Why do people do so poorly at day trading? – 07/18/2023 – Bernardo Guimarães

What should the temperature be in Curitiba at noon next Sunday?

Every year my students have to look for the best possible answer to a question like this for a graded assignment.

All of them invariably go to weather forecasting sites.

Until today, no one has tried to watch videos on YouTube to learn meteorology. They never thought to look at graphs of past temperatures to guess the future. The idea of ​​seeking a better forecast than that of the specialists did not cross anyone’s mind.

Reasonable, right?

Interestingly though, crowds seek to do just that in the world of day trading.

Day trading consists of buying and selling shares on the same day. The idea of ​​making a living from it is very seductive. Gambling is fun, being able to work with your computer anywhere is convenient, and whoever hits more than misses will actually become a millionaire.

The fact, however, is that, in the long run, almost every individual investor loses. And the logic behind this is the same that leads us to believe that the forecast from meteorological institutes is, on average, better than what we would do if we tried to learn from videos on YouTube how to predict the weather by looking at graphs of past temperatures.

Financial prices are like forecasts. If everyone thought that Petrobras shares tomorrow would be worth R$0.10 more than they are now, everyone would try to buy — but who would sell? That price wouldn’t be that low.

In reality, market participants have different expectations about asset prices. Thus, today’s market price reflects a sort of average of expectations about tomorrow’s price.

In this market, we have financial institutions with the best equipment and specialists in finance, economics, numerical methods and computer science. People who studied a lot, got a master’s degree, a doctorate, and that’s all they do for a living. Its computers operate inside the Exchange.

There is also an enormous amount of people learning on YouTube, reading texts with less than 50 pages with allusions to complicated terms (like the Fibonacci sequence), apparently sophisticated, but essentially simple.

Who will have the best prediction on price movements? Who will, on average, hit more?

Who can predict the weather better? Institutes with state-of-the-art equipment and experts in physics and meteorology, with many years of education and experience, or an individual using rudimentary methods and his personal computer?

I don’t know much about meteorology, but empirical studies of individuals’ day trading performance do exist.

Researchers Fernando Chague and Bruno Giovannetti have been researching the behavior and performance of day traders and individual investors for many years.

In one of their works, co-authored with Rodrigo De Losso, they show that the overwhelming majority of day traders lose money, much more than if they operated randomly. And their performance doesn’t seem to improve over time.

Most people who try to profit from day trading quickly find themselves in a bind. However, a substantial minority persists. Many only stop when the money is gone, the road has come to an end.

Long-term investments in the financial market can bring benefits to those who buy and sell assets. However, day trading is a zero-sum game, like a bet, a game, a fight: if one wins, the other loses. But we don’t see who he’s fighting.

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