Majority loses money in stock market, information flood out of internet makes it a generally known truth. But data-based researches help us to convert information into believe, helps improves our perception and sometimes enable us to understand WHY?
SEBI Study:
Whenever you login into trading account you can see following notification which mentions bullet data points from SEBI study and clearly tells that 90% of the participants trading in market incurred net losses.
University of California study:
Different researches conducted by Brad M. barber, Graduate School of Management University of California, and his colleagues on the data received from Taiwan stock exchange and other sources. They concluded following observations during various researches:
- Analysis of the day trading of hundreds of thousands of investors over a seventeen-year period showed that 60% of day traders left after only one month, remaining quitted after a period of 3 years and only 13% left, after a period of 5 years only 7% left and in future only 1.6% of them were able to earn more than fees paid. (2017)
- They also concluded in data-based research that value of around 2% of GDP is equal to loss of individual traders.
- Individual investors, incur huge loses in active trading, who mostly hold common stocks. (2000)
- Stock trading was reduced by 25% when lottery was introduced in Taiwan in 2002. (2009)
- wrong focus on earning huge money in short time like lottery.
Research published by Calvet, L. E., Campbell, J., & Sodini P. in 2009 in The quarterly journal of Economics states that :
- “Investors tend to sell winning investments while holding on to their losing investments.”
- wrong trading method of cutting profits in place of loses
Mr. Kumar, University of Miami, in 2008 published a research conducted on data collected from large brokerage houses says:
- “Socio-economic and psychological factors which are known to influence lottery purchases lead to excess investment in lottery-type stocks. Results suggest that due to our fundamental desire to gamble, the link between socioeconomic dynamics and the stock market behavior may be stronger than currently believed. Of course, this should not come as a surprise as psychological, social, economic, religious, and political identities of an individual supersede her identity as an investor.”
- wrong psychological process of remaining influenced from losses and profits of latest trades.
Sankar De , Naveen. R. Gondhi and Bhimasankaram Pochiraju in 2010 found that:
- “We find that the sign of the outcomes of recent past stock trades, where a positive sign indicates a profitable trade and a negative sign an unprofitable trade, influences the current trading decisions of investors strongly. Further, the influence of the sign of past trades is significantly stronger than the size of the gains or losses from the same trades. We also find that, on an average, trading under the influence of the sign of past trades consistently results in decline in profits for the investors. Our findings are consistent with a behavioral explanation suggested by recent research in experimental psychology that the investors are more sensitive to the affective intensity of a stimulus than to its magnitude.”
- wrong psychological process of remaining influenced from losses and profits of latest trades.
Through these researches we can point out some important facts.
- Only 1.6% of participants are successful in trading.
- Retail trader accounts to loses equivalent to 2% of GDP (a huge loss).
- Lot of traders enters stock market with a perception of lottery.
- Participants tend to hold on their loses but book profits comparatively earlier.
- People’s decision is highly impacted by their last trades.
These facts show that majority loses, and loses huge amount because of their wrong focus(focus on earning money not on the challenges) on earning huge money in short time span as they consider trading as lottery, wrong risk assessment & management of cutting profits in place of loses and because of wrong psychological process of remaining influenced from losses and profits of latest trades.
People with wrong focus are the majority in first category who quits trading in one month to 3 years. Because of their reckless approach, people with wrong focus, soon realize strong losses in market and quit.
People with wrong psychological process either change their psychological process or they quit market because Moving against your beliefs or psychology is pain and cannot be sustained for a longer period. Wrong psychology people are majority in category who quits in five year.
At the end, people with wrong risk management and assessment survive longer but quits after 5 years because of one huge loss due occurrence of some very low probability case which is not expected to occur.
Do fund managers also need to master above mentioned three traits ??? The straight answer is yes and even they being responsible for larger sum of money from public they should be master in these traits. But many times their inefficiencies leads to huge money loss and even collapse of such big size funds.
Following are some of the cases of broke hedge fund to understand the reason of failure:
Case 1: (GameStop) - people with wrong risk management and assessment
GameStop Corp. (NYSE:GME), a brick-and-mortar retailer of video games, consoles, and accessories, has been hit by the growth of eCommerce and its situation was further boosted by the pandemic-caused lockdowns. Seeing an opportunity, some major hedge funds worth billions decided to short-sell GameStop Corp. (NYSE:GME)'s stock, i.e. to bet on the stock going down. However, unexpectedly, an army of Reddit users decided "to fight back" and heavily invested in the stock making it rise more than 400%. This resulted in losses worth millions for hedge funds. Melvin Capital, one of the major short-sellers in this scenario, was down 30% and required an injection of $2.8 billion from Citadel to continue functioning at the level required.
- Case clearly shows over confidence of fund manager on his selling strategy while not estimating the very low probability chance of retail traders being producing higher buying pressure in comparison to hedge fund manager. Fund manger has not hedged for that case.
Case2: Marin Capital - people with wrong risk management and assessment
Marin Capital was based in California and had at least $1.7 billion in capital. It used complex financial arrangements such as credit arbitrage and convertible arbitrage to essentially bet on General Motors Company (NYSE:GM). In credit arbitrage, companies can basically transfer credit risk of a payment default to hedge funds. In the case of convertible arbitrage, convertible bonds are issued which are debt instruments that can be converted into stock. These are considered to be low risk strategies, except on the off scenario that the stock's price dips dramatically, which is exactly what happened with General Motors Company (NYSE:GM), and led to the closure of the fund.
https://www.marketwatch.com/story/marin-capital-hedge-fund-folds-sees-few-opportunities
- Again leaving low probability case as not hedged.
Case 3: Amaranth Advisors - people with wrong risk management and assessment
Next in line in our list of biggest hedge fund failures is Amaranth Advisors. Sometimes, a hedge fund can try its best and simply get suckered into a bad deal which ruins the fund. This is what happened with Amaranth, which had assets under management of around $9 billion, providing massive returns of around 86% due to using convertible bonds. However, some massive bets on derivatives failed to deliver, and the fund made losses of more than $6.5 billion
https://en.wikipedia.org/wiki/Amaranth_Advisors
So, trading on higher probabilities doesn’t guarantee your performance but it’s the risk assessment & management which guarantee your consistent performance. Be it a hedge fund trader or a retail trader for being successful in trading world you need –
- Right focus
- Right psychology
- Right risk-assessment and management capabilities
