How Retail Traders Lose Big While Enriching Wall Street
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Walk in the money for the rest of us. This is a personal financial on money, how IT works, how to invest in, how to live without worrying about IT. And in your host, David stein, today is episode four eighty six.

It's title how retail traders lose big while in reaching wall street recently on the money for the rest of us, plus community form. This is a premium membership site where we teach investing. A member posted.

I recently saw a blurb in bloomberg news that said americans are playing the stock market in record numbers, with almost three and five investing in stocks. The article goes on to say that baby boomers are on IT began investing in stocks when they were thirty five, or the average age that generes start investing in the market is nineteen. The article pointed out that sports bedding has exploded and said that stocks are now also a part of the gambling mentality in our country.

The member wanted to know if this was true. What academic studies are there that discuss this is the only confined to mean stocks, or does that involve all stocks? The member continued.

That sounds like a recipe for a stock market meltdown or at least increased, tilly. Yet IT seems like in recent years, the market has been less volatile. Long term investors be wary of the trend.

That's what we're going to take a look at in today's epson. Let's start with sports bedding. In twenty eighteen, U.

S. Supreme court struck down the professional and amateur sports protection act, known as P A S, P, A. P. But that act effectively banned sports bedding in the U. S.

Since nineteen ninety two, the supreme court determined that the original law did not specifically say that sports gaming was a federal crime for individuals. Rather, the law sought to direct the state legislatures to limit sports bedding. Spin court said.

The constitution confers upon congress the power to regulate individuals, not states. And since pasta was trying to regulate the state or direct state legislatures, IT wasn't constitutional. Been five years then since sports bedding has been legal in U.

S. states. But we look at the total growth. Gaming revenue in twenty nineteen IT was twenty nine billion dollars. Last year twenty twenty three, ten point nine billion dollars americans waged one hundred and twenty billion dollars on legal sports bedding in twenty twenty three.

Now it's fairly straight forward to measure the how large sports bedding is got because we can measure how much was waged in gambling at a casino. It's all track, but the stock market and other investment markets are not gambling domains before investing. Although we've talked for years about the difference between investing, speculating and gambling is one of the core principles that we introduce in our email series.

For the insiders guide, we talk about IT on asset camp, investing is something with a positive expected return. Typically there there's to be cash low involved dividends, interest speculation. There's a disagreement on what the rate return will be or even the Price in gambling is something with expected negative return. A long term investing in the stock market is an investment IT has a positive expected return, yet there are some security, some stocks and options, which are more lottery like they have a negative expected return. These investments have a positively stewed pay off, so the overall expectation is a negative return, yet there's a small probability of winning big.

We discuss positive skies and episode four eighty two, and we defined IT as where the average outcome, the average return for the stock market or investment is higher than the media or middle return because there are extreme outcomes that pull up the average, but a gamble would have an element of that positive. Good is a very few would win big, but their winnings are not enough to bring the average outcome, or even the medium outcome in the positive territory. These are high risk, high reward speculations in the reality is because there is a demand for these lottery like payoff s that can push up the Price.

Investors, speculators are are willing to pay more for the opportunity to win big, even though IT has a negative risk, adjust to return in the long run. Now it's difficult to measure what percent of these wagers in the stock market are lottery like our gambles. There's a paper a link to the lead author is a lot.

Humar is a university miami professor, 是 had only gamble in total stock market gambling around the world in market efficiency。 They had A A novell way to measure what percent of stock investments are gambles. And what they looked at is if most investors were long term mn investors or passive investors, the volume and trading would tend to be low.

If you look at amount of trading relative to the market capitalization or size of the company be fairly stable. But there are some stocks that are traded more because somebody that's more speculative gambling, those stocks have very, very high turn lover. And so they they looked at the global stocks market over many years and came up with an estimate based on the turn over a stocks, the percentage that was gambling versus not.

And they determine and and again, this is just an estimate that stock market gambling is about three at times traditional forms of gambling, sports bedding, a sitos and IT makes up fourteen percent of stock market volume in developed countries and a third in emerging market economies that are dominated by retail investments. And they they estimate that it's about three thousand hours per person per year gambling in the stock market compared to build eight hundred and five dollars for traditional gambling. And they looked over what determines is there more gambling? And they found a correlation, higher income, more GDP per capital, LED to more stock market gaming and greater incoming inequality LED to more stock market gambling.

The countries that had had the most were united states in hong kong. And they've found that the amount of gambling in the stock market is increasing. Before we continue, let me POS and share some words from one of this week.

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That's net sweet dot. Come slash David. Net sweet dot. Come slash David. Back in explode to thirty nine, we talked about trading, and I mention that I went to furnitures. Fact, there was a sleep number bed store that spot our podcast for a number of years in the sales person.

Sixty five year old had worked at the store for fourteen years, never participated in the foreman k plan, felt IT was too risky, but he had received an inherits from the passing of his mom, and spend IT twenty three thousand dollars, add a trading academy to learn how to trade his spouse says, you have to invest in yourself. And so he did, and he said he felt so goofy when he got a trade right. And IT worked.

