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Lyskamm Financials
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I’m a private investor who manages a few of my own portfolios, along with other for family members. I take due diligence very seriously and I spend considerable time doing thorough research on companies and industries. I generally favour dividend stocks for the long term, but also trade... More
  • Dart Throwing Monkeys 0 comments
    Mar 6, 2014 3:45 AM

    Thoughts on why day trading is detrimental to your finances.

    Everyone can take an educated guess, but no one can predict the future.

    How regression to the mean is pertinent in the stock market.

    ____

    I would like to pick your brains for a few moments and throw a challenging question at you to see what your thoughts are regarding the seemingly all-important skill of throwing darts, or actually a similar activity performed every day by millions of us humans.

    Like you, I am very interested and fascinated by the financial industry, especially when it comes to the stock market, where almost daily one can find a good dose of excitement and thrill. I spent plenty of my time researching and analysing companies, reading financial books and acquiring valuable knowledge and insight thanks to the internet. But recently I have been pondering over the difficult problem of predicting the future or, specifically, predicting the trends of any particular company share.

    Recently I discovered some insight on this topic. The economist Burton Malkiel, in his book A random walk down Wall Street, says that "a blindfolded monkey throwing darts at a newspaper's financial pages could select a portfolio that would do just as well as one carefully selected by experts." In 1988 this theory was actually tested by the Wall Street Journal and the results turned out to be marginally better for the experts than for the monkeys.

    Think of it this way, every day people sell stocks to buyers who believe that they know better than the people they are buying stocks from. In fact, both parties have at their disposal the same information, but both think they know better than the other.

    By analysing the behaviour of the owners of 10,000 brokerage accounts over the course of one year a finance professor, Terry Odean, found that on average the performance of the stocks that had been sold and of those that had been bought by a particular investor were almost identical. So, taking into account trading charges, going for a walk in the park would actually have had a more beneficial effect on someone finances than spending the day trading stocks. Of course these are the averages, there is always someone that does incredibly well or awfully bad.

    But then we should all know this if we had read Benjamin Graham, The Intelligent Investor, or taken Warren Buffet's advice. It appears that financial experts are not much better at predicting the future than the local clairvoyant in my home town. Study over study have been carried out on this very topic and all had the same outcome, the chances for any financial expert predicting the trend of the stock market or of any particular stock are scarcely better than average.

    In his wonderful book titled Thinking, Fast and Slow, Nobel Prize winner Daniel Kahneman, wrote: "the evidence from more than fifty years of research is conclusive: for a large majority of fund managers, the selection of stocks is more like rolling dice than like playing poker. Typically at least two out of every three mutual funds underperform the overall market in any given year". And for those few funds that keep performing well here is an explanation:

    more success = a little more talent + a lot of luck

    It seems that analysts, fund managers and individual investors can only take an educated guess armed with the latest information and statistics available, but ultimately luck is what counts most. Everybody likes to tell a coherent and logic reason why certain events take place, but the explanation is often mere statistics.

    Which brings me to the important concept of regression to the mean. It goes like this, when a CEO of a company (or a company's stock or a company's product ) performs remarkably well for a period of time exceeding all expectations, what follows is that with time the performance regresses to the average. Eventually the luck component tends to change and so we have regression to the mean. The same is true about exceedingly bad performance.

    So, here is the important question you should ask yourself when indulging in day-trading. Should you not go for a walk in the park instead?

    I'd love to read your thoughts on this.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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