Why Stock Picking Isn’t Just for the Pros
Even though they’ll spend all their time telling you it is
Since the onset of stay-at-home orders, a new breed of traders has taken center stage on Wall Street. With nothing to do, these individuals took their government stimulus money and put it to work in the stock market.
Better known as the Robinhood traders, this whole cohort is nicknamed after the trading app Robinhood because this application was the first to offer no commission trading to the masses. No fees have now basically become the standard and have created a resurgence in retail investing.
These investors were initially known to crowd positions in speculative COVID stocks like cruise lines and now bankrupt Hertz. Many professionals did not think this group would have the kind of staying power they have enjoyed.
But as of this week, Jim Cramer, my favorite stock market commentator, has said the Robinhood trader is here to stay, and it is time to stop mocking them and start learning from them.
What is the Big Deal?
I am sure some people reading this are wondering what the big deal is? The big deal is that there has been a prevailing theory in the halls of academia and Wall Street that it is impossible to beat the market over time. This theory is called the Efficient Market Hypothesis.
It says, “stocks always trade at their fair value on exchanges, making it impossible for investors to purchase undervalued stocks or sell stocks for inflated prices.”
If this is true, a stock picker should never beat the market over time unless they invest in highly speculative companies.
This kind of thinking has perpetuated the growth and popularity of index funds. Funds that just mirror the market, mainly the S&P 500. Many retail investors would follow this advice and only invest in these funds in their brokerage accounts.
But this sentiment has been changing, led by legendary investors like Peter Lynch and Jim Cramer. They think everyone can generate sizable gains without the need to just invest in index funds.
But why all of a sudden did this change gain so much momentum? I think this phenomenon can be credited to 2 things: commission-free trading and fractional shares.
Commission Free Trading
Many new investors don’t know this, but it used to cost money to execute a trade, which means you had to pay a fee to buy and then sell a stock. It used to be anywhere from $4 to $8 per trade on low-fee brokerage accounts.
This meant if you were buying $100 worth of stock, you would spend $8 ($4 to purchase and $4 to sell) just to realize some gains, meaning you had to make at least 8% to make a profit in that transaction.
To avoid losing all of your gains to fees, you would have to trade in larger amounts to offset those costs. This would turn away a lot of smaller investors.
Now, almost every broker features commission-free trading.
This is a big deal, but I think the other advent of this new revolution of retail investors is a less covered advancement — fractional shares.
Suppose you want to buy one share of Amazon that used to cost you around $3,000. Now you can buy shares of Amazon for as little as $1. How is that possible?
Fractional shares. Instead of stocks being all or nothing, you can get a small piece of them instead. Before this feature came out, the most popular stocks on Robinhood were companies like GE and Ford, which had shares trading for under $10.
Most novice investors think you can tell how pricey a company is based on the share price. GE at $9 is cheap, but Amazon at $3,000 is expensive. However, by using other metrics to measure value, I could easily say GE at $9 was much pricier than Amazon at $3,000, but that is too much to go over in an article.
Why this is only the beginning
With the lack of commission fees and the advent of fractional shares, I think the retail investor’s impact is just going to grow.
With this, everyone, no matter how much money they have, can buy shares in their favorite companies and build their own customized portfolios instead of just blindly buying index funds with 100s of companies you can’t even name.
I have personally built my own little fund that has been able to generate returns that for the last three years have beat the S&P 500, and I wasn’t buying anything speculative either.
I was just buying great companies consistently over time.
This doesn’t mean you can just buy any company and expect to make great returns. There is a little homework that should be done before you start trading all of your excess cash. But that doesn’t mean trading stocks should only be left to the pros.
I think these two books will equip any novice investor with the general knowledge and skills they need to be a great long-term investor. Notice the catch long-term investor. Not day trader. Investing and day trading are different things, so don’t get them confused.
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