He spent twenty three thousand dollars. He chose the second Price option. The highest was to spent fifty thousand dollars at this trading school for a master mind community.

This was his retirement plan to figure out how to trade. I have no idea how I turned out. I went to the trading academy, though, to figure out how all they were encouraging people to pay that kind of money, to learn to trade.

And typically with people that felt like they were behind that, they had to win big in order to catch ch up. This trading academy had a pattern that i'll linked to in the show notes. And in the pattern they mention that most traders, typically individuals, trade based on gut feeling and in the pattern that Operating under the assumption that trading in most markets is a zero sum game, winners win at the expense of losers losing.

It's important to identify the mistakes that other traders typically make in the markets so that these can be exploited. That was the approach each other retail trattes have to exploit retail trattes by teaching them a system. If gambling in the stock market has a negative spector return, then the majority going na lose.

And they do a linked to a paper by three academics called day trading for question mark. This study was based in brazil, where they evaluated the trading performance of fifteen hundred individuals that had traded for three hundred days, looked at how much they earned after fees, and ninety seven percent of investors lost money. Only seventeen, about one percent of the fifteen hundred earned more than the brazilian, a minimum wage of about sixteen dollars a day.

Eight of the fifteen hundred earned an initial salary of a bank teller, about fifty four dollars a day. One individual of the fifteen hundred that earned the most earn three hundred and ten dollars a day. You cannot make a living day trade as an individual investor because it's not a zero sum game.

Yes, winners offset the lose, but that's before fees that can make. Studies at a review and I referred to, found that the biggest reason that retail traders lose over the long term are indirect trading cost. This desire to find investments that are highly leveraged with the possibility of a big payoff ff, small, small possibility leads the overpayment.

So the bid ask bread is incredibly wide. The ask is what IT cost to enter a trade, while the bid is what IT cost to exit. Not much of the trading is in stocks, but the toss in stocks options, the stock option is a contract to give us the holder the right, but not the obligation to buy or sell a specific stock at a specific Price.

And there is a study that are linked to the lead author is letta galloways a. And in their study, they found that fifty percent retail trades were in alter short term option, many one day options. Now those options don't have commissions.

You can trade options and stocks on Robin hood without commission, but that doesn't mean there's not cost. They found that the short time options in their study average bid asked spread was twenty four percent. That's the difference between the buy and cell Price for one trade.

So think about that. If IT cost twenty four percent of what you invested to get in and out, or even at the around trip twenty four percent, that means you have to make that up in order to generate a positive return. When they looked at the trading, they found that seventy two percent the trades were at the money.

And so the strike Price was the current Price of the index of the stock. And often times this was done when there was an unlearning earnings announcement or something that potential could lead to a big pop in the stock. Now around earnings announcements, stocks can be very, very volatile.

And so one reason there were such large bid asks, read if someone was buying a call option, for example, somebody has to write or sell that conception. And if IT around earnings announcement, the risk of a big move is pretty high. And so the sellers of the options is difficult to headed out that risk.

And so IT leads to A A wider spread, so the option writer can partially protect themselves. The other reason though that spread is so wide is much of the trading is being done by whole sellers. And Robin hood and other brokers get a fraction of that order flow is called pay order flow.

They're getting money not from commissions but from getting a part of the spread. The bid ask read is flowing back to this whole sellers as well as to the brokers. One study I I saw in twenty twenty one found that U.

S. Burgers es. Receive two point four billion dollars in pay for order flow in stock options and one point three billion for stocks. And most of them were just three firms, hana and wolverine.

So when we say retail traders are losing big rating, they're losing because much of the money is flowing to brokers and whole sellers from these indirect trading cost. There's been a huge boom in shortage options, those that expire less than a day and and they're called zero days expiration. There's a hashtag zero D T E.

There's videos on youtube how to trade zero D T E options in the reason why there are especially popular because the shorter time to expiration the cheap for the option. And so you're able to get in and and get a pay off in less than a day. In twenty, twenty two and twenty and twenty three, seventy five percent of the trading volume by retail investors and S N P N X options were zero D T.

So there were wages that stock market will will go up or down in a given day. Now that's trading on gut feeling. There is no way a speculator can know within a few hours whether the stock markets gonna up or down, anything could happen.

And the fact most individual traders lose suggest how difficult IT is. Because, again, because of the indirect trading cost once said, they looked at, well, hold two other investors do in the zero dt e options. And they looked at a three year period of time and found that retail investors lost more than one hundred and twenty five million dollars in their study.

Ninety million of the hundred twenty five million dollar loss was due to transaction costs, indirect fees. The remaining was just poor position and they just got IT wrong to even if you get a right, the fees can suck up all the profits. Benjamin Edwards, es professor at U.

N, L, V, says we should stop pretending that what is going on is investing. He was referring to these zero D, T, E options. It's just gambling, he wrote, well, street journal had an article on the short term options and profiled a entrepreneur, lucas summer.

