Active investment commentary & analysis

What does the boom in online trading tell us?

What does the boom in online trading tell us? Perhaps not that there is valuable research that is accessible only to some social media pundits. Regulation and professional codes effectively limit the analysis that investment professionals can offer publicly on individual stocks. That leaves the field open to the anonymous and unregulated, letting misinformation reign. Even stocks as big as Tesla have been involved in short squeezes.

Short squeezes are just one factor contributing to greater stock volatility. With less capital in market-making, investment banks and market-makers have little incentive to intervene. And many smaller and medium-sized companies, or recent IPOs, have limited coverage from non-house brokers. There is little financial incentive to initiate negative research. Price formation seems less balanced now.

In a world of network effects and rapid scaling of platforms, it may be that the true value of a business can double or treble in a year, but it is still rare. Growth investors often face this challenge; a stock might be viewed inherently as a good long term business, but re-rating shows too much short term optimism. There is also a lot of risk as well as expense in trading, and it may in fact be difficult to repurchase the holding. In the initial market turmoil of March 2020, as pandemic fears grew, many stocks sold-off sharply. But buying into that sell-off in any meaningful way proved difficult, and a swift rebound followed.

If growth portfolios should have a bias to buy and hold, how can new research be implemented or the portfolio be refreshed? Bringing rigour to the process usually involves investing rules and a process that involves portfolio structure and step changes in position size with an upper limit. One of the signs of over-confidence is allowing excessive holding sizes, say of 10%, often with that result coming from stock performance. It is understandable that investment managers find a reflected glory from unrealised gains and big positions, but the Woodford saga reminded us all where this can lead. Healthy management of a portfolio should involve some profit-taking in the best performing shares. That can manage risks and control average valuations across the portfolio as a whole.