Is trading a viable alternative to investing? Can trading help you generate additional income? Can it replace long term investing?
There are a lot of freedom seekers who want to get financially free - quickly. And that is where the problem starts. Investors see 'trading' as a quick way to create wealth.
While we are coaching hundreds of seekers on their journey towards financial freedom through our ELITE Program, many always have this question - "Long term Investing is a slow and painful process. Should we get into trading?"
I am no expert in trading, but this post is an attempt to explain why I do not recommend trading as an alternative to investing.
1. Loss Making Idea
Last year, markets regulator SEBI showed that futures and options (F&O) trading was overwhelmingly a loss-making proposition for investors. The report showed that 89 per cent of investors lost money in these activities, and just 11 per cent made profits.
Imagine that! All the vast activity of trading you see adds to the enormous amount of noise generated on business TV, YouTube, WhatsApp and other social media, and just around 11% people make money out of it. If you go into the details of the SEBI report, you will see that about half of those who make money also have trivial profits of a few thousand rupees in a year. They would have earned more even in a bank fixed deposit.
Trading is generally a loss-making idea. You may make some money initially, but in general, you are going to end up in losses.
2. Zero Sum Game
When you buy actual equity and hold it through the volatility of the market, the returns are proportional to growth of the economy. And the growth of the economy (and the companies in the economy) is open-ended.
It is important to understand the meaning of 'Open-ended'. This means that if there are 100 long term investors, all of them can potentially make money if they are invested at the right place. This additional money comes from the growth of the companies (economy).
On the other hand, Futures & Options trading is a zero-sum game. Whenever someone earns a profit, it comes out of another trader's pocket. The thought that a vast majority, over 90 per cent, of the derivative trading activity on Indian exchanges is neither difficult to understand nor surprising.
3. Designed for Middlemen
Trading doesn't generate collective wealth. If one party is prospering, it's because another party is facing a loss. So, if all the losses are someone else's profits, who is pocketing all that money that ordinary investors are losing? Let us see.
Off late, the National Stock Exchange has been planning to extend the derivatives trading hours by adding a second trading session in the evening. According to reports, the markets will close at the normal hour (3:30 pm) but then reopen again from 6 pm to 9 pm. The news reports also say that at a later stage', the exchange might extend the evening session to 11:30 pm.
It's crystal clear that brokers, exchanges, and those lending stocks profit from this activity, which seems to be the primary objective. If investors trade round the clock, then they can lose money round the clock, which is good for everyone else.
Whether you make a profit, or a loss-making transaction, brokers and exchanges always make profits - as long as you make a transaction. They want you to make more and more transactions - and that is probably why they don't like long term investors who rarely transact for years.
You should understand that trading activity is not designed for you to make money.
4. Trading is not Passive Income
Unlike long term investors, whose aim is that they start earning passive income from their assets, trading continues to be only an active source of income, if at all - even for those 11% who make profits.
You will earn through trading only as long as you keep trading. If you stop trading, the profits will stop.
Investors, on the other hand, earn even if they stop investing any more. And this is a BIG difference. Investors just need to build enough assets that can serve them for their lifetime - a prerequisite to true financial freedom.
Traders, therefore, can never be financially free, while investors can be.
Summary
Wisdom lies in taking a step back, analyzing the facts, and making informed decisions. Resist getting lured by the glitzy allure of potential profits or swayed by the pervasive industry rhetoric. Roll up your sleeves, do the hard work, get your hands dirty, analyze the stocks, or invest in mutual funds if you do not have the time to do the stock analysis, but stay away from trading.
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I think trading capital should not exceed 10% of your investment.
ReplyDeleteWell, we can use any thumb rule. But trading is a highly loss making entity in the long run. Try and read the white paper on internet...
DeleteTrading is injurious to wealth.