10th July 2012: Day Trading 401(k)s

Software engineer Vlad Tokarev decided to day trade his retirement account. An LA Times profile documents the mistakes of Tokarev and other investors:

 

Minutes before the market closes every day, Tokarev buys or sells a mutual fund linked to the Standard & Poor’s 500 stock index. His goal is to profit from temporary fluctuations in stock prices, so he buys when stocks are falling and sells when they’re rising.

 

Wrong timing I: US stockmarkets tend to rally in the first hour of trade and the last half hour. Wrong timing II: buying at the end of day exposes the trader to overnight risk and possible market gaps. Wrong instrument I: a low-cost basket of exchange traded funds would be better than a mutual fund. Wrong instrument II: the S&P 500 is volatile and its index composition does not necessarily represent the market or sectors that perform well in current market conditions. Wrong asset allocation and decision biases: Tokarev is 49; wants to retire before 65; so his choice of day trading (availability bias) reflects an attempt to make-up for recent stockmarket losses (recency bias). Wrong risk management I: Tokarev day trades a third of his retirement fund whereas most traders recommend a position sizing of 1-2% of your portfolio on a specific trade. Wrong risk management II: Tokarev tells the LA Times, “”That’s what people usually say about day trading — but I don’t see how it can be dangerous.” This comment illustrates the irrational escalation bias, belief bias, blindspot bias, and the focusing effect. Tokarev also may not have factored in the  trading and execution costs, and capital gains tax implications of his day-trading. Instead, as Reuters’ Felix Salmon discovered, Tokarev appears to have based his trading strategy on a Wiley Finance book (Richard Schmitt‘s 4o1(k) Day Trading which has a bare-bones author-created website).

 

The LA Times article also quotes Wells Fargo customer complaints officer Joe Hansman:

 

Joe Hansman, 29, who handles customer complaints at Wells Fargo, shifts money among two conservative mutual funds in his 401(k) and the banking company’s own stock. He trades 10 to 15 times a month, steering money into Wells Fargo’s stock when he expects it to rally for a few day.

“When I told my wife about it she was really nervous … until I educated her on what it all entails and how poorly [the 401(k)] was performing before that,” Hansman said. “She’s still not 100% behind it but she said, ‘Just don’t lose everything. If you do I’ll divorce you.’ ”

 

In my view, Hansman makes a number of potential mistakes: trading expensive mutual funds instead of cheaper exchange traded funds; a home bias towards an employer in a sector (banking) that underperforms in a deleveraging (instead of using sector rotation); possible over-trading per month with higher transaction and execution costs; stocks that may have correlated returns and market beta exposures; and relying on swing trading without hedging. Handling his wife’s loss aversion and the potential, detrimental risks to his relationship are another matter: better invest in a copy of Diane Vaughan’s book Uncoupling: Turning Points In Intimate Relationships and a relationship therapist, just in case.

 

Neither Tokarev nor Hansman appear to have any background in finance or capital markets. Tokarev has a personal site with 401(k) day trading results.

 

Anxious Investors Day Trading With Retirement (LA Times)

 

Why Americans Won’t Day Trade Their 401K(s) (Felix Salmon)

 

Today in Awful Ideas: Day Trading With Your Retirement Fund (Gawker)

 

401(k) Day Trading (Vlad Tokarev)

Duelling Web 2.0 Scenarios: Boom/Bust

Has Tim O’Reilly’s Web 2.0 meme become a high-tech bubble about to burst?

Origins of the Web 2.0 Boom

O’Reilly’s vision of a new Web platform originally fused two developments.

The first development: C, Smalltalk and object oriented programmers devised design patterns in the early 1990s to reuse software code and workaround solutions across projects.  A 1995 catalog catapulted its four authors to software engineering fame.  To capture the rapidly growing number of design patterns programmer Ward Cunningham created the first wiki: the Portland Patterns Repository.

The second development: a re-evaluation of dotcom era business models to encompass new technologies that enhanced the end-user experience including the site interface and information architecture.  Industry buzz around News Corporation’s acquisition of MySpace (18th July 2005), Yahoo!’s purchase of Flickr (21st March 2005) and del.ico.us (9th December 2005), and Google’s stock-for-stock deal for YouTube (9th October 2006) made O’Reilly’s vision the ‘default’ vision for Web pundits and investors.

