We have witnessed a rapid growth in the participation of retail investors in the Indian stock markets over the last few years. As of March 2022, there were around 90 million demat accounts in the country with more than 50% of these added in the last two years. One big reason for the increased participation of retail investors is the rise of free stock trading platforms such as Zerodha, Upstox, Groww etc. Any individual can now open their demat account in a matter of minutes and start buying and selling stocks without needing to pay any brokerage (or very low in some cases). Accordingly, retail investors own 7.3% in the companies listed on the National Stock Exchange (NSE) as of December 2021, up from 6.9% in 2020 and just 1% in 2011.
Before these apps were launched, online brokerages charged as much as 0.5% of the transaction value per trade as brokerage. On a buy & sell combination, the transaction costs would be a 1% brokerage plus GST, STT etc. Today, transaction costs are zero or negligible in most cases. This is a huge benefit to retail investors who get to keep a bigger share of the profits of their investments. Still, it has actually worked out differently for many retail investors. What is wrong with free trading apps?
When something is free, your consumption of it can go up a lot. For most things that is not a problem, but when you start trading much more frequently because it is free, it is harmful for your financial health. By eliminating friction completely from buying and selling, these apps may actually cause you to trade much more often. This higher level of activity leads to an obsession with short-term price movements in your stocks and can cause you to make mistakes, not to mention the loss of time and extra stress from watching and trying to trade every move in the market.
In 2000, economists Brad Barber and Terrance Odean published a paper ‘Trading is Hazardous to your Wealth’ in the Journal of Finance. They analyzed the return on common stock investments from 66,000 households in the U.S. with accounts at a large stock brokerage during 1991-1996. The study found that households that trade more often underperform the benchmark index by around 6% annually.
Another such study ‘Trading Down: The effects of Active Trading on one month ETF returns’ was published by researcher Ian Gray in 2021. He analyzed the daily trading records of four actively managed funds of Ark Investment Management in the U.S. over a five year period. He compared the funds’ performance with his own portfolios created according to the holdings of the funds on the starting day of every month with no trading during the month. Ark’s funds underperformed his portfolio by over 16% annually on average, showing that even institutional investors can hurt their returns by trading too much.
