Zerodha co-founder and CEO Nithin Kamath on Tuesday said most traders lose money through overtrading despite low brokerage charges these days.
“The biggest reason active traders lose money is overtrading, the low brokerage doesn't help," Kamath said.
Kamath, also known to regularly share educational content and stock market learnings on Twitter and other social media platforms, said people forget that trading costs are charged as a percentage of every trade and can compound very quickly.
"Costs like STT, stamp duty, etc. are charged as a percentage of every trade and compound quickly," Kamath said, adding that traders can now see the total cost of the trade on the order form.
"Ideally, we should have introduced this feature even before the SEBI circular requiring all trading platforms to display costs on the order form. This was a miss from our side," he said.
According to him, the biggest cost for traders is the impact, which still can't be captured. Impact cost is the money lost due to the bid-ask spread.
"For example, if the bid is at Rs 100 and the offer is at Rs 100.2, buying at Rs 100.2 and selling at Rs 100 means a loss of 0.2% of the trade value. Impact costs aren't obvious, but add up when you overtrade," Kamath said.
"Controlling your impulse to trade is like a person with a sweet tooth going on a sugar-free diet — assume that you'll do something stupid," he said.
Taking to Twitter, Kamath further said a bet sizing strategy will limit the damage and that should be the goal in case of over trading.
"The goal should be to limit the damage. With diet, it is to have fruits and sugar-free alternatives. With trading, it is bet-sizing. A simple bet- sizing strategy is to trade with as little quantity as possible most of the time. Increase it only when you have conviction and are trading well," Kamath said in a series of tweets.
In such a scenario, even if one is overtrading, the risk, and the trading and impact costs don't compound quickly.
The Zerodha founder also shared a research paper, which shows how low brokerage can lead to overtrading and can hurt the eventual outcome for retail traders.
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As an experienced financial professional with a deep understanding of the intricacies of trading, I can affirm the insights shared by Zerodha co-founder and CEO, Nithin Kamath. Kamath's observations about the challenges faced by active traders, particularly the tendency to lose money through overtrading, resonate with a fundamental aspect of trading psychology.
Firstly, Kamath emphasizes the impact of overtrading despite the current trend of low brokerage charges. This aligns with the understanding that the frequency of trades doesn't necessarily correlate with profitability. In fact, as Kamath points out, the low brokerage charges might inadvertently contribute to overtrading, as traders may overlook the cumulative impact of additional costs such as Securities Transaction Tax (STT) and stamp duty, which are charged as a percentage of each trade.
Kamath's mention of the bid-ask spread and its role in impact costs further underscores the nuanced nature of trading expenses. The bid-ask spread represents the difference between the highest price a buyer is willing to pay and the lowest price a seller is willing to accept. The impact cost, or the money lost due to this spread, is a hidden factor that can significantly affect a trade's profitability, especially when compounded through overtrading.
Furthermore, Kamath introduces the concept of controlling the impulse to trade, drawing an analogy with a person with a sweet tooth going on a sugar-free diet. This analogy aptly illustrates the discipline required to avoid unnecessary trades and prevent financial losses.
Additionally, Kamath advocates for a bet-sizing strategy as a risk management approach. This involves limiting the quantity traded, especially during times of lower conviction or excessive trading impulses. The idea is to increase trade size only when there is a high level of conviction and successful trading performance.
In support of his insights, Kamath shares a research paper demonstrating how low brokerage charges can contribute to overtrading, highlighting the importance of understanding the potential pitfalls associated with seemingly advantageous cost structures.
In conclusion, Nithin Kamath's perspective, backed by his role as the CEO of Zerodha and his continuous efforts to educate traders, provides valuable insights into the challenges faced by active traders. The concepts discussed, such as the impact of overtrading, hidden costs, and the importance of disciplined trading strategies, resonate with the principles of sound financial decision-making in the dynamic world of stock markets.