The media’s buzz cycle soon went into warp speed as Facebook frenzy replaced MySpace mania.  In a move that exemplified the pivotal role of complementors O’Reilly & Associates morphed into the juggernaut O’Reilly Media.  Ajax and Ruby Rails soon replaced Java and C# as the languages for new programmers to learn.  For activists in community-based media, angel investors investing in scalable programming prototypes and international conglomerates seeking to control their industry white-spaces Web 2.0 provided an all-encompassing answer to venture capitalists on how they would change the world.

Two Scenarios: Web 2.0 Boom & Bust

For industry pundits Google’s decision in October 2008 not to acquire Digg may signal the Web 2.0 boom has become a bubble.  If true Google’s decision could be the mirror of News Corporation and Yahoo!’s acquisitions in 2005.  Slate‘s Chris Anderson points to several factors: no tech IPOs in the second quarter of 2008, the cyclical nature of the digital consumer market, the exit of Yahoo! as a potential buyer due to internal problems, market noise due to low barriers of entry for startups, and a smaller “window of opportunity in which startups can think of a new neat trick, generate buzz, and cash out.”  YouTube’s co-founder Jawed Karim adamently believes that Silicon Valley is in a bubble.

Twitter is the latest startup in the duelling scenarios of Web 2.0 boom versus bust. New York Times journalist Adam Lashinsky experiences a similar euphoria to Facebook and YouTube when he visits Twitter’s co-founder Jack Dorsey.  Sceptics counter that Facebook and YouTube have not ‘monetised’ their business models into profitable revenues.  Portfolio‘s Sam Gustin raises the ‘monetisation’ problem with Twitter co-founder Biz Stone who believes that service reliability is a priority over the “distraction” of revenue pressures.  In support of Stone’s position Anderson observes that cloud computing and open source software are lowering the operational costs and slowing the burn rates of startups.

Yet monetisation remains a primary concern for Sand Hill Road entrepreneurs and other venture capitalists.  They differ in their decision-making criteria to Web 2.0 pundits and high-tech futurists: for angel investors and first round VC funding the entrepreneurs will demand a solid management team, the execution ability to control an industry whitespace, and viable sources of future revenue growth.  This is the realm of financial ratios and mark-to-market valuation rather than normative beliefs and ideals which probably influenced the acquiring firm’s decisions and valuation models in 2005-06.

Furthermore, if a Web 2.0 bust scenario is in play, the ‘contrarian’ sceptics will look to Charles Mackay, Charles P. Kindleberger, Joseph Stiglitz and other chroniclers of past bubbles, contagion and manias for guidance.  With different frames and time horizons the Web 2.0 pundits, high-tech futurists and venture capitalists will continue to talk past each other, creating still more Twitter microblogging, blog posts and media coverage.

Several preliminary conclusions can be drawn from the Web 2.0 boom/bust debate.  In a powerful case of futures thinking O’Reilly’s original Web 2.0 definition envisioned the conceptual frontier which enabled the social network or user-generated site of your choice to come into being.  The successful Web 2.0 startups in Silicon Valley have a distinctive strategy comparable to their dotcom era counterparts in Los Angeles and New York’s Silicon Alley.  Web 2.0 advocates who justify their stance with MySpace, YouTube and del.icio.us are still vulnerable to hindsight and survivorship biases. There’s a middle ground here to integrate the deep conceptual insights
of high-tech futurists with the quantitative precision of valuation
models.

It’s possible that the high-visibility Web 2.0 acquisitions in 2005-06 were due to a consolidation wave and strategic moves/counter-moves by their acquirers in a larger competitive game.  There are two precedents for this view.  Industry deregulation sparked a mergers and acquisitions boom in Europe’s telecommunications sector in the late 1990s comparable to the mid-1980s leveraged buyout wave in the United States.  Several factors including pension fund managers, day trading culture and the 1999 repeal of the US Glass-Steagall Act combined to accelerate the 1995-2000 dotcom bubble.  Thus, analysts who want to understand the boom/bust dynamics need to combine elements and factors from Web 2.0 pundits, high tech futurists and venture capitalists.

If the Web 2.0 boom has become a bubble then all is not lost.  Future entrepreneurs can take their cue from Newsweek journalist Daniel Gross and his book Pop! Why Bubbles Are Great for the Economy (Collins, New York, 2007): the wreckage from near-future busts may become the foundation of future bubbles.  Web 3.0 debates are already in play and will soon be eclipsed by Ray Kurzweil‘s Transhumanist agenda for Web 23.0.