When it comes to money, be it spending or investing, most individuals like to think that it’s return which drives behaviour, you choose where you spend or invest based on what you get in return. However, time and again it’s been proven that in reality it’s the opposite – behaviour drives return; outcomes from your money decisions often depend on how you behave while making them.
When it comes to investing, findings of a recent SEBI report, Analysis of Profit and Loss of Individual Traders in Equity F&O Segment, confirm this theory. The report has studied the trading pattern and outcomes for individual traders across the top 10 brokers in India.
The findings, whichever way you choose to dissect the data, clearly say that trading is a deep loss making activity for individual traders and yet their numbers have gone up at least six times in the last three years.
In FY 22 (April 2021 to March 2022) 9 out of 10 individual traders made losses on average anywhere between ₹1.1 lakh to ₹1.25 lakh. There are 42.4 lakh individual traders in index options with 89% making losses and nearly 21 lakh individual traders in stock options with 82% making losses.
Here's why are individuals scrambling to lose money and know what behaviour traits lead them:
Maximum behaviour minimum numbers
Most of us are more inclined to negotiate down the price of one kilogram of potatoes which you know the vendor is selling at least 10% above average cost, but never try to do the same with chilli potatoes that the fine dining restaurant is selling at a ridiculously above average price.
Today a kilogram of potatoes costs about ₹45 to ₹50, a 10% hike is roughly ₹5. A serve of chilli potatoes on the other hand can cost anywhere between ₹250- ₹500, depending on where you are dining.
It may seem unreasonable to question the latter, because you aren’t expected to (behaviour!) and there is limited knowledge of how the price was arrived at.
Nithin Kamath, founder and CEO of Zerodha Pvt Ltd, India’s top equity broker, warned individual traders in July 2021, against the perils of option buying. “…. 80% of all open buy option positions at the end of every day are in losses. Buying options ruins most retail traders. Because they don't understand the risk of leverage, averaging down, & impact costs," he tweeted.
Retail, individual traders are allowing their own trading behaviour to get the better of them. Let’s unpack some of this to understand where transformation can help in changing outcomes. Here are some behavioural biases that lead to losses:
Optimism Bias
Human beings are inherently optimistic about the future. It’s the belief that we are likely to have more good experiences than bad outcomes. While this is arguably essential for survival, it can lead to disastrous outcomes for equity traders.
Optimism focuses only on historical growth in markets, without checking in on quality and longevity of a trade or the short term volatility. Recent global wins for retail traders (remember GameStop and the big retail win?) also contributes to optimistic belief that the small trader can indeed win big.
SEBI data, on the other hand, shows the opposite to be true.
Trading is an activity where losses are just as possible as gains. The difference between individuals who repeatedly make losses versus those who are consistent gainers, is the reliance on experience, knowledge, skill and discipline, rather than hope.
Fear of missing out
When you read about all the gains that others are making, see the numerous videos, webinars on acing the derivative trade and witness screenshots with a few crores in daily profits, it’s a natural reaction to want a piece of that sweet smelling pie.
Reality often is not what’s projected and when you start eating this pie, you realise that the taste is unfamiliar and not as delicious as you expected. Since everybody is eating and seems to be enjoying it, you continue, thinking maybe the next bite will taste better.
Instead of jumping in after others, understand where your risk tolerance lies, what are your goals and how much return is enough for you; chasing what your neighbour does without understanding the above can easily lead you down a rabbit hole.
Loss aversion
We don’t like to book losses, in the hope that gains will come someday. When you buy and hold equity shares, losses are limited, plus you can continue holding the stock forever without realising a loss. Derivative trades are different.
For example, when you buy an option, depending on your chosen expiry and the strike price you can potentially lose the entire premium you paid. There is always hope of getting the price trend right next week or month, however, you might keep losing money if you repeatedly get the call wrong.
Option trading requires you to be on point about the short term price trend of a stock or an index. Ironically, when it comes to equity prices it is much simpler to estimate the long term price trend, rather than movement in a week or a month. But this is where optimism bias kicks in and keeps you going back for more.
Lack of discipline
The inability to stick to stop losses and target prices, if they are going against your initial estimate, is a combination of all the above stated behaviour biases. Experts also point to the indiscipline in staking only a small portion, say up to 5%, of your portfolio value at risk when trading in futures and options. The reason why many are unable to do this has more to do with greed than any skill. You can’t keep the peckish rabbit away from the next red, juicy carrot even if the last one was bitter.
SEBI’s extensive study has clearly displayed that all the emotion you put into the futures and options trade is futile. With 90% traders losing money, this is an indulgence turned into a bad habit. Trading in equity derivatives with just an optimistic belief that success can be a consistent or even a majority outcome is misplaced for individual traders.
Instead, just like any other professional activity, trading requires careful study, large doses of discipline and objective positions rather than hope and emotional reactions.
Lisa Pallavi Barbora is a financial coach and founder of moneypuzzle.in
