Read less, Trade Less

Among the many misconceptions/myths prevalent, one is that you should be an active trader if you want to make money from equity markets. Well, ‘active’ does not mean actively buying or selling – but active in being knowledgeable about the economy/markets etc. Not every ball should be hit – good batsmen realize that some balls outside the off-stump should be left alone.

Traditional finance theory have always recommended that individual investors simply buy and hold the market portfolio, or at least a well diversified portfolio of stocks. The typical retail investor doesn’t hold a well diversified portfolio nor does he desist from churning his portfolio every now and then. The attached paper delves into the subject and concludes that younger and male investors trade more aggressively than older and female investors.

In addition to overconfidence and gender, the more frequently individuals invest in information, the more they trade. To stretch the point further, investor psychology research has also pointed out that trading behaviour is also sensitive to the sources of information used by investors. Overconfident investors trade more frequently when they collect information directly using specialized sources. Investors getting stock related information from banks and/or brokers tend to trade more frequently than those who interact socially and are informed via friends and family or those who use non-specialized media like newspapers, financial magazines etc.

News, ‘hot tips’, brokerage reports et al are like deadly vortexes that can suck in an average investor and sink his portfolio hard. When you play information (budget announcements, RBI will come out with a rate cut, employment figures, economic survey etc) you are playing a game which is dominated by the big boys. Big players use news events to trade. In fact, some of them may even not be above ‘creating’ news if there is no ‘real’ news available. I recollect myself buying a share nearly concomitant to the release of a nice upbeat equity research report on the stock only to realise that it was all downhill from there on. May not happen always and maybe i was just plain unlucky and that things are not so murky in the world of equity research, but it pays to be very, very paranoid if you a small chap. In any case, smart money gets to see the research report first before mainline media catches it and sends it out for the universe to consume. Furthermore, when the big players trade, they trade such large holdings that when they initiate trades, they typically move markets. If you are the sucker who’s caught the other end of the rope, chances are very high that you’re the small fry who has come in attracted by the recent news blurb on the stock and are entering the room just as the party’s ending and the biggies are leaving. Best bet for the little ones – do not rush into acting on every thing that you hear or read.

Worst off are the ones caught in the middle – i.e. ones between the retail rats and the fat cats; the higher net worth individuals who do not consider themselves to be small and ergo turn over their capital to professional wealth managers or bank/broker dealers. Sometimes, unbeknownst to them, their money managers may resort to excessive churning of the portfolio in the lure of commissions. In this regard, the stock turnover ratio has been commonly used to measure and keep tabs on such fleet footedness, but really it is another ratio – the commission to equity ratio which is a better way of measuring the impact of excessive trading in a very direct way, i.e. the cost impact.

The chart above shows how often I have traded over the past 10 years.