This is from wsj regarding small cap stocks trading:
Volatility in Small Stocks Is Tempting to Investors
By AARON LUCCHETTI
Staff Reporter of THE WALL STREET JOURNAL
Volatile small stocks and the ease of push-button electronic trading are
tempting individual investors overall to do more rapid-fire trading. But
studies are showing that a buy-and-hold strategy is better.
A study by two finance professors at the University of California-Davis
found that active investors on average turned over 80% of their portfolios
in a year. But the professors, Brad M. Barber and Terrance Odean, also
found that those who traded most performed worst. While a
value-weighted overall market index returned 17.7% between 1991 and
1996, the average individual investor gained 15.3%, often by quickly
trading volatile small stocks, the study showed.
"Very few can benefit" from lightning-quick active trading, says Mr.
Odean, who has also studied the stock-picking ability of individual
investors. "People don't realize how much it costs to trade." The
most-rapid traders turned over their entire portfolio in less than a year, but
gained only 10% a year, the study shows.
More-Rapid Turnover in Holdings
Buy and hold has long been the recommendation of experts. But some
stocks, particularly small stocks, have been increasingly volatile in recent
years, tempting investors to lock in big gains or cut big losses. Combine
that with the vast flow of instantaneous information available from cable
television and the Internet, and the ease and low cost of electronic trading,
and more investors are succumbing to that temptation.
Last year, 69% of the shares listed on the New York Stock Exchange
switched hands, an increase from 46% in 1990. On the Nasdaq Stock
Market, which is more heavily weighted in technology stocks and smaller
companies, 199% of the shares listed were traded in 1997, about twice
the percentage in 1990. In other words, each Nasdaq share changed
hands twice last year, compared with once at the beginning of the decade.
Of course, it isn't just individual investors churning the market. Mutual
funds have increased their turnover by 16% since 1993, according to
Morningstar Inc., which tracks mutual-fund performance. And savvy
brokers aren't ignoring the trend toward more trading, especially since
their commissions rise along with the pace of trading activity.
On-Line Trading
But individual investors needn't deal with brokers if they don't wish to
these days. A not-too-substantial investment in computer hardware and
software can get an active trader up and running from a simple home
office. "On line, for $6,000, you can get the quotes and the news" to trade,
says John Markese, president of the American Association of Individual
Investors. "For not a whole lot of money, you can have a pretty powerful
trading tool. The only thing you're tripping over is your own ability."
At Charles Schwab & Co., average daily trading volume for April shot up
to a record 144,100 trades, a 60% increase from a year earlier. "It's a
compelling argument that the low-priced Internet brokers are attracting
people who turn over their portfolio more frequently," a Schwab
spokesman says. Schwab's minimum $29.95 charge for on-line trades is
more than that of many on-line discounters, but the San Francisco-based
discount-brokerage firm rewards frequent traders with access to a free
research Web site.
Hurt by 'Spreads'
Whether investors get anything out of the added ability to trade is fiercely
debated. Certainly, the cost of on-line trading has fallen sharply since the
data were collected for the UC-Davis study. But trading quickly brings
higher capital-gains taxes. And Mr. Odean argues the difference between
the bid and ask prices for many small stocks keeps trading costs high and
hurts fleet-fingered Internet traders. The "spread" between the bid and ask
prices helps account for the poor performance in high-turnover strategies,
especially in small stocks, analysts say.
Investors have been encouraged to trade more because "they think they're
getting a great deal" on low commissions, says Thomas S. O'Keefe,
president of the National Association of Investment Professionals in St.
Paul, Minn. "But that's like going to buy a bunch of stuff at Kmart because
there's a sale on even though you don't need it."
Especially for small stocks, "the cost of entering and exiting these stocks is
huge," adds David Bayer, president of money-management firm
Knappenberger Bayer in Minneapolis. "Investors should try to understand
what they own." If they understand what they're buying, they won't be so
tempted to sell it soon, he says.
Steven J. Reid, portfolio manager of the Oakmark Small Cap Fund, greets
a growing number of inquiries he gets about short-term trading with a
standard reply: "I don't think it works," he says. "We look out three to five
years because we feel that over the long term, being able to stay with a
company is much better."
Increase in Liquidity
Nevertheless, rapid trading can sometimes be lucrative. According to a
Morningstar study last year, small-stock growth and value mutual funds
performed better when they traded more, unlike larger-cap funds that
performed worse as they increased activity. In a large fund, "it's hard to
add value by trading in and out," says Don Phillips, the research firm's
president. But with a smaller fund, he adds, getting in and out quickly helps
investors because opportunities can evaporate in days and "the penalty for
being wrong can be great."
Nobody seems to know what all that quick trading does to the overall
market. Claudia Mott, director of small-cap research at Prudential
Securities Inc., says the entrance of more short-term traders could
increase volatility, especially if the quick-on-the-trigger traders are jumping
into stocks that are already on the move. "My fear is that people are
getting caught up in the momentum of a stock not because they did the
research, but because they've heard bits and pieces of hype," she says.
Other traders see a silver lining in the short-term trading, saying more
activity boosts liquidity and makes it easier for buyers to find sellers and
vice versa. "A lot of people are willing to step up to the plate and trade,"
says William Walcher, senior vice president of brokerage services for Jack
White & Co. in San Diego. "This helps things be more stable." |
