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Reflections on Actively Trading in the Stock Market for a Year
Disclaimer: None of this is trading/investment advice. All opinions are mine alone. Do your own research before engaging in such activities. I am merely sharing my own experience in the market. This article is meant for information/entertainment purposes only.
I have been interested in the stock market for a long time. When I was younger, there weren’t so many resources available on how to get started with it. Besides the market wasn’t really all that accessible either. More importantly, I didn’t really have any capital to meaningfully participate in the market. I am talking about high school days here.
Nowadays, there are so many beginner-level resources available on how to get started in the stock market. The market itself is so much more accessible as well. Brokerage apps like Robinhood (US), Wealthsimple (Canada), and Trade Republic (Europe) present a possibility for people to easily participate in the market and manage their investments through well-designed user interfaces.
At this point, I have been invested in the stock market for almost 15 years. Having said that, I have never been an active trader up until this year. My strategy has been primarily around buying stocks and ETFs and then forgetting about them.
For me, buy and forget (aka buy and hold) hasn’t necessarily been a deliberate choice. There is so much friction to the brokerage applications that I have been using that I haven’t been really tempted to check on how my investments are performing. This actually has been a blessing in disguise since buy and hold is a surprisingly powerful and reliable investment strategy. It is just not an interesting one.
Those brokerage apps that have I mentioned above have started to alter how I and many other people interact with investing and trading. They make it extremely easy to buy and sell stocks, check your investments and discover new assets to purchase. They are built using user experience patterns that almost gamifies investing and trading. This is both a good and a bad thing.
It is a good thing because you can now get invested in the stock market fairly early. One of the golden rules of investing is maximizing your time in the market. The overall trend in the stock market is upwards so if you stay invested long enough, you have a lot of chance to make profits. This essentially means that the earlier you are invested in, the more benefits you can reap. These apps also have democratized investing. They put it in the reach of more people. There are so many more retail (non-professional) investors nowadays than it was before thanks to these apps. Retail investors now have a voice at the table and can make a meaningful difference in how the market functions.
These apps have also been bad though. Some of them (not all) make it really easy for people to take uncalculated risks and expose themselves to huge downsides. One of the riskiest things you can do with trading is to risk the money that you don’t have. This could happen through using a margin account or when dealing with financial instruments like Options. In my 15 years of investing, I have never even been tempted to utilize such things because they have been way out of my reach. But unfortunately, some of these apps make these approaches and instruments very accessible for the potentially uneducated masses.
I am living in Germany so I have decided to open up a Trade Republic account at the beginning of 2021 and use it to do some active trading for a change. As I have mentioned above, passive investment is actually a reliable and powerful way to be invested in the markets. It is also incredibly boring. That’s why I have decided to take things into my hands. My timing was perfect because this was right before the GameStop short squeeze and WallStreetBets went mainstream.
After opening my Trade Republic account at the beginning of 2021, I have YOLO'ed into a bunch of meme stocks like AMC. By end of February, I was already down around 20%. My intention was to treat this as my play account but my losses started to annoy me.
The problem with these applications is that they have addictive properties. It is really easy to constantly check your account. Having said that, it is not fun to open the application to see that you have lost money in almost all of your trades.
By the end of June, my total account value was almost down around 35%. The problem with being down in huge percentages is that the stock needs to gain so much more in value for you to recoup your losses. Here is how it works. Say you have started with 100$. Imagine it lost 10% in value. Now you have 90$. This means that now your stock has to increase by 11% for it to become 100$ again. There is not too much of a difference between 10% and 11% but this effect is magnified with larger losses. A stock that lost 35% of it is value needs to increase by almost 55% to get to its previous price point. This implies that the larger the loss, the harder it becomes to recoup it.
Having suffered a lot of losses, I have decided to follow a different, more deliberate strategy. I was going to start actively trading using a trading style called Swing Trading. Swing Trading is a style of trading where you are making investment decisions based on periodic patterns that are displayed in the price of a stock (or any other security like bonds, etc.).
There are two main methods for analyzing securities to make an investment decision. Fundamental analysis requires you to deep dive into the fundamentals of the business to assess the fair value for the corresponding stock. Analyzing securities based on statistical patterns is called technical analysis. It doesn’t require you to know anything about the business. You just look at the historical and statistical patterns on a chart to try to make predictions about the future price action.
When I first heard about technical analysis, it sounded like bullshit. However, the argument that made me re-evaluate my position is that you can never have complete information when performing fundamental analysis. There could always be something that you are missing that might cause you to over or undervalue a business. Besides who has the time to do fundamental analysis, anyways? It seemed like technical analysis could be good enough for my needs and purposes.
There are also multiple styles of trading that you can follow based on your preferred time range. Day Traders can enter and exit positions (meaning buy and sell stocks) multiple times during the day. Position or Trend Traders look for long-term trends in the market. They could be in a position for months or even years. Swing Traders are somewhere in between where they buy and hold shares for a couple of days to a few weeks. I was attracted to Swing Trading since it didn’t require active management of trades like day trading would. It also had a relatively short feedback cycle so that I could still learn from my decisions and mistakes.
I have started to Swing Trade at the end of June. Since then I was able to recoup all the losses that I have suffered at the beginning of the year. Even though I had successful several months of trading, I have closed all my positions after 6 months due to the macroeconomic uncertainty and increased volatility of the market.
Lessons Learned from Swing Trading
I am in no way an expert in Swing Trading. But I was able to have several consecutive months of success with it and I think I have learned a thing or two on what and what not to do when swing trading or active trading in general.
