Sell low, buy high

August 13, 2011 in Finance

The WSJ is running an article comparing today's second-by-second "iPad inverstors" to the day traders of the dot com bubble. The article's point, near as I can tell, is that volatility makes people worry more about the markets, and that people aren't comfortable without instant feedback.

I have a suggestion for the WSJ: A decade ago, you championed day-traders as the New Investors. You were wrong. Don't make the same mistake.

More importantly, stop writing about the trading activities of people who aren't involved in finance!

The article profiles five individuals with the following jobs: public-relations executive, advertising strategist, website editor, comedian and real estate consultant. I have nothing against these people, but why would anyone pay attention to their investment ideas? Does the website editor go polling financial analysts every morning? Does the comedian run his jokes by his broker? I fail to see the relevance. I'm sure the Journal would like us all to believe that "anyone can do it!" because that's great for their subscriptions, but this is ridiculous. If I opened a car magazine and saw the recommendations of some bond trader, I'd throw it away.

I'm sure if these people were offering legal advice we'd recognize it as ludicrous, but we seem to have no problem accepting financial advice from just about anyone. The truth is that this is because it's very hard to separate skill from luck when it comes to investing. Careers have been made (and lost) on that principle. But I don't understand why most people err on the side of "skill" rather than "luck" when evaluating someone else's ability.

Nonetheless, the article tries to use these people to demonstrate some "good" principals (I hope you can hear the sarcasm dripping off those quotation marks). For example, one man says "I'm just a regular guy who started the month with a 401(k) balance, and am trying to make sure it's still there next month." His solution: day trade volatile markets on his lunch break! Please, do NOT follow his lead. If you want your 401(k) to survive, then set it and forget it (at least for a few weeks). You run a greater risk of harming it through active trading, especially since 401(k)'s are generally invested in mutual funds, not individual stocks, which can only be traded after the close. So how are you day trading in the first place? The bottom line is: 401(k)'s are multi-decade investments. If your strategy depends on the hour or minute in which you execute a trade, then you're doing it wrong.

And it gets worse:

Andrew Clark, a 30-year old, real-estate consultant in Birmingham, Ala., sold about half of his Apple Inc. stock on Monday morning after it opened 3.2% down. During a client meeting, he missed a brief rally when the stock went up 1.7%.

"I would have bought those back at that point," Mr. Clark says. "If you aren't glued to these movements, you miss so much."

So just to be clear: AFTER it fell 3.2%, he sold. AFTER it went up 1.7%, he would have liked to buy back in. In other words, even though the stock only was down 1.6% over two days, he would prefer to have lost 2.4% (effectively, half of his shares losing 1.6% and half of them losing 3.2%). You could argue -- and he probably would -- that this is actually rational behavior, because he sold when it wasn't clear whether or not the stock would stabilize. Therefore, it's easy for us to say in retrospect that he should have stayed in, but if it had kept going down he would have looked really smart. But that's wrong -- if he genuinely wanted to get long the stock when it was down 1.6%, why didn't he really want to be long when it was down 3.2%? If that single gain of 1.7% was sufficient to tell him that the stock was going to continue upward, then the man is a brilliant investor beyond any I've ever encountered. I think it's much more likely that he committed a common investment fallacy: sell low, buy high.

I've mentioned many times a theory that financial bubbles accompany any expansion of the investment universe. Day trading (and its more recent cousin, mobile trading) epitomize that trend. A few weeks ago, a colleague of mine sold his portfolio when his cabbie started giving him unsolicited stock tips. Just because everyone should invest does not mean everyone can invest. It's about time we stop trying to perpetuate that myth and focus more on real financial education. Investing is a very serious business with real potential for significant loss, not a hobby.

So if you find yourself wondering if you should call your friend in advertising for financial advice, just stop.

Frankly, if you find yourself wondering if you should call your broker, you should also reconsider. His objective may be your commission, not your wealth.

And if your first thought is to call your lawyer, I'm afraid you may have larger problems than we can address here.

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