Last Updated on 26 July 2021 by Dan
Hello everyone! In today’s post I wanted to focus on the shift into investment via retail trading apps particularly when these apps are being used either for day trading or short term investment.
Increasingly this form of investment has come more and more into focus with the rise of apps such as Trading212, EToro, IG Markets and RobinHood over in the US.
These app enable you to own single stocks or even a fraction of a stock, which an increasing proportion of the market hold with the aim of either holding for just the day or for relatively short term period.
If you’re new to investing you’re likely to come across this style of approach quickly, because it’s the side of investing that seems to have taken off from a social media point of view – you don’t have to search too far to find excitable YouTube videos talking about trading strategies, dividend reports, and some quite aggressive marketing campaigns.
A couple of minor celebrities like Dave Portnoy also used their “time out” from their business to talk about how well they’d done with day trading. – he had a really good run when starting it out and through a series of rather brash if tongue in cheek videos on Youtube declared himself to be a better investor than Warren Buffet!
Now given we’ve talked in the Starting to Invest series repeatedly about the benefits of investing, a logical question might be to ask if getting involved in using these apps for day or short term trading is a strategy I’d suggest trying.
And my answer? Well it’s easy:
There’s a fundamental difference between trading and true investment. Trading is often a short term bit of positioning on something very specific to try and make a quick buck or advantage of a specific situation. Investment is long term and based on underlying fundamentals that are about understanding long term business performance.
And for avoidance of doubt I am talking about short term trading only when I discourage it – I am a firm believer in careful, long term investing, and will happily point you towards index and tracker funds as an alternative to trading apps.
What do I mean by short term? Being in anything you don’t feel you’d be happy to hold for 5 years if you needed to.
Here’s my reasons why I think the short term/app approach is a bad one and likely to set back rather than advance your financial goals. Don’t get me wrong – a professional, experienced investor can still avoid all of these traps using the apps, but from what I’ve seen those that are using them often do not fall into that category.
The reasons why I would avoid retail trading apps as a rookie investor:
You largely lose the benefits of diversification, exposing yourself to greater downside risk
To construct a stock portfolio optimally we ideally want to maximise the reward that we can get (in the form of returns) whilst minimising the risk (of you losing money).
Now whilst you can never get rid of risk entirely whilst trading, professional portfolio construction (when done well) will focus on stocks that will behave differently in market conditions – so you end up less exposed to what’s happening in the wider market that you otherwise would.
This is largely done through mixing stocks which are cyclical (such as consumer goods) with those that can be counter-cyclical (some commodities spring to mind).
When the wider stock market is going up, you largely don’t care – in fact you’ll probably conclude the day trade is easy and wonder why you didn’t do this sooner. It’s like when you’re at a casino and have a sudden hit of beginner’s luck – that thrill of winning your spoils is so exciting! It’s on the way down it can hurt, and hurt badly…..
Obviously you can do the diversification element yourself – but it’s not the first thing a lot of rookie investors will have thought about, and the apps are not built for this kind of analysis.
I’m going to write a fuller, more technical post on how the maths behind diversification works, but it’s one of the stock investing principles that holds up as tried and tested time and time again.
You expose yourself to high short term volatility that has little to do with the company you own.
This is a variant on the above. When it comes to valuing a stock, at the very least you’re usually giving this company money because at the most basic level you like their long term business plan, and in an ideal scenario you’ve analysed their financial statements and been able to come up with a reasonable valuation of the company that you can match to the share price.
The problem is that when we get away from those fundamentals, in the short term there’s such a wide range of factors that can come into play to hit a stock’s value for a short period of time. A run of bad economic data can cause the market to sink, and take the value of your stock with it. A lull in sales can see a bad quarter.
When you’re a long term investor you can shrug these things off quite happily – because you know that a good business will have the reserves to shrug it off and adapt as necessary for the future.
Investing is usually at it’s most successful when it’s the opposite of love – cold and dispassionate! When I’ve made mistakes investing, it’s usually because I’ve “fallen in love” with a particular share or business model. Like when your friends tell you that someone is probably bad for you (and are inevitably right) I didn’t want to listen. You lose sense and reason when the emotions come into play.
The apps have increasingly focused on making trading most exciting with rewards and animations – now whilst investing shouldn’t be an entirely dull affair, some of them I’ve seen create an emotional attachment effect to get you on them more. A little like Facebook, where you feel that compulsion to check it out and get all the latest updates, but not sure why.
It’s not healthy behaviour or the foundation of good decision making – it becomes very easy to overstretch or feel mental effects from the ups and downs. Godfather of investing Peter Lynch at Fidelity wrote that ironically, one of the most successful performance strategies is buy some solid stocks and not look at them or read a newspaper for several years, no matter how counter-intuitive that may sound. His point is that we have a major tendency to overreact to the short term.
You can avoid all the above worries cheaply and easily
The apps often market themselves in terms of “democratising finance” and making it easy to trade, but in practice investing is not hard and it’s very easy to do in much safer ways, which avoid all of the above traps.
Yes, I’m talking about boring index or simple funds. They’re so low cost now, and provide easy access to the markets where the advanced risk construction elements are done for you. Yes, it’s not as exciting but if you aim is to make money long term, they consistently pay off.
The Apps increasingly provide a gateway to CFD products, complex options and leveraged products.
This is where I get really worried with these. A lot of the apps have their roots in products called Contracts for Difference (CFD’s) and option products.
Now these have legitimate and good purposes to professional investors in banks, but they’re dangerous products for retail investors and rookies as they have the most extreme upsides and downsides. I consider myself an experienced investor, and I’m not touching these with a barge pole. (With good reason I think – the numbers show 72% and 80% of retail investors lose money on CFD products, simply a statistical fact.)
Another potential danger is the use of leverage – borrowing money to finance trades. When it goes wrong it can go wrong big time as your losses are not just limited to what you’ve put in. It’s something I wouldn’t countenance with a single investment, and it’s at it’s worst with the more complex products where things are more likely to go wrong.
Now, the apps in fairness don’t grant you automatic access to these products – they are you to self-certify that you’re an experienced investor that can handle these types of products.
It’s to some degree on you if you say you are and enter this world, but it worries me when I see the guides to complex option strategies from people on YouTube who are definitely not experienced investors.
The Youtube videos I looked at as research varied in quality, to some genuinely good trading advice to lots of focus on the gains that were apparently from trading, often the the form of sports cars.
I think YouTube is great for learning a lot of things (I fixed my shower from it for example) but remember that the Instagram effect is in full effect here. Most videos were relentlessly positive, focusing on how everyone was having a great time and doing so well, but remember “instagram vs. reality!”).
People like to talk about doing well and show off. The bad decisions and losses (and associated mental stresses) get much less airtime.
You focus on doing your thing, and never fall for the illusion that everyone else is doing well except for you (and that applies to far more than just investing).
I sound very negative on these from the above. In practice, I think they’re not all bad if you either can really, honestly say you know what you’re doing in depth and want to build a portfolio, or you do actively want to position on a stock because you think there’s a really good case for it.
My concern is more about those at the newer end of investing for whom these apps are increasingly becoming a gateway. It’s jumping into the deep water, before you’ve learned how to swim. I’ve felt a bit of a killjoy writing this article because I feel I’m going “that looks fun, so don’t do it” – but the aim of this blog has always been for you to get the most out of your money and investments in the safest and most efficient way possible.
And that’s it!
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