
Trading Is Hazardous to Your Wealth [pdf] (2000) - alokrai
http://faculty.haas.berkeley.edu/odean/papers/returns/Individual_Investor_Performance_Final.pdf
======
lend000
If markets were truly random, you might expect 50% of day traders to lose
money, not 90%. Of course, markets are not random and most untrained humans
have emotional biases that actively optimize for losing money in markets.

This is likely a controversial opinion: 90% of the time, someone who wants to
break out of the "rat race" or achieve wealth for some future vision should go
the startup route, or if the wealth part is not as important, do
freelance/consulting. However, I believe there are 10% of people where trading
the markets provide the better way to achieve the same goal. The reason being
that for certain personality types (you need to be smart, disciplined, and
creative to beat the market, and it still requires a lot of time), I suspect
trading offers a higher expected value of return than starting a bootstrapped
company. Startups, especially those not started by someone wealthy, have a
higher failure rate than day traders. If you are not passionate about anything
you can get funding for (would SpaceX have been successful if it were Elon's
first company?), and you fit the criteria, trading is not as terrible an
option as its reputation suggests.

~~~
jaredtn
Two counterarguments:

1) Trading fees. If the house takes a cut of 0.1% on every transaction, then
on average those who trade more lose more money.

2) Risk/reward tradeoff. If you buy deep out-of-the-money options, you might
have a 5% chance of profitability, but expected return of $0 (neither positive
nor negative). 95% of the time you lose $X, and 5% of the time you make $19X.
If traders are pursuing riskier strategies, you'd expect most of them to lose
money.

~~~
lend000
Trading fees are a valid counterargument here, and while they are non-
negligible (especially back when the "90% of day traders lose money" rule was
established), I don't think they account for the full 40%.

For point 2, if there is an expected return of 0, then on average this should
push the portfolio toward 50% chance of profitability.

It is the psychological factors combined with a non-random market that ensure
most traders lock in losses (usually after riding them too long or not long
enough).

~~~
jaredtn
If I roll a 100-sided dice that pays me $99 if I roll a 1 and -$1 if I roll
2-100, then my expected value is $0, but my chance of profitability is 1%.

~~~
bugzz
He's saying that traders don't just make 1 bet in their lifetimes though.

~~~
jaredtn
True, but you have to account for the chance of ruin. Once you go broke, you
have to stop betting. Many traders will continue betting larger and larger
amounts of money when they win, but stop betting if they lose big. Making
risky bets is quite likely to make you go broke, especially if you scale the
size of your bets with the size of your bankroll. The [Kelly
Criterion]([https://en.wikipedia.org/wiki/Kelly_criterion](https://en.wikipedia.org/wiki/Kelly_criterion))
is the best way to approach it.

------
WalterBright
I read an article a few years ago that compared the trading performance of
various strategies. The number one performer was the "dead people" strategy,
which happens when a person dies and his portfolio cannot be traded while the
inheritance issues are sorted out. Next best is the broad index fund, and dead
last was the average investor.

Edit: Found the article!

[https://www.businessinsider.com/forgetful-investors-
performe...](https://www.businessinsider.com/forgetful-investors-performed-
best-2014-9)

~~~
ashtonkem
What’s the difference between the dead person strategy and an index fund? The
dead strategy involves whatever stocks they had selected at the time?

~~~
tripletao
The dead person can't make bad decisions on when to buy/sell the index fund.
Those "bad" decisions don't even require an attempt to time the market, if
e.g. you always invest whatever's left over after ~fixed living expenses, and
you get paid more when the market's higher.

------
encoderer
> Trading costs are high. The average round-trip trade in excess of $1,000
> costs three percent in commissions and one percent in bid-ask spread.

A lot has changed in 20 years. The conclusion may still be the same, but
spreads are much tighter (thanks in part to HFT) and trade commissions no
longer exist.

~~~
WalterBright
Trading also subjects you to short term capital gains tax rates, as well as
losing the effects of compounding.

~~~
Bubbadoo
Short term capital gains rates have been 15%, right? Which is, based on my
last gander at the tax charts, less than the regular w2 tax rate bracket many
successful traders would file under.

~~~
jandrewrogers
No, short-term capital gains are taxed at your marginal income tax rates. 15%
is for _long-term_ capital gains below $500k.

