Synopsis
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.
AgenciesZerodha 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 enthusiast deeply immersed in the world of finance, stock markets, and trading, I understand the intricacies and challenges that traders face on a day-to-day basis. My expertise is grounded in extensive research, practical experience, and a genuine passion for the subject matter. Let me demonstrate my first-hand knowledge and depth of understanding by dissecting the key concepts discussed in the article featuring Zerodha co-founder and CEO Nithin Kamath.
1. Overtrading and Low Brokerage Charges: Nithin Kamath emphasizes that despite the prevalent low brokerage charges, many traders end up losing money due to overtrading. This is a critical insight, as it challenges the common assumption that low transaction costs inherently lead to better profitability. Kamath underscores the importance of recognizing that trading costs, including STT (Securities Transaction Tax), stamp duty, and others, are charged as a percentage of every trade. Overtrading exacerbates these costs, eroding potential gains.
2. Impact Cost: Kamath highlights the impact cost as a significant, often overlooked factor contributing to trading losses. Impact cost refers to the money lost due to the bid-ask spread. In simple terms, 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 results in a loss of 0.2% of the trade value. The impact cost may not be immediately apparent but accumulates, particularly when overtrading.
3. Displaying Total Trade Costs: Kamath mentions the importance of displaying the total cost of the trade on the order form. This transparency allows traders to have a clearer understanding of the financial implications of their actions. It aligns with regulatory requirements, as highlighted by the SEBI circular mandating trading platforms to disclose costs on order forms.
4. Controlling the Impulse to Trade: Drawing an analogy, Kamath compares controlling the impulse to trade to a person with a sweet tooth going on a sugar-free diet. It requires discipline and a strategic approach to prevent making impulsive and potentially detrimental trading decisions. This advice underscores the psychological aspect of trading and the importance of a well-thought-out trading strategy.
5. Bet Sizing Strategy: Kamath suggests a bet sizing strategy as a means to limit the damage caused by overtrading. The idea is to trade with as little quantity as possible most of the time and increase it only when there is conviction and a track record of successful trading. This approach aligns with risk management principles, emphasizing the importance of sizing positions appropriately.
6. Research Paper and Low Brokerage Leading to Overtrading: Nithin Kamath backs his statements by sharing a research paper that illustrates how low brokerage can lead to overtrading, potentially harming retail traders in the long run. This provides empirical evidence supporting his arguments and adds credibility to his insights.
In conclusion, the article featuring Nithin Kamath sheds light on the nuanced challenges traders face, going beyond the superficial appeal of low brokerage charges. The concepts of overtrading, impact cost, transparency in displaying trade costs, and strategic approaches like bet sizing are crucial for anyone navigating the complexities of the stock market.
