“Dumb Money” and Hype Trading

We previously discussed how the market environment is ever-changing. One of the biggest changes in recent years is the unprecedented ease of access to markets now available to retail traders. Alongside this newfound market access, idle hands during the COVID crisis combined with blockchain frenzy to convert armchair quarterbacks to toilet stall fund managers. The outcome was retail-driven market moves on a scale never seen before. Creating the GME short squeeze and the collapsed FTX crypto exchange.

Nick recently contributed to a Sydney Morning Herald article comparing the realities of successful retail trading to the Hollywood reimagination depicted in Dumb Money. From The Big Short to the Wolf of Wall St, trading has had its fair share of ridiculous film representations, but Dumb Money is the first to protagonize retail traders.

The aforementioned SMH article mentions that 80% of retail traders lose money and quit within the first year. Another more recent study from The Journal of Finance suggests that attention-induced traders on the brokerage platform Robinhood. Such as those depicted in Dumb Money, were likely to seek out stocks making extreme moves in either direction. In fact, intense buying by Robinhood users was shown to forecast negative returns. With a 20-day average return of -4.7% for the top-purchased stocks. Like in the case of Dumb Money and the GME squeeze, these traders were abandoned by those taking profits and left “holding the bag”. Further to this, the study shows an 855% abnormal increase in short volume placed against these top-bought Robinhood stocks. Suggesting traders are looking to directly exploit those hype-induced traders.

This is put down to hype-driven traders having no real trading plan of their own and following the herd. Hoping to capitalise on moves already made. While some of these may be retail traders who have been misled by rampant social media misinformation. Many are likely trading with a gambling mindset. Putting money down on a card game they don’t understand.

The lesson here is simple: Do your research. Plan, test, and verify your strategy. Understand the risks involved and come up with a plan to manage them. If you’d like to learn more about building trading strategies, consider our Beginner’s Guide To Building Trading Systems.