------
hash872
Not in any way defending day trading, but I think it's interesting that it's
become such accepted wisdom about how bad it is- here on a website dedicated
to startups. 90% of day traders lose money, what are the odds for startup
founders? Probably more than 90% fail, yeah?

Imagine if, within the next 20 years, it becomes normal & accepted wisdom that
joining a startup and taking their basically worthless 'equity' is more likely
to lose you money than day trading. Just kind of an interesting juxtaposition-
Hacker News, Website Devoted To Risky Startups, Decries Risky Day Trading

~~~
sm0ss117
You don't work at a startup to make more money, you work at a startup for non-
monetary benefits and if you're extremely lucky you might get rich quick.
Average case is you make less, good case is you make even if your company is
highly successful.

~~~
hash872
Without pointing any specific fingers, people were pushing 'you should spend
your 20s working 60-80 hours a week at a startup so you can get rich' really
hard for a while there. It's only relatively recently that this is understood
to be a bit of a con

~~~
TuringNYC
>> It's only relatively recently that this is understood to be a bit of a con

This go-around, there is a lot of private capital, so companies stay private
for a decade or longer and lock employees out of liquidity events (meanwhile,
founders can negotiate to take some cash off the table during a financing
round.) The incentives are skewed. In the 90s bubble, companies with a $50M
valuations could go IPO -- you could hopefully sell after your lockout. (Oh,
and houses cost a tenth of what they do now.)

This go-around, there is HN, Quora, Blind, and so it is harder for people to
get suckered into starry visions.

That said, it is _still_ worth considering working at startups for the high-
learning, low-BS environments you can find as compared to big companies.

------
esotericn
Can someone explain to me why people keep referring to average return as some
sort of magical answer to the question? The median person makes the median
income, that doesn't mean that trying to get a good job is pointless.

By definition in order for you to make more than the market, someone else has
to make less than the market.

Assuming that knowledge has superlinear returns (I consider this to be obvious
without proof required), of course less than 50% of participants will 'win' \-
those at the bottom are totally useless and burning money, whilst those at the
top are quite skilled indeed.

It's fair to say that one should not expect to be in that upper echelon, but I
don't think it's reasonable to state 'most people lose' and just leave it at
that, it's blindingly obvious that most people lose, it would be impossible
for them to not.

(Adjusted for balances - a guy with 20 billion quid can lose 1 pound each to 7
billion market participants and in that case 'almost everyone wins more than
the market')

~~~
leetcrew
a lot is stacked against you as a private investor. being very smart is not
enough to beat the market consistently when your competition is other very
smart people who themselves have a support staff of very smart people and they
all spend 8+ hours a day analyzing the market and making trades.

even if you quit your day job to trade full-time, they can collect information
in ways that you can't (eg, satellite imagery), and they may also have direct
lines to an exchange to execute trades faster than you. unlike you, they trade
in large enough volume that they can get people to pick up the phone to trade
after the exchange closes. they have access to entire classes of investments
that are closed to you due to capital requirements.

~~~
heavenlyblue
Hm.

I would argue that working for an institution that gives you access to
satellite imagery also implies you can’t really play below a certain threshold
of volume.

Otherwise it’s like hunting deer with a ballistic missile: you will kill the
deer, but for that money you could have raised a whole tribe of them.

------
praptak
A related blog post: "Why I don't trade stocks and (probably) neither should
you" [http://edmarkovich.blogspot.com/2013/12/why-i-dont-trade-
sto...](http://edmarkovich.blogspot.com/2013/12/why-i-dont-trade-stocks-and-
probably.html)

~~~
loeg
And consider also, "The 15-Stock Diversification Myth,"
[http://www.efficientfrontier.com/ef/900/15st.htm](http://www.efficientfrontier.com/ef/900/15st.htm)
:

> One of the most dangerous investment chestnuts is the idea that you can
> successfully diversify your portfolio with a relatively small number of
> stocks, the magic number usually being about 15.