He said he's been trading an option since twenty eighteen, says, i've dict to this option stuff for quite some time. You get, you get hooked. He uses Robin hood for most of his trading, and he calls IT his gambling account.

He said, you have the power to gamble in your pocket. He said he lost thousands of dollars in his Robin hood gambling account. Twenty twenty two.

He was roughly even in two and twenty three, but he's had to have discussions with his spouse about times that he's lost a large amount of money trading. Summer says you hit black, double down, black, double down black, double down red. You're zero.

That's what they found in the study. Brazilian traders, now he's changing a strategy a little bit. He wants to use options to protect stock positions rather than just roll the dice.

So here we have retail traitors. They are attracted to the potential short term payoff s large payoff s significant leverage using short term options or stocks. They're overwhelmingly losing a negative expecting return due to more positioning and indirectness cost.

We have brokers and whole sellers making billions of dollars of these trades, often times game of flying IT. In terms of the brigades encouraging the trading, not sure. But now but Robin hood, the the options that they listed, the default were typically the shorter term options which have the lower prize.

But what is the impact on the overall market for investors that don't trade? Before we continue, let me pause and share some words from this week. sponsors.

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And veteran securities veteran is not a bank Julian staff, who is a founder of geneva based investment firm staff capital. This was in the world street journal article. He says it's a really big revolution for the market in the U.

S. Speaking of options, at one point, IT will be dangerous. The boom and trading has helps the press stock market volatility, but IT could make any turbulence worse, leading to a deeper market.

Now the chicago board of exchange is the largest option exchange, said concerns about height and volatility due to trading in S P. Options are overblown. It's not affecting the broader market, so we don't know.

Although what's interesting is, in theory, all this trading by retail gAmber in the stock market actually provides liquidity a lot. Koa and his study with his co authors wrote, perhaps more surprisingly, we find that increased gambling in stock markets improves measures of informational efficiency, intends to duce noise and Prices. The finding is consistent with theoretical models, which predict that higher liquidity facilitates arbitrage and create senate for sophisticated traders to gather private information and trade on IT.

They continue. Therefore, even if gamblers are relatively or completely uninformed traders, they can still contribute to market efficiency by making markets more liquid and thereby encouraging informed trading. So uninformed traders providing more liquidity allows informed traders, gives informed traders, institutional investor, wall street more and sent to figure out, alright, maybe this is some information I can trade on because there's greater liquidity because of all the uninformed traders providing that liquidity, because they're trading so much.

So it's actually helpful to inform traders to have uninformed traders providing liquidity even though those uninformed trader ultimately are losing money. Much of IT through trading cost Better flowing to the broker es and whole sailors, we don't actually know, but that the theory and IT does make sense. And that has been supported in other studies.

Additional liquidity, if provided by uninformed traders, s provide opportunity for informed traders. One of the concerns and this was expressed by clifton Green and emr university finance professor, that that all the losses that retail traders experience that, that will discourage them from investing in using sound investment process. So does give up and you will miss out on the long term gains that can be achieved ved through diversion and index funds in tps.

I hope that's not the case. That's why we launched asset camp, that is our investment education platform that we provide the software, the tools brain tivy vestals understand the stock mark that look at long term returns. I understand the drivers of those long term returns come up with expected returns for forty six different stock indexes developed emerging growth value, small cap, there's enough interest, think things to do, investing if you're interested, investing that you don't have to trade.

I have found professionally and individually being an acid cator using etf, using closed and funds selectively to be way more rewarding and interesting than trying to outsmart wall street. I want my wages to have a positive expected return by relying on cash flow. And is that cashle growing through earnings or other means? History, ally, much of that data for index funds in etf in the underlying index that they track has have been available to individual investors, and we're passionate about making that available.

And we launched the acid camp to do that because I got tired of spending six figures a year on research for money. For the rest was plus. And we couldn't even share evaluation chart because we didn't have permission from the index providers like ga, si, bloomberg.

And now we do, and we're sharing IT to individual investors at a Price people can afford, can learn more about that at as a camped out com. But the point is we don't have to trade options to find investing interesting. And the realities are not not going to get wealthy trading.

We get wealthy earning income in other areas and then growing that investment portfolio long term, we can make changes to IT active changes if we choose. We have to rebaLance, obviously, but he has a positive expected return. Why wouldn't we put our effort on that rather than gambling and away? Now maybe you don't get the same pupa mine hit that high from getting a trading right, but the reality is most of the time we would get IT wrong to switch your mindset focusing on longer term.

But we can still be experts to understand the stock market, the drivers Better than most individuals and many institutional investors because we're focused on what works rather than trying to predict the future. That's are up at forty six on why retail traders s lose big in our reaching wall street. Don't be one of them.

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Everything I have shared with you in the eps, it's been for general education. I've not considered your specific risk situation. I've not provided investment advice. This is simply general education on money investing in the economy. Have a great week.