Hold vs Day Trading: New research ends the debate

Hold vs Day Trading: New research ends the debate

Do you buy-and-hold because are you a wise investor or because you are a bad trader? Maybe you prefer day trading because of the greater opportunity for profit or maybe you love the trill of it just like gambling. Whatever your preference between the two, research on the subject has shown a clear winner. How much can individual investors gain or lose with heavy trading? What kind of performance can individual investors realistically get in the face of banks, hedge funds and other large financial institutions? Read on to find out.

We all want to buy low and sell high. But how to get there? One trading strategy is to buy-and-hold, otherwise known as “hodling” in the Bitcoin world. The buy-and-hold strategy is what it sounds like, you buy an investment and hold onto it no matter whether the market is going up or down. The mindset is to not be reactive to the whims of the market. To seek out great ideas or businesses and invest in them long term. The appeal of buy-and-hold investing is simplicity.

Warren Buffett, one of the world’s most successful investors, claims that buy-and-hold is the best strategy. And there are many others that agree with him. Examples of people sticking to their guns through market crashes abound. An excellent example of this are people that held on to their investments during the great Bitcoin crash of 2013. Those that are still “hodling” today have reaped quite the financial reward.

Another investment strategy is day trading. Day traders seek to make money by exploiting price changes of investments during the same day. They buy and sell throughout the day in the hope that prices continue to climb during the time they own the investment to make a quick profit. It is a strategy that many investment firms rely on to make profits.

With the advent of high-frequency trading (HFT), which uses sophisticated automated tools and computer algorithms to rapidly trade, large financial institutions have taken day trading to the next level. At the turn of the 21st century, HFT trades had an execution time of several seconds. By 2010 this had decreased to milli- and even microseconds.

While day trading and it’s more advanced incarnations works for banks, hedge funds and other large financial institutions, can individual investors like you and I do the same?

Brad Barber and Terrance Odean, professors at the University of California at Davis business school, looked into this very subject. Their research demonstrated that individual investors who buy-and-hold generally outperform those who trade often.

In Barber and Odean (2000) they studied the trading of 66465 households at a large discount brokerage firm over a six-year period ending in January 1997. Comparing the performance of the 20 percent of households that traded the most often against a value-weighted market index showed 5.5% lower annual net returns.

The professors concluded that these folks were losing to the market because they were trading too much. Commissions and fees were taking a significant bites out of the profits.

A lot has changed since the time of Barber and Odean’s original work which uses data that is almost 20 years old. With so many new trading platforms, costs for the individual investor have gone down. While the high cost of commissions and fees might have prevented people from being successful active investors in the past, is that still true today?

In a paper that was published a few months ago, European researchers Magnus Dahlquist, José Vicente Martinez and Paul Söderlind show that investors who are actively involved in managing their pension accounts earn higher returns than passive investors.

In Dahlquist, Martinez, and Söderlind (2017) they tracked the performance of people managing their own pension investments in Sweden’s public pension system. The investment options offered are a subsample of the mutual funds offered to retail investors. People may choose up to five funds and can change their allocations on a daily basis at no additional cost.

It was found that individuals with an active initial selection and no subsequent changes earn returns of 1.7% per year. Individuals who make more changes earn returns of 2.5% to 8.6% per year. Differences in risk-adjusted returns are similar, suggesting that higher returns are attributable to better investment performance and not due to risk compensation.

Controlling transaction costs helped remove barriers for people to take a more active role in their investments. This research clearly shows that activity leads to higher performance.

Barber and Odean’s analysis was done during a time when transaction costs were much higher. When those costs are lower, day trading becomes the clear winner.

That’s exactly what happened for financial institutions. As trading technolgy advanced, allowing for faster and cheaper transactions, more firms started using day trading strategies.

The same has become true for individual investors.

In today’s market individual investors can definitely do well by taking a more active approach to trading. But are there any dangers in going down this path apart from the obvious financial ones?

There is mounting evidence that stock market trading can become excessive and addictive similar to other behaviors (e.g., Grall-Bronnec et al., 2015; Marković, Nikolac, Tripković, Haluga-Golubović, & Ćustović, 2012; Turner, 2011). Research shows that excessive trading can be conceptualized as a subset of gambling disorders.

The link between day trading and gambling seems to be a two way street. Both Arthur et al. (2015) and Arthur and Delfabbro (2016) showed that day traders were significantly more likely to also engage in traditional forms of gambling compared to the general population. They also had a distinct preference for skill-based formats such as poker, casino table games, sports betting, and horse and dog racing.