> …

> The reason is simple: a grossly disproportionate fraction of the total
> return came from a very few "superstocks" like Dell Computer, which
> increased in value over 550 times. If you didn’t have one of the half-dozen
> or so of these in your portfolio, then you badly lagged the market.

~~~
clairity
there is a lower bound, but it's closer to 60, and those need to be picked
carefully to avoid excess correlation. at that point, you might as well buy an
index fund since you're unlikely to beat the market anyway.

------
riazrizvi
On average. Also on average, starting a business is hazardous to your wealth,
it's likely to fail. On average, don't do competitive sports, you're likely to
lose.

Maybe 'Less Than Excellent Trading Is Hazardous to Your Wealth'? Don't do a
trade unless you have an excellent advantage on it...

------
alexandercrohde
It's my understanding that, if commissions are free (e.g. Robinhood) then on
average, any trading strategy is going to perform comparable to the market
average.

If you can find any reliably bad strategy (in a fee-less market), then you
have necessarily found an outperforming strategy that is the opposite.

~~~
jaredtn
Eh, if I wanted bankrupt a trading account by playing a reliably bad strategy,
I'd buy deep out-of-the-money options expiring this Friday. The expected value
is $0 (neither positive nor negative), but they have only a miniscule
probability of profitability.

~~~
socketnaut
When you say "expected value" are you trying to say most likely value?

~~~
jaredtn
No, I mean the mathematical mean, not mode. If you take this action infinitely
many times, what is your average (mean) return?
[https://en.wikipedia.org/wiki/Expected_value](https://en.wikipedia.org/wiki/Expected_value)

~~~
socketnaut
I see, so you're saying the expected profit on the trade is $0 assuming an
efficient market and ignoring trading costs? Your comment is confusing the way
it's worded because the expected value of the option is non-zero.

~~~
jaredtn
Ah, sorry for that. I meant E[return on option - cost of option] ~= 0.

------
halfcat
The biggest problem with trading is unrealistic expectations.

If people believed they could become a medical doctor by taking a weekend boot
camp, you would see extremely high failure rates.

But that high failure rate would not suggest that it’s impossible to become a
doctor.

Same with trading, if a person thinks they will make a few trades as their
side hobby, it’s going to go about as well as the hobbyist surgeon. But if
you’re obsessed with trading for a decade you can become quite competent.

~~~
Bubbadoo
Studies have shown it takes about 3 years of constant trading to develop a
sense or intuition about markets.

------
naveen99
Trading is just connecting buyers with sellers and pocketing a spread. It’s
been a most profitable activity for a long time. You just have to optimize the
carrying costs and manage risk. but it’s the same thing everywhere, being
average is useless in wide competition. You need an edge: be smarter, faster,
better capitalized, better connected, informed etc...

------
rufus1
The more access the average joe has to the market the more seemingly plausible
the idea that it's "impossible" to beat the market. No, it's just really hard.
Just because most sculptures are statistically made with playdough doesn't
mean it's impossible to create a great sculpture.

~~~
rufus1
The best comparison anyone's made here is competitive sports. Most traders are
doing the skill equivalent of shooting free throws in their yard; this doesn't
mean there are not professional NBA players.

------
exabrial
I don't trade individual stocks, I don't know enough. But I do buy ETFs, which
are ran by people that [theoretically] do know enough. As an experiment I
bought in after the March crash on a few ETFs that got hit hard. I'm pacing
with the index which is good enough I guess.

------
blobbers
Notes they're including this: "In aggregate, round-trip trades cost about one
percent for the bid-ask spread and about 1.4 percent in commissions." Not
necessarily the case anymore. The spread on apple is 0.04 cents on $300.

------
lihaciudaniel
why do people think trading will make you rich?

~~~
nostromo
Because there are some very rich traders, including the fourth-richest person
in the world.

~~~
clairity
he's an investor, not a trader, and has outsized influence on the outcomes of
his investments.

~~~
nostromo
A distinction without a difference. He is an active trader that moves in and
out of businesses all the time.

In fact, he just dumped all of his airline stock recently due to Covid-19.

It doesn't matter if you trade based on research or not, you're still a
trader.

~~~
clairity
_au contraire_ , it's precisely the most carnal difference, that of intent and
of effect. investors want investments--the companies--to succeed, and thereby
externalizes a net positive societal effect; traders want their bets to
succeed, others be damned.

------
WalterBright
Cognitive biases play a large role in poor investment performance, see
"Thinking Fast and Slow" by Daniel Kahneman.

