard way.
