New Research: Success is limited until DIY investors break bad habits

Global lockdown measures, low interest rates and a search for additional income in the wake of a global pandemic have unwittingly helped spearhead a movement of traders keen to take the reins and invest for themselves. According to research by Euronext, the share of total trading carried out by retail investors in Europe jumped to nearly 7% in mid-2020 from 2% in 2019. In the US, Morgan Stanley estimated that retail investors accounted for roughly 10% of daily trading volumes on the Russell 3000, the broadest U.S. stocks index, after peaking at 15% in September 2020 when lockdown measures were first enforced.

But even as people continue to turn to trading apps and online platforms to try their hand at investing, the age-old question remains - can people make money from do-it-yourself (DIY) investing?

It is widely accepted across the investment fraternity that the vast majority of retail traders lose money - any seasoned investor will tell you this. In fact more than 70% of DIY investors lose money.

But an experienced hand will also tell you, with the benefit of hindsight, that common trading mistakes can be avoided providing you know where to look; and knowing where to look begins with psychology.

According to the Data Science team at Capital.com, we can learn a lot about investors’ psychology from their trading patterns.

In the 18 months to July 2021, more than 70% of trades executed on Capital.com were closed within 24 hours—and nearly half (45%) were closed within 60 minutes. Meanwhile, losing positions were closed 1.4 times more often within five minutes than winning ones.

“Hanging on to losing trades for too long and exiting successful positions quickly to lock in profit is often symptomatic of disposition bias, a common psychological trait which tends to affect novice traders,” explains Arty Rusetski, Head of Data Science and Artificial Intelligence at Capital.com.

Disposition bias can cause investors to sell assets that have increased in value, while holding assets that have dropped in value. It influences investors to retreat from their original trading strategy, which usually leads to risk management mistakes and larger, unexpected losses.

A chronic fear of losing may also explain why many investors hold onto losses for longer than they should. “To avoid experiencing the pain of a loss, people will continue to hold onto an investment even as their losses increase. This is because they want to avoid facing the psychological impact of their loss. In their mind, as long as they haven’t yet closed out the trade, they haven't lost.”

Most DIY investors fail to stick to their stop-losses

To help mitigate the extent psychological factors affect DIY investment strategies, investors could apply a pre-determined exit strategy using a stop loss. This can help to override emotional impulses and minimise losses. Yet many DIY investors still don't use stop losses and when they do, they are prone to move their limits.

Between January 2020 to July 2021, some 60% of Capital.com traders globally were not using stop-loss strategies, of which only 44% were making a profit. Among those traders who did use stop-losses, 49% of them adjusted the value before the original stop price was triggered.

“Most people don’t use stop-losses. We can draw a lot from the psychology of this,” says David Jones, Chief Market Strategist at Capital.com. “Much of it revolves around the idea of ego and not being willing to admit you are wrong. When it goes wrong, you have to come out of it. This is the biggest pitfall for traders as long as trading has taken place, ” he adds.

Ego, an investor’s nemesis

“The whole process of trading is a story about the ego, otherwise why bother doing it at all, but the problem occurs when the ego gets in the way of an investing strategy,” says Rusetski. The ego often leads traders to overvalue their own ideas, abilities and knowledge about what the market should do, reasons for profitability, chances of success, and ultimately believing they can control the situation.

To help traders identify when they may be falling into psychological traps, Capital.com is developing a dedicated AI solution to monitor their activity. Based on an investor's trading patterns, the platform will deliver personalised and tailored content via in-app messages, push notifications and emails prompting traders to carefully consider what they are doing and the decisions ahead of them. The solution will help traders identify their strengths and weaknesses, and fill in their knowledge gaps with relevant education materials. It is designed to help people make trading decisions that are less impacted by unconscious, psychological biases.

Ultimately, there are no guarantees when it comes to investing. Nerves, ego and emotions will always influence behaviours. At best, investors can help mitigate some of these risks by being aware of the common psychological traits that affect investment decisions, but this takes time - - there are no shortcuts here. Experience, education and patience are key to DIY investing. Those who consider themselves long-term, successful investors will undoubtedly agree.