Is online trading safe? Security-wise yes, but it can lead investors into trading way too much.
Online trading is the buying and selling of stocks through an online brokerage account. Trading online also allows for quicker transactions compared to calling a broker on the phone.
But is online trading safe—not in terms of, say, security of the transactions, but rather does it promote investor behaviour that could hurt your returns? Some investors may look at online trading as a quicker and more convenient way to build wealth, but there are hidden dangers that may not be easy to spot at first.
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Is online trading safe? Realize that frequent stock trading online can lead investors into dangerous territory
The main risks of online trading come from the fact that it all may seem deceptively easy. The lower costs and higher speeds of online trading can lead otherwise conservative investors to trade too frequently. As a result, you could wind up selling your best picks when they are just getting started.
This random element can be profitable for short periods. But you can’t reliably profit from it over the long term. In fact, most short-term traders wind up losing money. By the time their beginners’ luck fades, many are trading in dangerously large quantities.
Frequent trading can also lead you to buy lower-quality, thinly traded stocks. The danger arises from the fact that the bid and ask spreads of many of these investments can be so wide that the share price will have to go up significantly before you’ll even begin to make money on a sale.
You can make trades quickly in online trading, and that cuts your commission costs. However, for successful investors, this is a bonus, not the object of trading stocks.
It is far more important to follow the Successful Investor approach and focus on high-quality, well-established companies and how they fit into your portfolio. The longer you hold these stocks, the greater the chance that your profits will improve, as well.
We do our own stock market research for our newsletters and investment services, and we apply it from a portfolio manager’s perspective. That’s why we advise sticking to well-established companies; they tend to hold on to more value when things go wrong, or at least tend to recover more quickly.
Is online trading safe? Automated stock-picking systems can backfire when you trade stocks online
Some investors who trade stocks online use automated stock-picking systems to help them make investment decisions. These systems are typically marketed with impressive-looking performance records designed to make investors think they are sure to make guaranteed profits. However, those records are typically derived by “back-testing” the program against past data. In other words, the promoters go back through old trading records and see what would have worked in the past.
Automated stock-picking systems essentially do two things: First, they narrow down the data you use when you make investment decisions. Second, they apply a fixed rule, or rules, to draw a conclusion or an investment decision from that selection of data. Unfortunately, the market’s key concerns continually change.
Today’s good investments can turn into tomorrow’s dead ends. For a time, these systems seem to work, but that’s usually coincidental. If the market is going up and the system tells you to buy volatile investments, it automatically generates profitable trades. But they can just as quickly turn around and begin pumping out unprofitable trades. Often this happens just when they can do the most damage to the investor relying on the system.
Bonus tip: Don’t miss these key points for investors on the basics of successfully investing in the stock market
It’s essential to diversify, as you do if you are investing your money with our three-pronged Successful Investor approach. Meaning, you are investing in well-established, dividend-paying companies, spreading your investments across most if not all of the five economic sectors and avoiding stocks in the broker/media limelight.
In addition, successful investors need to limit their involvement in trouble-prone areas like new issues, start-up companies and illiquid investments.
They need to stay out of companies in which they have doubts of any sort about the integrity of insiders.
They also need to recognize the special risks of investing in fashionable or excessively popular minefields, such as Internet stocks in the late 1990s, or income trusts in the 2000s.
In fact, you could sum up the basics of successful investing quite simply in four key points:
Don’t depend on luck to make money for you or to prevent losses.
Be skeptical of the claims and recommendations of brokers, promoters or anybody else with a vested interest in a particular investment.
Don’t do anything stupid.
Win by not losing.
Some online trading companies offer a no-fee model for stock trading, which has the ability to entice many young investors. What are your thoughts on this?
What do you think about online trading? Is there potential to generate big, long-term profits through an online approach?
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