Private trading has surged as a result of the ongoing coronavirus outbreak. As people are urged to spend more time at home, have no social commitments and are bombarded by news relating to the global economy, they may feel more equipped than ever to keep abreast of developments in the financial markets.
For some, the experience of trading follows a similar pattern to that of gambling. A quick win can lead to overconfidence and, while many people will stop trading once they’ve taken a hit, others will find the process addictive. With a heightened focus on trading in the media, there is also an element to which people begin playing the markets to jump on the bandwagon and to avoid feeling as though they are missing out on potential gains.
At Moneyfarm, our strategy is built on a long-term outlook and is designed to create growth in spite of short-term volatility, not because of it. The temptation to buy into markets as they move quickly in search of short-term gains is understandable, but long-term growth is almost always best left to those with the expertise to make the right calls.
Consensus is a powerful thing
Herd mentality is a powerful social influence. Nobody wants to miss the next big investment opportunity or the new must-have product just because others were quicker on the draw.
A practical example is the empty shelves seen in supermarkets across Europe. Anyone looking for toilet roll, flour or pasta will have found stocks to be surprisingly scarce. At the beginning of the coronavirus outbreak, people stockpiled these items in large quantities. As a result, they were sold out for a short time. Since then, many people have followed this example – they realise that flour and pasta are in demand so, for fear of ending up empty-handed, they themselves stock up and the cycle begins again.
This is irrational. The practical need for these products during the crisis is not significantly greater than it was before and there is nothing to suggest a supply shortage. People were affected by perceived panic and followed what they saw as smart behaviour. They jumped on the bandwagon.
This behaviour is reflected in the stock market – particularly in the case of IPOs. When companies go public, the announcement often generates a lot of buzz and investors assume that the value of the company will increase from the IPO onwards. There is, then, an exaggerated rush for shares, leading to a price hike on the first day of trading. As it becomes clear over time that the company does not justify the high price, investors exit and the share drops its value again. As the share price falls in the first wave of sales, investors are influenced again and sell their shares in a panic.
Overconfident and underequipped
Another problem with personal trading is the Dunning-Kruger effect. This is the phenomenon that says that people are prone to overestimate their ability at a task when their knowledge of it is limited. This confidence then dissipates once the person learns enough about the task to understand their own limitations. This can affect how people invest, particularly at the beginning of their time in the markets.
The issue with overconfidence and bandwagon trading is that many have no knowledge of the fundamental data necessary in making sound financial decisions. This can be manageable when the markets are subject to moderate movements in times of relative calm. In times of extreme volatility, though, this lack of knowledge can lead to large losses and an inability to know how to mitigate those losses can be costly.
It is important to remember that, while day trading, you are pitting yourself against companies that do this professionally and on a large scale. Experienced financial giants will take any opportunity to take advantage of less-informed investors without the technical nouse to compete – don’t let yourself become one of them.
Enjoying day trading is perfectly fine so long as those doing it recognise that it is not a viable way to invest and protect capital in the long run, at least not for most people. In times of volatility like this, even the most considered strategies will be subject to risk, the level of which is only heightened once you start attempting to time the market.
Use a proven investment strategy
Ultimately, most people looking for quick wins with amateur day trading will lose out. This comes down to a lack of research and properly scrutinised trading methods, with far too much trading driven by gut instinct, the thrill of pseudo-gambling and blind opportunism. Making money work for you in the markets is a skill that takes years to develop, and even the very best investors cannot predict the future.
At Moneyfarm, we match investors with portfolios that fit their long-term goals and their capacity to accept risk. We have seven carefully curated portfolios, each with a different level of risk assigned based on an investor’s attitude and timescale.
We diversify with a combination of different asset types, regions and currencies that show a low correlation, to ensure a robust investment strategy for each of our clients. Our higher risk profiles will, typically, be more heavily invested in stocks and shares while our lower risk profiles focus more on bonds. We also use carefully selected high-quality exchange-traded funds (ETFs) to help protect portfolios from the ups and downs that individual stocks might go through.
Our lack of focus on trading is beneficial in terms of costs, too. We keep costs to a minimum by focusing on long term trends and our investment in ETFs, keeping your fees down and ultimately adding more to your returns. For more information on our portfolios, click here.