Advertising-Increasing The Biases
Every day you are bombarded with advertising that magnifies your psychological biases. This is no accident. Financial services firms, online brokerages, and even Internet providers know how to increase your level of excitement.
An E*TRADE commercial claims that online investing is "A cinch. A snap. A piece of cake." A middle-aged woman in a Datek Online commercial declares, "I'm managing my portfolio better than my broker ever did." Two suburban moms return home from jogging in an Ameritrade commercial: a few clicks later one says, "I think I just made about $1,700!"
Consider the infomercial run by "Teach Me to Trade, LLC." Many testimonials describe how the system being sold has allowed them to trade four to five hours a day, even as little as one to two hours a day, and earn $1,700, $2,500, even up to $4,600 in profits per day. Clearly, it must be easy to obtain wealth by frequently trading. Comments abound like "everyone is trading," "this system is all you investments." Notice how
the social aspects, the illusion of information, and the illusion of control are fostered. Unwittingly, the infomercial also gives a peek at the addictive side of trading with testimonials that proclaim to "love the excitement," or "I don't think anything can compare to the rush."
ONLINE TRADING AND PERFORMANCE
So online investors trade. They trade a lot. However, if the advantages of the Internet outweigh the magnified psychological biases, then we should all start trading. What kind of returns do online traders really get? The online trading study also examines the performance of the investors before and after going online. Before switching to the online trading service, these investors were successful. As illustrated in Figure 12.2, these investors earned nearly 18% per year before going online. This represents a return of 2.35% more than the general stock market per year. However, after going online these investors experienced reduced returns. They averaged annual returns of only 12%, which underperformed the market by 3.5%.
The successful performance of these investors before going online may have fostered overconfidence due to the illusion of control (via the outcome sequence). This overconfidence may have caused them to choose the Internet trading service. Unfortunately, the Internet trading environment exacerbates the psychological problems, inducing excessive trading. Ultimately, investor returns are reduced.
DAY TRADERS-THE EXTREME CASE
Although the term day trader has emerged as a household phrase, the number of true day traders is quite small. Day traders trade stocks as their full-time job. Although there are no industry numbers available, probably less than 1% of online investors are actually day traders. They trade into large positions temporarily to capture quick
|
20%-r |
Before Going Online
After Going Online
H Market Adjusted
Return □ Total Return
Figure 12.2
profits and then trade out of the positions. Indeed, the average day trader makes 130 transactions in a six-month period. This compares to about 12 trades for the average online investor.
The day trader's tools are a souped up computer and a fast connection to the Internet. These traders may work at a day-trading firm or trade from home. Imagine the attraction of a large screen with multicolored lights. Some lights are flashing indicating a chance to make some money. Add some bells and whistles and you have the Las Vegas casino environment. Indeed, if you are trading at a day-trading firm, then you are near others shouting for joy and anguish. If the Internet environment increases your psychological biases, imagine the amplification in the day-trader environment. Interviews with day traders yield quotes like "it's very addictive" and "you lose sight of everything."
Day-trading firms seem to recognize the psychological problems and the stress associated with day trading. Companies like Broadway Trading LLC offer counseling through a psychotherapy clinic. The nature of day trading is similar to casino gambling. Traders can become addicted. High stress and addiction can cause you to snap.
Consider what happened to Mark Barton. His Atlanta day-trader colleagues described Mark as a nice, religious family man who was having an unlucky streak.6 (Note the reference to "an unlucky streak"—the idea that profits derive from skill and losses derive from bad luck is a typical psychological bias for an overconfident investor.) Unfortunately, it was much more than an unlucky streak. Like an addicted gambler, Mr. Barton followed big losses with more risk and higher stakes. He could not stop gambling on stocks. Eventually, he had exhausted his money and his credit. Mark Barton snapped. After killing his wife and two children, he showed up at the two day-trading firms he used and killed 6 people and wounded 13 others.
Mr. Barton's case is the most extreme. However, many others feel the same addiction. Consider Gary Korn, a 43-year-old lawyer.7 He was a day trader in the morning at home, and then went out to practice law in the afternoon. He often made more than 100 trades a day. Mr. Korn describes being mesmerized by the trading screen and hooked on trading. But Mr. Korn is lucky—he recognized his symptoms and quit. After realizing his return over a six-month period was only 28%, he moved his money to a broker. He properly diversified and says he even owns General Motors Corp. stock, although he is "bored to tears" by it.
The day-trading addiction is strong! Mr. Korn may have quit just in time. Not many do. Securities regulators investigating the day-trading firm Block Trading Inc. allege that only 1 of its 68 accounts made money.
SUMMING UP
Overall, the psychological biases induced by online trading and day trading seem to outweigh the advantages. When your focus moves from investing to trading, your wealth is harmed.
Internet investors don't just risk hurting themselves. Sometimes the frenzy of trading leads to an exuberance that harms the companies being traded. How much of an influence this exuberance has is demonstrated in Chapter 13.
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