Day-trading reality check: humans are poor investors and even worse traders
The shocking death of Alex Kearns, a 20-year-old day trader who recently died by suicide, highlights a broader caution to young people: do not get sucked into digital trading platforms — no matter whether they have noble-sounding names or are “free.” You will most likely lose your money or worse. There are better ways to make money.
With the exception of people like Warren Buffett, humans are poor investors and even worse traders. Sure, the occasional human might get lucky, but in general, the odds are heavily stacked against you. Unless you have some special information or expertise, you are best off investing in a market index as early in life as possible and enjoying the benefits of compounding.
I have been teaching and engaging in systematic investing for over 20 years. My core message to all students and professionals is to not overestimate their competence or the quality of their beliefs, but to continually challenge them.
The second reason for caution is more sinister. It involves the “objective functions” of the platforms where you park your money. How do they make money if they are free to users?
Digital trading platforms make money through a complex web of rebates for funneling trading activity downstream to various venues, and collecting interest on money flowing through the system. Their objective is to therefore maximize the flow of dollars through the system, period. All accounts of any size are welcome. How you perform is largely irrelevant to their business model as long as there are some “intermittent rewards” for the user, like a winning trade. Indeed, the experience created is one of gamification. It is fun, like being in a casino, which is pumped with oxygen to stimulate flow. As a former designer of Google recently remarked “if you’re an app, how do you keep people hooked? Turn yourself into a slot machine.”
But digital platforms are worse than casinos, where most games are relatively simple and easy to understand. And the casino doesn’t loan you money to make your bets.
The trouble is that most people, including professionals, don’t often understand the subtle but important nuances of the financial products they trade, which increase in complexity by the day. Many products, for example, provide “free leverage,” like a triple-levered version of the SPDR S&P 500 ETF Trust
SPY,
an exchange-traded fund that tracks the S&P 500 index. A common misconception is that the triple-levered version, which is called a “derivative” product, will result in triple the performance of the single-levered ETF. In reality, however, performance can diverge considerably even over a few days, depending on how the product is managed, which is typically in fine print that retail investors don’t read. The marketplace is full of…
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