Don’t Catch a Falling Knife
Before Swing Trading, I would have been inclined to be interested in stocks that are dropping in price. Swing trading helped me to be mindful of the chart patterns. A price drop could be interpreted as a buying opportunity but it is likely a hint at a problem with the security. The assumption here is that the price is decreasing because the market as a whole knows something about the stock that you don’t. It is better to wait for an upwards trend in price than to buy a stock dropping in price (aka trying to catch a falling knife). This can be unintuitive because usually when we are shopping for things, we tend to look for sales and discounts. It can be uncomfortable to buy things that are getting more expensive. The difference here is that when we are shopping we have a rough idea about what the fair price of an item should be so any discount presents an advantage. It is much harder to know what a price should be when looking at a stock.
Know your Upside and Downside
We can’t predict what the market will do tomorrow. It is impossible. The best thing we could do when trading is to hope for the best and expect the worst. You can plan for the bad things by setting a Stop Sell order on your trade. Stop Sell is an order that automatically sells the stock if the price of it falls below a designated value. How you determine that value is the big question here. There are ways of doing so that involve using something called technical indicators. Technical Indicators are essentially statistical analysis tools that can help you understand various trends and patterns of a given asset. You can use a technical indicator to show you the volatility (the range of price swings) of a stock, for example. You would want to set a stop loss at a price where you wouldn’t be prematurely forced to exit a position, but also at a limit that is not so deep that if you are to drop out of a position, you wouldn’t suffer heavy losses.
Always Limit your Downside
Imagine betting on a coin toss where a correct guess would pay 100$ but an incorrect one costs 200$. Would you take that bet? Probably not. You stand to lose much more than you gain. There is no point in playing that game. The same applies to swing trading as well. You should only enter a trade if your expected gain is larger than the money that you are risking to lose. Otherwise, there is no point. You can again try to assess those expected returns by looking at technical indicators such as resistance and support.
Execute with Discipline
It could be tempting to adjust your stop loss after entering a position. You might start to think that you could have more chances of making a profit in the long run if your stop loss was only a bit lower. You are probably mistaken. It is highly likely that you are having an emotional reaction to the unraveling situation instead of thinking clearly. After all, no one wants to prematurely exit a position and lose money. Being guided by your emotions while trading is one of the worse things you could do. You should decide on your stop loss and expected gains before entering a trade and then forget about it. A trade has more chances of success if you just leave it alone. Emotional detachment is the key.
You will be Right, You will be Wrong
As I have mentioned above, you can’t know what the market will do tomorrow. There will be days where you will be right and there will be days where you will be wrong. The aim should be to be right more often than you are wrong. Another thing you could do is to limit the downside of your losses while trying to get the most from your wins.
Don’t Swim Against the Current
Imagine a scenario where 70% of all stocks have been losing a few percentages of value for a couple of weeks now. Without knowing anything else, would you bet on a random stock to increase in value in the short term? That’s not a bet I would want to take. In a macro environment like that, the stock might not fare well even if the business that issued that stock is succeeding. Now, imagine the opposite scenario where there is an upwards trend in the market. I don’t think it would be naive to assume that you could profit even from a random stock pick. All that is to say that you shouldn’t try to bet on an outcome that is against the macro trend. It is easier to swim when you have the current behind you.
Know When to Stay Away
Being an active trader doesn’t mean you should try to participate in the market at all times. Sometimes the most profitable thing to do is to sit on the sidelines to wait for uncertainty to resolve or a recession to turn around. The way to win a losing game is to not play.
Don’t Put Your Eggs in One Basket
There is no way of knowing what happens tomorrow. A business might get sued for misconduct, get hacked, lose or leak private data, or simply go bankrupt. I am willing to bet that every single company will fail at some point in time. Given enough time, anything that can happen is going to happen. We can’t fight the inevitability but we can cover ourselves by spreading our bets wide to not tie our entire success or failure to the performance of a single company.
Is Active Trading Worth It?
The recommended approach for reliably profitable participation in the stock market is buying assets and then just holding them for a very long time. This strategy is particularly suitable for retail investors who generally don’t have the time and energy to do extensive research before doing any investments. The general trend of the stock market is upwards so you are bound to profit over the long run. They say that active trading is a losing game and even professional money managers don’t fare much better than the market average on a long enough time horizon.
However, there are investors and traders out there who are clearly profiting from the market while being active participants so I don’t know if I am completely buying into those arguments. I am pretty sure there is some statistical truth to them. However, to say that you should never actively trade is similar to saying you should never become an entrepreneur or an artist because the odds of success are stacked against you. It is against human nature to forego taking action just because the probabilities are not favorable. Maybe it is a good thing that we are so bad at statistical thinking in general. It allows us to explore and take chances. Knowing the odds of success might save you from a dissapointment but you can’t have any meaningful growth without experiencing failure.
So do I recommend active trading to you? It is really up to you. Remember this is not an advice piece but more so an exploration of my experiences.
To me the advantages and disadvantages of active trading have been as follows:
- It allows you to develop a feel and understanding of market cycles. Things go up and things go down. It all is transitionary.
- It is a great way to educate yourself about risk management.
- It puts you behind the driving wheel. You are rewarded for your gains, and punished for your mistakes. Tight feedback loops help you develop discipline.
- It makes you work for your money. It gives you control and agency.
- It curbs your curiosity. To me, the stock market was this magical thing. Well, not so much anymore.
- To me, the biggest downside of my experience was that it made money to become my focus. When you control something, it starts to control you as well.
- It requires time and effort that might be better utilized somewhere else.
- In the long run, it is extremely hard to beat the market.
My active trading has helped me recoup my losses from the FOMO-based trades I made earlier. The funny thing is that, turns out if I were to just hold on to those meme stocks instead of selling, I would have at least doubled my money by the end of the year. But then I wouldn’t have had a reason to write this article and have all these learnings. I guess I ended up paying the price of admission to my education in the market via this opportunity cost.