The Inequity of the Market
by andrew@JijiniMarkets - Tue 20 Feb 2007
The stock market is a zero-sum game. For every winner there is a loser (if not several). Who are the winners, how do they win and who are the losers?
Like a casino, the house always wins. In the stock market, the establishment is the equivalent house -- brokers, investment banks and regulatory bodies that take a fee/commission of trading activity. On the NSE the average trading commission is 2%, with the broker taking 1.68% or above and the Capital Markets Authority taking a fixed fee of 0.32%. What this means is that given an average daily market turnover of KSh100m - KSh200m, between KSh2m and KSh4m is made daily in trading commissions and fees. Such sums explain why brokers have been proactive in attempting to sign up as many clients as possible. Amongst retail investors, the winners tend to be long-term investors that hold stocks for years if not decades. Most of the wealthiest NSE investors are testament to this. Granted there are some that have made a quick buck but in relative terms, the strategies used -- betting on IPOs or speculating on market events -- have historically proven to be unsustainable.
The losers, as expected, are predominantly retail investors. Institutional investors such as funds also have their share of big losses but given that most manage other people's money and still charge fees regardless of gains or losses the ultimate loser is still the private investor. Most of the losses stem from poor stock picking and even poorer timing. In addition to inferior stock picking, frequent trading is also a major source of lost revenue due to the commissions paid for each transaction. As an example, say you have KSh102 to invest and buy 1 share for KSh100 (taking out the KSh2 for the 2% commission). To break even the share has to rise by approximately 4% to KSh104 as selling will also incur a 2% commission. Evidently, though few realise it, frequent trading attempting to pick up gains of 4%-5% or less is generally a losing strategy.
Most fund managers advise holding stocks for at least five years while Warren Buffet goes further and recommends an ideal holding period of "forever". Buying shares is like buying lottery tickets except in this case the tickets are valid almost indefinitely. Day trading (i.e. regularly buying and selling shares by constantly watching market activity and prices) is akin to attempting to guess each day's winning numbers which in most cases is a futile exercise. Historically the optimal strategy for the retail investor has been: pick your stocks wisely through adequate research and correct timing; and be patient enough to hold on to your stocks for the long term as you await the day when your ticket will be called as having the winning numbers.
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