As a rule, the more investors trade, the worse they do relative to the market as a whole. Frequent trading requires that you pull off the near-impossible feat of consistently outwitting the collective intelligence of the stock market, and do so well enough to outweigh the added burden of commission costs and taxes (which are much higher on short-term capital gains than on long-term gains). There has never been a serious academic study, in fact, that has shown anything different.
So Gretchen Morgenson’s front-page article in Saturday’s New York Times lamenting the boom in short-term trading among individual investors was right about the detrimental effects of such trading on the bank accounts of the people doing it. But the evidence the Times offered for the widespread nature of that boom was confused and not especially convincing. And the attempt to draw conclusions about the broader negative effects of increased trading was even less plausible. Short-term trading, as I’ve argued here before, is a fool’s game. But it’s not a fool’s game that hurts those of us who aren’t playing it.
The premise of Morgenson’s article was drawn from a new study by Steve Galbraith of Sanford C. Bernstein, which shows that the “average” investor now holds shares only eight months, whereas a decade ago he/she held shares for two years. What we weren’t told, though, was whether the “average” here was the mean or the median. After all, if most investors are still holding stocks for years, but a smaller group of investors are now holding stocks for 20 minutes, or three hours, and trading those stocks constantly, the mean holding period would drop significantly, even if the experience of most investors had not materially changed.
The same problem is even more true of the statistics about share turnover, with the Nasdaq shares turning over more than 200 percent of its shares in a single year. Day traders and technical-trading firms now account for a significant percentage of each day’s volume on both the Nasdaq and the NYSE, and by essentially trading stocks among themselves–and serving as buyers and sellers for the rest of us–they have contributed massively to share turnover. But it’s a mistake to say they’re emblematic of the investing world as a whole.
Of course, investors trade more now than they ever did. If you drop the cost of doing something by two-thirds or more (which is what the advent of the Internet did to commissions), people will do more of it. And as it’s become clearer and clearer that mutual-fund managers and stockbrokers are no more likely to have market-beating knowledge than the average investor is, it’s also become harder to justify giving your money to either, especially with the fees they charge. To be sure, you shouldn’t take your money from a mutual-fund manager and run it yourself. You should put it in an index fund. But even long-term investors think they can be Warren Buffett. I know I do.
All of this, though, is a far cry from saying that all of us who use the Net or discount brokers are day traders, which is what the Times seems positively bent on saying. There is no evidence for that at all. More important, there’s no evidence that all this trading is having detrimental effects on the capital markets. Morgenson argues that excessive trading is responsible for the increased volatility of the market. But there’s no control group here. The rise of individual investing has occurred simultaneous with the creation of an entirely new industry, the Internet, which has spawned hundreds of new companies whose future prospects are incredibly difficult to evaluate. In that situation, volatility is to be expected, since the market’s view of those prospects is more likely to change rapidly than will its view of, say, Coca-Cola’s future. And, as I suggested a couple of weeks ago, the more information you have, the more noise you’ll have in the stock market, leading to more volatility. Trading here may be a symptom more than a cause.
In any case, the thing to remember about all this is that every time someone sells a stock, someone else is buying it. And in terms of capital allocation, it’s irrelevant whether the person selling the stock has held it for seven years or seven days. All that matters is whether the price is higher or lower than the last trade. Morgenson’s article is full of these vague forebodings that all this trading will lead to doom once the bull market ends. But just as on the way up there have been no buyers without sellers, on the way down (if we do go down) there will be no sellers without buyers. To reiterate a point I’ve made before, the more people there are in the market (though how much they trade is irrelevant), the deeper and more resilient it is, and the smarter it is.
So, yes, for our own sakes we should all buy and hold. But for the market’s sake, well, it doesn’t really matter.