If you have any investments in stocks, a retirement account you can monitor or any other form of long-term investment, you’re probably tempted to keep an eye on it day to day. If you really want to get a good return, stop checking so often.
Picture: J R/Flickr
According to research from two finance professors from the University of California, Davis, and University of California, Berkely, households that traded more often had a lower average return on their investments. Frequent trading isn’t a new risk, but the research highlights that the more carefully you watch the market, the more likely you are to believe that you have a good handle on things (and thus trade more often). The problem is you actually don’t:
The online environment fosters cognitive biases that lead to overconfidence. One such bias is the illusion of knowledge. Studies show that, as people acquire more information, their confidence in their ability to predict outcomes rises far faster than the accuracy of their predictions. Online investors have access to vast quantities of data. This data may give them a false confidence that they can pick stocks. Unfortunately, data related to a task aren’t always relevant to the task. Suppose you wished to predict the next number to come up on a roulette wheel. You could know all the historical outcomes on that wheel, and a great deal about how, where, and to what specifications the roulette wheel had been manufactured, but you wouldn’t know which number was going to turn up next. Billions of bytes of market data give most investors no more ability to pick individual stocks than to pick numbers on a roulette wheel. Of course some investors will succeed anyway, and they will be certain that they knew all along which stocks would be winners. And those who fail will be certain that they too were right, but unlucky — this time.
The cost of commissions for trades is already enough to make frequent trades risky (you can’t just make more money than your purchase price — you have to make enough money to pay for the commission both buying and selling). However, unless day trading is your profession, you’re probably not going to swindle the market. Do research and pick investments that have a healthy rate of return, and then check in occasionally. Don’t try to maximise your investment on a day-to-day basis.
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