Do it yourself

Mitesh Gupta, an average student, passed senior school in 2021. He failed to pass the admission test for graduate school. He joined a distance learning course in 2022 but did not like it. His father retired from a mid-level government job in early 2023. He convinced his father to give him Rs two million from his retirement corpus and started trading stocks and derivatives. He learned a few things from YouTube videos, blogs, and social media posts. He has lost more than half of his initial capital in the past year but is hopeful to recover all lost money and make a decent living out of this occupation.

Arvind Agarwal runs a small packaging material manufacturing unit. His business had not been growing for the past few years, especially after the implementation of GST. He advised his 29-year-old son Anuj, a commerce graduate, to learn and start trading stocks as a side business. Anuj is learning stock trading from his friends, social media, and blog posts. He has also taken some online classes for technical analysis, and option strategies, etc. Anuj now remains glued to his laptop from 9 AM to 3:30 PM. In the past three years, he has been able to earn 18% CAGR on the capital employed in stock trading.

Neha Arora, a software developer, works as a mid-level manager with a top IT Services company in India. Her salary has grown at a CAGR of 8% over the past five years, much less than her household expenses. She started trading stocks during the Covid-19 lock-down while working from home. So far, she has been able to supplement her salary with the trading income. Neha plans to increase the capital deployed for trading and make it her full-time profession in the next three to four years.

Evidently, in the past four years, stock and derivative trading has become a full-time profession of choice for a variety of individuals. Incidentally, it is not an India-specific phenomenon. Similar trends are being reported from countries (developed and developing) across the world.

We have already reached a situation where a handful of people are innovating, creating businesses, and building wealth; whereas an exponentially higher number of people are just piling on their success, and trading their ideas, success, failures, business cycles, and performance with little or no sense of commitment to their business. Cynically speaking, a part of society is becoming like the plot of the much-acclaimed 2019 South Korean movie ‘Parasite’.

The question is “Is stock trading as a full-time profession" sustainable if a much larger number of individuals make it their profession of choice?”

I shall try to find an answer to this inquisition over the next few months. There are strong arguments on both sides. For example, —

·         Many traders quote the traditional market saying, “Owners of businesses make more money than the managers of the business”. This implies that passive shareholders of a company shall earn more than the people who are managing the business. The problem in this argument however is that not many traders are interested in becoming owners of businesses. They are happy buying and selling stocks for immediate 3-5% gains.

·         There is an argument that stock trading is a perennial business. It continues even during wars, natural calamities, and pandemics. There is no business like this. This argument comes mostly from young traders in their 20s and early 30s. They have not seen a three-decade stagnation in the Japanese market; over a decade of stagnation in the US and the UK markets, and frequent disruptions and stagnation in the Indian markets during the 1990s.

·         The strongest argument in favor of stock trading is that in this profession anyone can get significant leverage easily. Thus, the opportunity to multiply the capital is the best in this activity. The easy leverage part is true. But it works as a double-edged sword. The probability of losing the entire capital rather swiftly is also the highest in this profession.

·         The ability to earn above normal return depends on a combination of capital base, risk appetite, and skill set of the trader. This could be different for all traders. Traders with a small capital base, poor risk appetite and/or inadequate skill set are most likely to underperform the others, just like any other business or profession.

·         The sustainability of stock trading as a regular profession would depend on a continuous supply of quality businesses that employ new ideas (product, process, or service) and innovative techniques. If new quality businesses are not continuously added to the existing inventory of stocks available for trading, a serious demand-supply mismatch may occur in the market – driving the stock prices into the realm of irrational and exorbitant. That would make the entire stock market prone to sudden crashes, imperiling the overall economic growth of the country. So, to sustain so many new traders in the stock markets, we would need a matching number of entrepreneurs successfully seeding & cultivating new ideas, and providing adequate inventory for traders to pursue their activities.

·         If stock trading becomes a medium of livelihood for millions of youth, the entire regulatory framework may need to be overhauled. A massive paradigm shift may be needed to redefine the way stock trading is presently perceived by policymakers, regulators, and society in general. For example, RBI considers it an undesirable activity and imposes a plethora of restrictions for credit to stock traders. This activity is taxed heavily, instead of getting the usual “job-oriented” activity incentives. SEBI and Finance ministers have openly spoken against the popularity of option trading as a regular activity. The regulations do not provide any protection to regular traders.

I would like to share some of my impressions gathered from my numerous interactions with a variety of investors and traders - from very small ones to ultra-high networth; from frequent and short-term traders to long-only investors; from highly educated to less educated; professionals, businessmen to salaried; metro residents, tier2 & 3 town residents to semi-urban residents, etc.

·         The understanding of equity derivatives is poor and misplaced. Most investors/traders assume Futures and Options to be speculative instruments only. They are mostly unaware of the hedging function of the equity derivatives. The intermediaries are playing a negligible role in promoting this awareness. Often their role is limited to making the clients sign complicated and illegible risk disclosure documents and posting some elementary guidance material on their websites.

·         Contrary to popular belief, a significant number of traders are looking to buy precious metals (gold and silver) for short-term trade.

·         The knowledge about precious metal market dynamics is abysmal amongst investors. Most people are buying gold and silver based on preconceived notions or word of mouth. Silver in particular is a strange case. Very few people have previous experience of buying or holding silver as an investment or trade. Given the complications in owning silver in physical form, most of them are looking at buying silver derivatives. Only a few are aware of Silver ETF etc.

·         Cryptocurrencies are becoming a normalized trading option for young participants. Notwithstanding the regulatory limitations and frequent cautionary statements from the regulators, a large number of urban youth have taken to trading in cryptocurrencies. A large number of young traders are trading in cryptocurrencies on the advice of unregulated and unauthorized advisors. Their understanding of the underlying currencies is almost zilch. There is no effort from any side to create awareness about the cryptocurrency.

·         A large number of household investors have been advised to allocate a larger proportion to bonds to benefit from anticipated rate cuts. Some of these investors are edgy as the narrative is moving away from “imminent cuts” to “cut or not to cut”.

I clearly remember in the 1980s and 1990s a large majority of Indian households believed investing in equities to be akin to gambling. They avoided investing in equities and preferred bank deposits. In the 2000s awareness about equities started to grow. New-age businesses, especially IT service companies and financial services firms, which paid a significant part of remuneration to their employees in the form of stock options, made equities an essential part of many middle-class households. The cult has been growing ever since.

However, in recent times, I am finding the fears of the 1980s generation are now coming true. Trading in equities, precious metals, bonds, etc. is increasingly becoming akin to gambling.