Why Stock Markets Have More Day Traders than Value Investors?

Actual Question:

Why does there seem to be so many more day traders than value investors in the style of Warren Buffett, etc.?

Answer:

Dear Friend!

Such a wonderful question!

I too wonder the same.

In my opinion there are three fundamental reasons for the gross aberration that there are more day traders than value investors operating in the stock market.

Greed:

Greed and fear are the most common and difficult to control human emotions. Of the two greed comes first and fear follows. When markets are rising (present situation) greed attracts more players. Most of the people enter not knowing anything about stock markets. They have simply overheard somebody saying that markets are rising and there is a killing waiting out there!

Desire for making a quick-buck:

Many people have a strong desire to make a fast-buck. They do not want a longer but surer path like value investing. This fundamental nature of human beings is further reinforced by modern technology, which strives to provide instant gratification of needs - people just don’t want to wait anymore - they want internet banking, immediate downloads, and so on. Marketers, online shops, et al, work hard to satisfy this craving for instant gratification.

Gambling Instinct:

Man seems to have been created with an inborn gambling instinct. This is not new. We have been having it since the Mahabharat times, with the Pandavas betting and losing even their beloved wife in fit of gambling rage.

Day trading provides a very convenient dignity to what is otherwise pure gambling. Families of day traders honestly believe that day traders are engaged in serious and respectable business or profession, and they spread this belief about their day trading family members among the larger family and the society at large.

Related:

• Trading/ Day Trading
• Margin Trading
• What is Short Selling?
• What is the Differences Between Fundamental and Technical Analysis?
• Why Day Traders Cannot Quit?
• Is Algorithms Based Trading Safe?
• How Warren Buffett Trades in Stocks?

Conclusion:

Finally, my dear friend, please do not think I am delivering this sermon standing tall from a high moral ground.

I had been once what I have described above, till one day I lost all my life’s savings in the fraction of a second during a market meltdown.

After this costly burning of fingers, I had abandoned the stock markets for a very, very longtime.

Fate touched me and made a value investor after a long interlude.

I too am striving my bit through my blog ‘Wealth Vidya’ to convert day traders into value investors, but cannot fail to wonder, just like you, why there are more day traders than value investors operating in the markets today!

Thank you,

With Best Regard,

Anand

Is the Stock Market a Place to Make a Fast Buck?

I have met in my long consulting career of about three decades many people who believe that the ‘Stock market’ is the place to make a fast buck – a place where one can become rich quickly. I have also met an equal number of people who is convinced that stock market is the most dangerous place on the earth, and that it is meant solely for gamblers and speculators and certainly not for investors. I can state with conviction that both the extreme views are far from the truth.

Playing the stock markets is certainly not the get-rich-quick solution. On the other hand those who enter with such a notion are sure to burn their fingers. Of course there are a few exceptional examples of individuals who have consistently made successful bets on stocks, currencies and commodities, but these examples do not hold good for most of the large number of speculators indulging in day trading. Those who had made quick gains a few times should attribute the success only to pure luck; they are bound to run out of lady luck soon and are face the unpleasant consequences.

Stock market is also a place where through prudent, disciplined and sustained investments, spectacular wealth can be built over very, very long periods of time, spanning two to four decades.

Why is it that there are no shortcuts to wealth creation? What are the essential ingredients of wealth creation?

Essentially there are two key factors behind wealth creation: natural growth in companies and secondly by the operating of the compounding effect.

Natural Growth:

Companies that supply goods and render services in an innovative and efficient manner are bound to prosper and consequently the long term investors owning the shares of such companies are also bound to prosper through regular dividends received during the long period of investment and appreciation in the market price of the shares, on the back of growth in the ‘Earnings Per Share (EPS)’.

Compounding

The amazing results of compounding were discovered and propounded by Albert Einstein. The ‘Miracle of Compounding’ works only over long periods of time and especially the spectacular results start occurring at the fag end of the very long period. Being a natural law like any other law of physics it operates at its own pace as per its own nature – there are absolutely no shortcuts.

To conclude, one cannot consistently make a fast buck playing on the stock markets, but through disciplined investments one can build significant wealth over very long time.

If you buy things you do not need, soon you will have to sell things you need

Besides being one of the world’s richest persons, Warren Buffett is also one of the greatest teachers. He leads a simple life and advises others to do the same. He says, “If you buy things you do not need, soon you will have to sell things you need”. How true and what golden words of wisdom!

