A sharp recovery in share prices, following the coronavirus low earlier this year, has created an army of day traders and speculators aided by some clever apps that allow easy investing at the click of a button.
The concern is rational, long-term investors are now being tempted to join their number, despite the pitfalls of this high-risk world.
Tim Bennett (pictured), head of education at Killik & Co, examines why this can happen and suggests some ways to resist the urge to gamble.
The only way is up
Perhaps the most important ingredients underpinning the share buying frenzy we have since the lockdown low back in the Spring are volatility and rapidly rising prices.
While almost every day we read about how the global economy is in a downward spiral, share prices nonetheless march on.
In some cases, they are even hitting new record highs if you look at the US technology-heavy NASDAQ index. This has set the scene for a share trading gold rush.
Everyone is doing it
As humans, our natural survival mechanisms, honed over thousands of years, tend to make us follow the crowd and also leave us prone to FOMO – the “fear of missing out”. Share trading has recently become the latest crowd craze.
Over Webex and Zoom, in chat rooms and even in socially distanced bars, you will read about and hear tales of the spectacular gains being made, sometimes in a matter of hours, on individual stocks.
And because we only ever hear about the winners in such forums (no-one ever boasts about losses), we are all prone to think, “well, if they are doing it, why can’t I?”.
We love a good story
Every gold rush needs a good story behind it and coronavirus has provided it in the form of the hunt for a cure. This has generated some truly eye-popping share price movements. For example, on 20 July, a relatively small UK stock called Synairgen doubled in price in just one morning.
Meanwhile, Eastman Kodak rocketed around 1,000% in one week towards the end of July. When we hear tales of such seemingly easy money being made, we are naturally tempted to join in – why wait 20 years to make steady gains when you can double your money in a morning?
In short, our natural impatience and relatively short attention spans start to get the better of us.
It is (too) easy
Well before gamification app Robinhood arrived on the scene, there were countless others out there that let investors set up an account and start betting on shares easily, quickly and cheaply whether in the form of direct trades, spread bets or CFDs (contracts for difference).
While this democratisation of investing is welcome in some ways, it is dangerous in others. Too many people are being drawn into what they believe are one-way bets on single stocks, despite all the warnings out there that their capital is at risk and the recent past is no guide to future performance.
While shares can offer decent gains on the way up, they can also wipe out 100% of your investment on the way down.
We crave some fun
Lockdown was a brutal experience for many people; isolated from friends and family and left with few leisure outlets outside of work. Even now, holidays are being compromised by new quarantine rules and jobs are under threat across many sectors.
Gambling on share prices is pitched as being fun and a money spinner at the same time. It also brings people together online, or in the real world. Who would not be tempted?
It will not happen to me
A phrase packed with danger. Just as studies have revealed that we all rate ourselves above-average drivers, so a part of us may think, “sure, one day this stock will fall rapidly, but I will not be the one left holding it”. In short, overconfidence kicks in and we start to lose the ability to disentangle skill and luck when it comes to our share trades.
This happens fastest when investors make a rapid gain early on. There is nothing like an easy win to feed greed over caution and lead us into taking bigger and bigger risks.
Stop!
Knowing just how easy it is to get drawn away from investing in the riskier world of the gambler, how can we stop it happening?
Here are some rules of thumb that should help you to distinguish one from the other and resist the urge to switch:
1. Investors diversify and never bet on single stocks. Not “having all of your eggs in one basket” reduces risk. Most investors need at least 20-25 different baskets when it comes to stocks
2. Market timing is a no-no. Think you can judge the top of the market and sell before then identify the bottom and buy back in? Think you can beat market analysts and veterans at their own game? Turn off your computer immediately and go take a cold shower.
3. Every short-term winner creates a loser. For every person boasting about a share trade, there is someone else silently licking their wounds, having got it wrong. That is the price of short-termism.
The moment you start dreaming about how to make a fast buck from stocks, rather than waiting for long-term compounding to work its magic, you are becoming a gambler
4. Ignore crowds. Sure, a football match or theatre visit is a dull experience without a crowd. But when it comes to investing, stick to your principles and resist the urge to board the next bandwagon.
You can stay apart from the day trading crowd by not peering anxiously at stock prices or checking your portfolio value every ten minutes and not paying attention to every snippet of company news that comes your way.
Also, consider automating your investing – put a fixed amount to work in stocks every month and then forget about it and do something else.
