By PATRICK CAIRNS
By any measure, 2020 has been an extraordinary year for stock markets. After experiencing such a swift crash in February and March, the S&P 500 has since enjoyed its strongest quarter since 1998.
From the start of April to the end of June, the index gained 20%.
The late 90s were the heady days of the dotcom bubble, when it seemed that internet stocks would only ever go up. Despite the current global context – the fact that the world is still in the grips of a pandemic and the massive impact that is having on economies — some of that indiscriminate euphoria appears to have returned.
One way bets
Most notably, markets have seen a substantial increase in activity by day traders. Online brokerages have seen spikes in registrations and trades.
This has been accompanied by a surge in buying of call options — a financial instrument where the buyer takes a position that a share price or index will go higher. In other words, the majority of traders seem to be betting on the stock market going up more.
A few social media celebrities have also become market punters overnight. The most visible of these has been Dave Portnoy, founder of the satirical sports blog Barstool Sports.
His blog is partly owned by casino company Penn National Gaming, and is usually frequented by sports gamblers. He has, however, transformed himself into a day trader who appears to have very little by way of a thesis except that if he makes a trade, the stock is going to go up.
“You just take a couple of letters, you mush them together, you press buy, buy, buy and you watch it go up, up, up. That’s how this works,” said Portnoy in a recent video on Twitter.
Probabilities
For anyone with a working knowledge of the stock market, this is obvious nonsense. Share prices don’t only move in one direction.
Pacome Breton, an investment manager and head of risk at Nutmeg, detailed this excellently in a recent blog post.
“Looking at global stock market data between January 1971 and May 2020, if you had randomly picked one day during this period and chosen to invest just for that one day, you would have had a 52.3% chance of making gains — almost a similar odd to the toss of a coin,” he wrote.
What this shows is that over the extremely short term, stock prices are essentially unpredictable. That is why day trading is referred to as speculation, not investing.
Likelihood of success
A fascinating study published by Fernando Chague, Rodrigo De-Losso, and Bruno Giovannetti from the Sao Paulo School of Economics and the University of Sao Paolo bears this out.
The authors wanted to answer the question whether it was possible to day trade for a living. What they found is that among those who traded for only one day, about 30% made a profit after fees.
For those who traded for more than 300 days, 97% lost money.
“The probability of an individual exhibiting a positive profit monotonically decreases with the number of days he or she trades,” the authors wrote. “This peculiar pattern is contrary to what ‘self-selection’ — individuals who persist in an activity are generally those with better performance – and ‘learning by doing’ would suggest.
“In turn, patterns like this are usually found in gambling activities, such as the casino roulette, where the proportion of successful players also monotonically decreases with the number of rounds played.”
Put the odds in your favour
Simply put, the longer you speculate on the stock market, the more likely you are to lose money. And, as the study found, even if you do make money, it’s unlikely to be very much. Only 1.1% of the traders they sampled earned more than the Brazilian minimum wage of $16 per day.
As Nutmeg’s Breton noted, however, the exact opposite is true for investors. The longer someone stays invested, the more likely they are to make money. In his analysis of returns on the MSCI World Equity Mid and MSCI Large Cap Total Return Indices in pounds, he found that:
“If you had invested your money for a quarter, or 65 days, during that same 49-year period, your chances of making a profit increased to 65.09%. Investing for any one year would have generated a positive return 71.83% of the time, while investing for ten years increased your chances to 93.91%.
“Interestingly, an investor that invested in the stock market for more than 13 and a half years at any point during this period never lost money.”
One of South Africa’s most respected financial journalists, PATRICK CAIRNS is a trusted commentator on the world of investments and the quirks of behavioural finance. Over more than a decade he has built a reputation for keeping the industry honest, and putting the interests of investors first.
If you’re interested in reading more of Patrick’s work, here are his most recent articles for TEBI:
Is there such a thing as a “normal” stock market?
Give yourself the best chance of success as an investor
Could anyone have predicted Warren Buffett’s success?
You don’t need to know the future to invest successfully
There’s no such thing as a perfect investment
Are markets still rational, even in a crash?
© The Evidence-Based Investor MMXX