My Teenage Foolish Advice to Buy Things You Do Not Need

I also used to debate a lot on matters of science, economics and politics. In youthful rashness often stupidly I used to lead the debates into heated arguments. I still vividly remember the fiery disagreement I had with my eldest brother one day. In the quarrel, I vehemently contended that during times of high inflation it was better to blow the money instead of saving. When I reflect on it today what a stupid and absurd argument it was.

Of course, I was not completely wrong; it was useless to save when the return was lower than inflation.  But the solution I suggested of blowing away the money was not right.  Splurging on unwanted things simply because inflation was high cannot be justified. We should explore alternate avenues. of investment that yield returns greater than inflation; history proves that prudent investment in shares, or index mutual funds, coupled with patiently lying invested for a few decades, will certainly yield spectacular results.

Practising Austerity Not Difficult

It is not very difficult to practice austerity once you realize how compounding can produce spectacular results from tint investments. Even the few dollars you spend on a pizza can buy you a couple of stocks of a wonderful company. If the cost of a pizza can produce remarkable results, imagine what the cost of an expensive holiday can do?

Sadly, We Don't Heed the Advice

Unfortunately, we realise simple but solemn truths only late in life, by this time it might already be too late. And the realisation useless. Advertisers are marketers are ever trying to make spend on unwanted luxuries.

Recently I saw a tempting advertisement for a luxury, one-way flight ticket costing US$ 38,000 from New York to Mumbai. They provide you with a residence,  comprising a bedroom, lounge and a shower room.

There are many such alluring offers, urging us to splurge.

Conclusion

Sadly, every day I see young and bright youth blowing away their handsome salaries on unwanted luxuries like expensive clothes, mobile phones, holidays and automobiles as if there is no tomorrow.
If only we could heed Buffett’s advice, lead simple lives and invest judiciously, we can not merely achieve financial freedom but can accumulate inexhaustible wealth.

If you don’t and continue in wayward ways and buy things you do not need soon you may have to sell things you need.

It is Far Better to Buy A Wonderful Company at a Fair Price than a Fair Company at Wonderful Price

When Warren Buffett said, “It is far better to buy a wonderful company at a fair price than a fair company at wonderful price”, he is clearly stating that the investor should only buy excellent companies’ shares and pay a reasonable price for them. 

So there are two distinct caveats in his advice – Excellent Company and Reasonable Price.

What is an Excellent Company?  Buffett has given ample clarity.  It should not only have had a long and successful existence, but should also be capable of thriving for a long time in future, and its products or business should be such that people will need them for foreseeable future. Mere longevity is insufficient, the business should have been profitable for a long time into the future and should be capable of generating profits and “”Free Cash Flows” well into foreseeable future.  The company should stick to its core business, never or insignificantly borrow, and shall possess the culture of rewarding the shareholders with handsome, regular and uninterrupted dividends.  Let us take the example of Gillette.   It produces excellent razors.  One can never foresee a replacement for razors or people not needing a shave, thus endowing permanence to the company’s business.  Thus, Gillette satisfies all the qualifications of an “Excellent Company”.

Now let us examine the price element.  We should not pay a fancy or unrealistic price.  If we do so the “Return On Investment” or “ROI” for the money we have invested will be poor.  However, this is easier said than done.  Today, on 7^th July 2016, Gillette India Ltd. Shares are trading at an unrealistic, “Price-to-Earnings” or “PE” multiple of 63.76 as against the acceptable 10, and a “Price-to-Book Value” or “P2BV” of 20.44 as against the recommended 1.5.  Under such impractical market conditions what can we do? 

No reason to despair.  One can always find a handful of excellent companies whom the market is disfavoring at that time.  We should invest in those companies.  We should also make a list of the other excellent companies but which are expensive.  We should revisit them during large market crashes like the post “Lehman Brothers”.  My own experience shows that even during such extremely depressing times, companies like Gillette will not be available at the idealistic PE of 10 and P2BV of 1.5.  You may find them at a PE of 25 and a P2BV of five to ten, at that time you should BUY.  If you hesitate, you will never get the opportunity to own such companies.  I had vacillated, and let me admit, I do not own any of these good companies.

On the other hand, when people buy shares based on “Tips”, usually given by brokers and the So-Called-Experts, they end up doing the opposite of what Warren Buffett has warned, Buying Fair Companies At Wonderful Price, instead of Wonderful companies At Fair Price.