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September 30, 2014

Warning Sign: Day-trading Back En Vogue?

By Wolf Richter at Wolf Street

Stories like these – “Return of the daytrader: can you earn a living by copying other investors?” which the Telegraph ran on Saturday – are priceless:
It promises an irresistible combination of wealth and independence. All you need is a computer and an internet connection – and then you can earn a fortune from the comfort of your home.
This is the lure of financial trading for profit. As the popular BBC programme Millions by the Minute has shown, the dream seems to be gaining hold. It appeals to parents who hope to be able to squeeze in some profitable trading between school runs. And it is equally a way out for those who simply don’t want – or don’t fit into – the corporate world of the office.
Now the world of social media has added an additional, attractive twist to the dream of being your own boss and making a killing. With “copy trading” – which enables you to mimic the investment moves of the “professionals” – you can supposedly cash in even if you know nothing at all about the markets.
The fact that this day-trading theme – the idea that anyone can just shuffle stocks around for a living – is showing up on public television, even in the UK, that companies see an opportunity to make money off these folks, and that big newspapers like the Telegraph report on it, even if tongue in cheek – that’s like so January 2000.

There are many parallels today to the zaniest days of the dotcom bubble, but this time, it’s different: it has a darker hue – particularly concerning retail investors.

The Wells Fargo/Gallup Investor Optimism Index, released on Friday, jumped 17 points to +46, the highest level since fall 2007. That was the time when the US was teetering on the Great Recession and the Financial Crisis. It was the time just before all heck broke loose.

But these exuberant respondents are not investment pros on Wall Street, or wealth managers, or big investors. These are people with $10,000 or more in stocks, bonds, mutual funds, or in a self-directed IRA or 401(k). So not the entire American public but only those who have a stake (if a small one) in the markets. The results are based on interviews with 1,011 of these folks, 374 retirees, 631 non-retirees, and 6 people who I would guess checked “neither.”

So how knowledgeable about the markets are these exuberant folks? Turns out, these are the same kind of folks, based on the same selection criteria, who in a Wells Fargo/Gallup poll in August had mostly no clue how the stock market did last year.

They were asked a simple questions: “As far as you know, how did US stocks perform on average in 2013 – did they increase in value, stay about the same, or decrease?” If they chose “increase, they “could pick 10%, 20%, 30%, 40%, or 50%.

It so happened that 2013 was a special year. The S&P 500 chalked up a total return, including dividends, of over 32%, the most phenomenal performance since 1997. So not exactly a common event. These retail investors should have noticed. But they didn’t. The bulge bracket (37%) figured that stocks had gained 10%, while 21% thought stocks had remained flat, and 9% thought stocks had declined. Only 7% got it right.

These folks are now finally the most optimistic since 2007.

But this time it is different. At the peak of retail-investor and day-trader mania during the dotcom bubble in January 2000 before their brokerage accounts got cleaned out, the index hit 178, before plunging to 50 by mid-2001. In early 2002, the index climbed to back to 121, only to plunge to 5 a year later. By the end of 2003, it recovered to 108, dropped to 34 in 2005, and rose to 103 in early 2007. It then entered what at first looked like its habitual plunge. Only this time, it didn’t stop and just continued plunging until early 2009, when it bottomed out at -64.

Since the optimism peak in January 2000, small investors have consistently gotten fleeced, buying during the late stages of the run-up when their optimism surges, and selling when their pessimism plumbed new depth near the bottom of each downturn.

Each time, their optimism got whacked a bit more. And after each recovery, their peak optimism was weaker than before. It’s a downward slope of lower lows and lower highs. But what is still missing in this scenario is the next major downturn, and how, after it cleans out the brokerage accounts of these retail investors, it will decimate even further their long-run optimism about investments.

If this downturn grows into a crash, it will be for many retail investors the third crash in their investing lives; and for middle-aged retail investors, it will be the fourth crash. Confidence and optimism about stocks might go the same route that it went with retail investors in Japan – where it went completely to heck.

Courtesy Wolf Richter at WolfStreet.com (EconMatters archive HERE)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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