Saturday, January 13, 2018

In The Mind of A Day Trader

Why do we invest as we do?  As it turns out, it is basic psychology - the less we have, the more risk-averse we are, and ironically, we thus take the most risks!

A reader sends me this interesting e-mail:
I guess you're right about mutual funds and index funds being the best option for average investors. It's just that the market seems so high right now that I feel more confident to buy stocks that appear undervalued. After the next major correction I plan to increase my position in index funds. 
Funny you mention day trading. I tried that for a while in my early 20s (31 now). It was very exciting, but I hated it. I was checking my phone all the time, even in the middle of the night. I felt almost relieved when my account hit zero, lost about 4k there. The price for being a sucker. 
For the next few years I didn't invest at all, I just worked and saved. Only two years ago I began to invest again. It's fascinating reading blogs on early retirement and on living below your means. It feels great to know my wife and I are making progress towards our financial freedom. 
You're right on the cryptos. Although I'm holding it feels a bit like day trading again, checking the rates multiple times a day and feeling excited or agitated because of the numbers. And it's so stupid. Suddenly, in the last two months or so, so many people have begun talking about it. Friends I meet, people at work, conversations I overhear. It's insane. These are people who have never showed any interest in investing.
What struck me as interesting about this, is it reflected the way I felt when I first started investing.  When I first started out, as I noted in earlier blogs, I was chagrined to discover that my net worth was negative.  I had never thought about net worth until law school, and when I sat down and totaled up my "assets" (hardly anything) and "obligations" (mountains of debt) I was in the hole - pretty far, too.

This is embarrassing to admit, but I decided I was going to "invest" my way out of that hole.  I had a very clever plan - a scheme, if you will.   I would only buy stocks that were going up, and before they went down, I would sell them and buy another stock going up!   I would make nothing but profits!   What a great idea, eh?

I would watch the financial channels, buy the stocks they said were "going places" (and they were, like the dumpster) and then profit!   What could possibly go wrong?

Yes, this is the "thinking" from someone with a college education (in Engineering, no less) who was also in Law School.   I'm afraid I was terribly naive at the time.   The market gave me a first-rate education in very short order, and I realized quickly that expecting nothing but gains in a portfolio was naive.

What was worse than this cockamamie "scheme" was that I was throwing away the best piece of leverage I had in my toolkit.  And that is the weapon of time.   When you are young, you have time on your hand.  Rather than try to "trade your way to success!" the smart thing to do is put money away in a number of things and then forget about it and let time do its thing.

It is funny, but the people selling the hyped investments always look to time to sell their product.   "If only you had bought gold/bitcoin/apple/whatever several years ago, you'd be a millionaire today!" which is a great argument for buying things several years ago before they went up in value.   They are arguing you should "buy and hold" but at the same time, selling a "churn" system of investment.   The irony is lost on most.

What changed is that I realized my 401(k) plans were chugging along and making money and I was not intervening in their operation in any way.  I realized also that you have to expect to lose money on occasion - even a lot of money and that's OK - there ain't much you can do about it.   Trying to "time" the market is often the worst thing to do, particularly if you are trying to "spot the winners!" as I was.  I stopped trying so hard and instead started saving money, paying down debt, and making a plan to be debt-free and accumulate wealth, rather than trying to "make money" by sharp investment.

And it worked, too.   Granted, about half of what I have in savings is capital gains, dividends, and interest on initial investments.   But I would not have those gains without the investment.   The more you invest, the more you gain.   The day-trader approach is the opposite - put a little in, and make it grow by hundreds, if not thousands of percentage points.   This is not to say this never happens, it just isn't that likely to happen to you and me.   Basing your retirement and financial well-being on a long-shot probability is, well, like buying lottery tickets in place of your 401(k) plan.

You have to be prepared to lose money.   Every day, it seems, I gain or lose enough to buy a fairly nice car - because by now, I have accumulated wealth.   It is scary when the market goes down and you realize that you just "lost" $30,000 in 24 hours - particularly when that is enough money to live on for a year, when you are debt-free.  In February of 2009, I lost a lot of money in the market - perhaps close to a half-million dollars.   But within a year, I had made it all back.   A friend of mine panicked and sold all his stocks at that point - locking in his losses - and then put it all into gold.   Gold went up - and then down.   And by that time, his stocks he had discarded were worth far more than the gold he had bought.

I am not picking on gold or bitcoin or tech stocks or real estate in particular - they are not different things, they are all the same thing.   They can sometimes be good investments.   But when they are hyped by the media and then the market over-values them, and then the small investor says, "Gee, I should get into this!" it all goes horribly wrong in short order.

Our reader tried this with day trading - and day-traded his account all the way down to zero.  Now, you'd think he would have learned a lesson here, and realized the siren song of Bitcoin was the same song as the day-trading schemes of yesteryear.   But the human mind works the opposite way.  Licking our wounds, we don't vow "never to do that again!" but instead double-down our bet, trying to earn our way out of the hole.

Note also how peer pressure and today, social media play an important role.  My day-trading friends were in an "investment club" which was some sort of scheme they bought into.   It is like buying timeshares - they use peer pressure in the sales meeting to get everyone to group-think.   Today, on Facebook or other online sites, you can have your opinions about crypto-currency validated by others in the group.  And the funny thing is, too, we all know now, after the last election, how the internet becomes an echo chamber with regard to belief.   You go to a crypto-currency discussion forum, and you are not going to hear any dissenting views about this "new paradigm" banking system.

So many people end up lurching from one bad "investment" to another.   As I noted in my previous posting, the people burned by real estate in 1989 got into "dot com" stocks in the 1990's (when I was making money in real estate - through rational investing in profit-making properties).   They got burned on dot-com and saw me making money in rentals and thought they'd get back into that (without even bothering to rent out the properties!  Duh!).   They lost their shirts in that, and started day-trading.  When that money was gone, they jumped on the gold bandwagon.   Today, they are into bitcoin.   They are not big-time investors - throwing a few thousand dollars at most at these "investments" - but over time, that same money, invested in more rational things, would easily accumulate to over a million bucks by retirement, in an almost guaranteed fashion.

It is a sad, predictable pattern.
Bullwinkle:  "Hey Rocky!  Watch me pull a rabbit out of a hat!" 
Rocky:  "But that trick never works!" 
Bullwinkle:  "This time for sure!"
Listen to Rocket J. Squirrel.   That trick never works!

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