Overtrading: When Less is More
More activity doesn't mean better results. In fact, the most successful investors often trade the least.
The Overtrading Problem
Overtrading = Buying and selling too frequently, usually driven by:
- Boredom
- Overconfidence
- Reacting to news
- Trying to time the market
- Chasing performance
The Garden
A gardener who constantly digs up plants to check their roots will kill the garden.
Plants need time to grow. So do investments.
The best gardeners plant carefully, then let nature work. The best investors buy carefully, then let compounding work.
Why Overtrading Hurts
1. Transaction Costs
Even with $0 commissions, there are costs:
- Bid-ask spreads
- Market impact
- Time spent trading
2. Taxes
- Short-term gains taxed at higher rates
- Frequent trading = frequent tax events
- Tax drag compounds over time
3. Missed Compounding
- Selling winners stops their compounding
- Best returns come from long-term holds
- Time in market beats timing the market
4. Behavioral Errors
- More decisions = more chances to be wrong
- Emotions influence frequent traders more
- Analysis paralysis
Key Takeaways
- Frequent trading usually reduces returns
- Costs, taxes, and behavioral errors compound
- The best investors trade infrequently
- Patience is a competitive advantage
The Data on Overtrading
Study: Barber and Odean
Analyzed 66,000 households over 6 years:
- Most active traders: 11.4% annual return
- Least active traders: 18.5% annual return
- Market return: 17.9%
The most active traders underperformed by 7% annually!
Why Active Traders Underperform
- Overconfidence leads to excessive trading
- Transaction costs add up
- Taxes eat into gains
- Selling winners too early
- Buying losers (chasing)
Signs You're Overtrading
Frequency Red Flags
- Trading weekly or more often
- Checking portfolio multiple times daily
- Reacting to every news headline
- Can't remember why you own certain stocks
Behavioral Red Flags
- Trading when bored
- Trading to "do something"
- Feeling anxious when not trading
- Confusing activity with progress
Results Red Flags
- High turnover in portfolio
- Many small gains/losses
- Underperforming buy-and-hold
- Significant tax bills
The Right Trading Frequency
For Most Investors
- Buy: When you find a great opportunity
- Sell: When thesis breaks or better opportunity exists
- Review: Monthly or quarterly
- Trade: A few times per year
Warren Buffett's Approach
"Our favorite holding period is forever."
Buffett has held some stocks for 30+ years. His low turnover is a key reason for his success.
The 1-Year Rule
Before selling any stock, ask:
- Has my original thesis changed?
- Is there a better opportunity for this capital?
- Am I selling for emotional reasons?
If you can't answer "yes" to #1 or #2, don't sell.
How to Trade Less
1. Set Rules
- Only trade when specific criteria are met
- Write down reasons before trading
- Review trades after the fact
2. Reduce Inputs
- Check portfolio weekly, not daily
- Limit financial news consumption
- Ignore short-term price movements
3. Raise the Bar
- Require strong conviction to trade
- Make selling harder than buying
- Default to holding
4. Automate
- Set up automatic investments
- Use limit orders, not market orders
- Remove the temptation to tinker
When Trading IS Appropriate
Good Reasons to Trade
- Rebalancing (annually)
- Tax-loss harvesting (strategically)
- Thesis change (fundamental shift)
- Better opportunity (rare)
- Life changes (need the money)
Bad Reasons to Trade
- Boredom
- News headlines
- Short-term price movements
- "Feeling" like you should
- Everyone else is trading
Overtrading Traps
- Confusing activity with productivity
- Thinking more trades = more returns
- Reacting to daily market movements
- Trying to time short-term swings
- Trading to feel in control
Next up: Ignoring risk—the dangers of overconfidence.