Gambling when taken to excess can lead to insomnia, anxiety, depression and suicidal thoughts. Problem gamblers aren’t the only ones who can suffer. Migraines, insomnia, depression and other stress-related issues can affect the family of people with problem gambling as well as the gamblers themselves.

Day trading doesn’t necessarily lead to these problems but there is a link between the two. Much is said about the financial risks of day trading but there are also health risks involved. While more research needs to be done in this area, someone that is going to start day trading needs to seriously consider these risks.

Even if you’re comfortable with those risks and start trading more actively, financial institutions also use sophisticated investment options to help give them an edge.

The problem is that even when individual investors have access to more sophisticated investments, like structured financial products, the average person could not turn a profit. Even when transaction costs are ignored.

The results from Entrop et al. (2014) suggest that investing in innovative financial products does not pay off for individual investors. Rather, the issuing banks are able to exploit the investors’ inability to calculate fair prices for complex payoff profiles by selling products at high premiums.

Moreover, retail investors seem to find the task of selecting complex products for their portfolios difficult. One possible explanation for these results is that investors lack the necessary skills, knowledge, and time to understand this complex market, which is characterized by a wide variety of products and high search costs.

Individual investors are at a clear disadvantage not only because of the lack of sophisticated investment but also from lack of knowledge and time.

Knowing all of this what can the average investor do?

The real question comes down to what makes sense for you.

Buy-and-hold is definitely a strategy that works and it has made people like Warren Buffett very rich.

It’s also a strategy that takes less money, no advanced tools necessary and less brokerage fees.

More importantly it takes less time, something that most people today are short of between work, friends and family.

Buy-and-hold most definitely has it’s disavantages. What to buy? Stocks, bonds or comodoties like gold? And when is the right time to sell?

There’s an endless stream of headlines that will promise you adivce on the best stocks to hold. But is the stock market a good option for buy-and-hold?

Investment indexes based on stocks like the S&P 500 are often used to support the case of buy-and-hold. The truth is more stocks have vanished or gone to zero than have survived to this day. That is why the very indexes used to support the research for buy-and-hold do just the opposite – they sell and replace stocks regularly. Why would you do any different?

Bonds are a great options for holders but with current interest rates this is not much of an option.

Finally what about a solid tangeble commodity like gold?

Gold is great. Over human history no other investment has been a more stable store of wealth.

None the less over the short term there is still the potential for large volatility, and a miss timed purchase or sale can still result in strong loses.

Historically gold is more resilient, and holds its worth better than any other investments, particularly in times of economic instability.

So what if there was a way to have an investment that was based of gold which used the commodity to limit downside risks?

On May 8th 2017 that new option will be available.

OneGram is a new type of investment that utilizes blockchain technology to create a new kind of cryptocurrency, where each coin is backed by one gram of gold at launch.

No investment can guarantee absolute stability, but what OneGram does is it limits your exposure to the downside risk. Because the base price of OneGram is always at least equal to the spot price of gold, OneGram has a floor price.

When the coins will go on sale at the Initial Coin Offering (ICO), there will be 12,400,786 tokens. All of them will be available for purchase through our partner gold exchange, GoldGuard, an online gold trading platform that enables customers to buy and sell gold at spot rates and physically store it.

OneGram has an intrinsic value as they are backed by physical gold.

In addition, transaction fees collected from the use of OneGram coins (OGC) are reinvested in more gold (net of admin costs) increasing the amount of gold that backs each OneGram. Therefore, each OGC increases in real value over time, making OneGram unique among cryptocurrencies.

OneGram is an asset class that increases in value. Not just from the price of gold but also from the amount of gold that backs each coin, which increases with each transaction. This makes OneGram a forever increasing valuable asset.

In today’s world, day traders have a technilogical advantage over regular investors.

OneGram aims to help level the playing field and offer those that like to buy-and-hold a new option that has limited downside and unlimited upside.

J. Paul Getty says it best when it comes to investment advice:

“If you want to make money, really big money, do what nobody else is doing. Buy when everyone else is selling and hold until everyone else is buying. This is not merely a catchy slogan. It is the very essence of successful investment.”

In a world where the chips are stacked against those that buy-and-hold, OneGram is a new investment option for hodling.

To find out more about the OneGram Initial Coin Offering, feel free to sign up to our mailing list or contact me at @onegram.co.uk.

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