A recent report came out that showed trading activity at discount stock brokerage firms has recently accelerated. For the month of January, at three discount firms, activity increased from 17 to 28 percent from the year earlier period.
Trading activity can increase by one of two ways. Either there are more people who have accounts, or those who have accounts are trading more. Both factors seem to be at work, though people with existing accounts, who are more active appear to be accounting for the bulk of the increase.
A sign confirming that people with existing accounts are more active, is that margin debt has increased substantially over the past year. The use of margin, which is borrowed money, allows investors to purchase more than the capital they are employing. This is a risky strategy that magnifies both gains and losses.
When markets are performing well there is a tendency for some people to want to increase their holdings in stocks. Unfortunately, we tend to see the opposite reaction when markets are performing poorly.
In addition, when markets are performing well, some individual investors believe their recent gains are due to their trading skill. This causes some people to commit more money to stocks, oftentimes with borrowed funds. Some people fail to realize that their gains are due to a strong market, not their trading ability.
One reason that allows for investors to trade frequently is that trading costs are relatively low. At discount brokerage firms someone can commonly trade a stock for $5 to $10, and sometimes for free for a period of time, when opening a new account. Also, with stocks trading by decimal rather than fractions, the spread for buying or selling a security is often only 1 cent. However, just because you can trade cheaply does not mean you should trade frequently.
What investors need to remember is that investing in the stock market should be a long term endeavor. This is true whether you are buying funds or individual issues. Trying to be in the market only when it is going up, and likewise being out when it is going down seldom works.
Even professional investors can seldom time the market with great precision. Someone may make a great timing call at one point in time, and be totally wrong another time. That is why people need to stay invested throughout various market cycles.
This is not to say that someone should never make any changes. Rather a person should keep their investments within ranges, such as 50 to 75 percent in stocks. Too often you see people, either all in, or all out of the market, and inevitably they are making changes at the wrong time.
For most investors it is easier to invest in funds, whether mutual or exchanged traded. For a 401K or 403B plan, you have to invest in funds, unless you work for a company that has a publicly traded stock. In that case you should put no more than a limited amount in the company stock.
If someone prefers to invest in individual issues it would need to be done, either with an IRA account or personal money. When investing in individual issues it is important to stay diversified. Someone can own 20 stocks, but if half of the companies are in one industry, the portfolio will not be well diversified.
For many individual investors their approach to investing is to buy a limited number of stocks that are frequently talked about in the media. This is not a good approach, and your performance will likely differ significantly from the market averages.
Buying a limited number of stocks is only appropriate, if you already have the bulk of your portfolio in diversified funds. A portfolio, whether in funds, individual issues, or a combination, needs to be well diversified and managed with a longterm perspective in mind.
Allen Wisniewski has been involved in finance for more than two decades. He lives in Culver City with his family.
