You have heard the hype. Everyone is trading stocks at home. What could go wrong?
Reporters at The Wall Street Journal write that today’s retail investor mania, pumped up by popular trading platforms like Robinhood Markets and E*Trade, appear “even bigger—and broader—this time” than during the dotcom era.
For those of you old enough to remember the dotcom bubble burst, that’s not a good comparison.
Trades this year by individual investors more than doubled the usual level of retail activity, said Joseph Mecane, head of execution services at market maker Citadel Securities. Individuals now account for a fifth of all stock-market activity and a quarter during the busiest sessions, he added.
The influx of traders has increased the demand for most stocks and sent shares of some individual companies soaring, analysts say. As the benchmark S&P 500 has climbed more than 40% from its March lows, Goldman Sachs Group Inc. said stocks popular with individuals have generally outperformed those held mostly by hedge funds and mutual funds.
But there are reasons for concern about the overall performance of individual investors. For one thing, some academic studies have demonstrated the challenges individuals have in trying to beat the market. Barclays examined trades by Robinhood customers between March and early June and concluded that the more they bought a specific stock, the worse that stock performed.
It’s never been cheaper to trade. Robinhood pushed commissions to zero, a move Charles Schwab Corp. and other brokerages followed last year. To lure new customers, brokerages are now offering incentives including free shares of stock and free access to riskier financial trading tools.
“How much of this is a permanent or temporary change? My best sense is it’s a little bit of both,” said Mr. Mecane, referring to the impact the elimination of trading commissions has had on retail activity.
Don’t forget though, that you invest, but they win. The WSJ goes on to explain how investors are paying for the “free” trades:
Brokerages make money on free trades by sending customer orders to trading firms in exchange for cash, a controversial but legal practice in the brokerage industry called payment for order flow. While customer orders must be executed at the best available price, trading firms have numerous ways to use the trades to their advantage, including to mask larger buying and selling by the firm or its clients.
Brokerages also can profit from cash that sits idle in customers’ accounts.
If things look too good to be true, they are, or they will be. Focus your investing–not speculating like the day traders looking to a “greater fool”–on diversification, compound interest, and prudent decisions.
If you’re ready to get serious about your financial security, subscribe to my monthly Survive & Thrive newsletter. But only if you’re serious.
E.J. Smith - Your Survival Guy
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