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Stepan Lavrouk
Stepan Lavrouk
Articles (603) 

Retail Traders Rush Into Speculative Trading

Today's speculators would do well to learn from history

September 28, 2020

Speculative trading is not a new phenomenon. One only needs to look at the countless historical examples of bubbles that have blown up and burst spectacularly: the Dutch tulip bubble of 1637 (the first recorded bubble in history), the South Sea and Mississippi bubbles of 1720 (two of the earliest stock market bubbles ever recorded), the Panic of 1825 (the run-up to which saw wild speculation in the debt of newly created Latin American states), Black Tuesday of 1929, the dotcom bubble of the early 2000s and, of course, the real estate bubble of 2007-08 - what these episodes all demonstrate is that the human desire to speculate has always been strong. Here's why this is relevant today.

Playing with fire

Another thing many of these bubbles have in common is that they were fuelled by expansionary monetary policy and the provision of cheap credit. So it might not come as a surprise that in today's extremely loose monetary environment, retail investors have been flocking to apps and websites that offer zero-commission trading and easy access to the public markets. In particular, there has been a huge explosion in the use of options and other financial derivatives to make leveraged bets on highly volatile stocks.

The volume of options for individual stocks has simply skyrocketed. In the month of August, option volume averaged 18.4 million contracts per day, a record high and up 80% from the monthly average for 2019. On top of this, funds are rushing into triple leveraged exchange-traded funds, with both retail and institutional investors eager to capitalize on the bull rush in tech and growth stocks. And what's more, data shows that a large amount of these contracts are being bought in small batches, indicating that a lot of this activity is being driven by small, probably unsophisticated, investors.

There are two problems with this. The first is that many speculators likely don't know the real risk they are taking on. There have already been many horror stories about wannabe traders losing their life savings because they didn't understand the exposure they were taking on by executing exotic options strategies.

The second is that when you speculate, you have no real basis on which to value the stocks or options that you are buying, which means that all you have is the hope that the next person will pay even more for a security than you did. This makes this kind of activity inherently risky and unpredictable - it is, in effect, gambling. Over long periods of time, it's almost impossible to make money by doing this.

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About the author:

Stepan Lavrouk
Stepan Lavrouk is a financial writer with a background in equity research and macro trading. Specific investing interests include energy, fundamental geoeconomic analysis and biotechnology. He holds a bachelor of science degree from Trinity College Dublin.

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