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We all know there are a number of folks today that are day traders who buy a stock for a few hours and then turnaround and sell them. Granted there will be times that these types of trades will make money. However, most of these types of trades will lose money. And more importantly, your broker will always make money on all of these trades. Plus if you are very eager to buy or sell you will lower your returns. If you are up against a hard deadline of only a few hours you will end up having to bid higher to get a seller willing to part with their shares. This is referred to a “market impact” which is very real indeed even though it never shows up on your brokerage statement per say.
Let’s assume you have to bid up an additional $0.10 per share to find a seller on 1,000 shares. You just added an additional $100.00 cost yourself. Now if you think about the situation when investors are in panic mode and are selling off their stocks as fast as they can just to dump it at far less than the most recent market price, then “market impact” hits home again. The cost of trading wears away your returns kind of like rubbing and rubbing sandpaper on a piece of wood. Thus the cost of trading your hot stocks can cost 2% to 4% or 4% to 8% for a “round-trip” buy and sell transaction. And let’s not forget that when you trade rather than invest, your long-term gains (taxed at a maximum capital-gain rate of 20%) into ordinary income (taxed at a maximum rate of 38.6%). All of this adds up and the stock trader needs to gain at least 10% just to break even on buying and selling a stock. Maybe you can do that once. But to do it often enough to justify the obsessive attention it requires plus the high degree of stress is unbearable. The bottom line is clear, the more you trade the less you keep.
Two finance professors, Brad Barber and Terrance Odean both of the University of California examined the trading records of more than 66,000 customers of a major discount brokerage firm. From 1991 through 1996, these folks made more than 1.9 million trades. Before the costs of trading sandpapered away at their returns, these folks actually outperformed the market but an average of at least half a percentage point per year. But after trading costs, the most active of these traders who shifted more than 20% of their stock holdings per month went from beating the market to under performing it by an abysmal 6.4 percentage points per year. The most patient investors however who traded a minuscule 0.2% of their total holdings in an average month managed to outperform the market by a whisker even after their trading costs. See chart below.
Instead of giving a huge hunk of their gains away to their brokers and the IRS, they got to keep almost everything. The lesson is clear: Don’t just do something, stand there. It’s time for everyone to acknowledge that the term “long-term investor” is redundant. A long-term investor is the only kind of investor there is. Someone who can’t hold on to stocks for more than a few months at a time is doomed to end up not as a victor but a victim.
Why would you ever be a day trader or a hare? Are you trying to make money for your broker or yourself? At Port Wren Capital, LLC, we are the tortoise as we are always trying to make money for ourselves and our customers, not the brokers and we take a more long-term view. Our subscription service saves you hours of time and brings actionable investment research.
Source: The Intelligent Investor, by Benjamin Graham, revised edition, copyright 1984, Commentary on Chapter 6, Dying a Trader’s Death section, page 148 to 150 and Figure 6-1 on page 151.
At Port Wren Capital, LLC, we specialize in picking specific undervalued U.S. stocks using fundamental analysis developed by Benjamin Graham using a five step process. We have beaten the S&P500, DJIA and NASDAQ benchmarks since we started 5 years ago on our own investments. Discover the difference for yourself. To learn more contact us today.
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