Last week, Nathaniel Popper wrote a stunning story in the New York Times about new investors who have gone into massive debt because of online stock and options trading. Robinhood is of particular interest because it’s quickly become the most popular online trading platform thanks to its slick design and intuitive interface. In fact, we picked Robinhood as 2020’s Best Investment App during The Simple Dollar Awards earlier this year.
Apps like Robinhood allow users to buy and sell individual shares of stock, including fractional shares as of this year. You can also participate in options trading, which gives you the right to buy or sell shares of stock at a certain price for a certain period of time. So, you might have an options contract to buy 100 shares of Coca-Cola at $45 a share between now and December 31 (this is known as a “call” option, where you’re buying shares), or you might have an options contract to sell 100 shares of Coca-Cola at $39 a share between now and November 30 (this is known as a “put” option, where you’re selling shares).
Options contracts can be extremely volatile, much more so than buying and selling shares of stock directly.
4 things to keep in mind when venturing into stocks and options
1. Only invest money you can afford to lose
For many people, the potential for getting a huge return on their money quickly from online stock and options trading is a huge draw. However, it’s just as easy to lose that money quickly, particularly if you start buying and selling options contracts, and especially if you start buying on margin.
My advice to anyone who wants to try this is to only use money you can absolutely afford to lose without damaging your financial future and keep a firm grip on it. I essentially recommend using “hobby money” for this and treating it as such. If you lose “hobby money,” it’s not that big of a deal — it’s not affecting your retirement planning or your home mortgage or anything else in your life.
This is the same advice I offer to anyone who is engaging in risky financial choices. You have to wall off your “financial foundation” from those risk-filled decisions. If you don’t do that, then if unexpected events happen (like, say, a global pandemic), you may find yourself in a situation where you have lost everything.
2. Do not go into debt in any form for online trading
In Popper’s article, he shares the story of an individual who took out multiple home equity loans to fund his online stock trading, only to lose most of that money in short order. Because he made that decision, he’s now stuck with additional debts on his home that will take him years to repay.
It’s simple: unless you have the capacity to easily repay a debt without impacting your financial future, you shouldn’t go into any kind of debt to do online stock and options trading. This comes back to the “financial fortress” idea above. If you take on a personal debt to continue trading, you endanger your financial future. You want to keep stock and options trading in a place where it is almost a pure upside for you, where even if you lose, it’s not going to affect the foundations of your life.
3. You are competing against “the house”
The thing to remember about investing is that there’s no point in putting in the tremendous effort unless you aim to do better than the market average. If you just want to meet the average returns on the stock market, that’s easy — put all of your money into a low-cost index fund and just sit on it.
If you’re doing stock and options trading, it’s with an aim to beat the market, and when you’re playing that game, you’re playing against extremely well-funded people with a lot of tools and brainpower who have studied this problem inside and out. You may be able to identify a few things and make a profit some of the time, but the odds are heavily against you being able to do it consistently outside of a market bubble.
This leads back, again, to the issue of protecting your financial foundation. Do not put your financial foundation at risk in an investment world where you have a much smaller pool of money to invest and a lot fewer resources and a lot less insider knowledge. It’s not a winning recipe.
4. Be aware that it can be addictive
My final point of advice is to be aware of the addictiveness of online stock and options trading. For many — myself included — it can quickly become psychologically addictive, gobbling up your attention throughout the day and filling your thoughts even when you’re not looking at a screen.
Whenever you engage in something that’s psychologically addicting, you are taking your focus away from things in your life that deserve your attention — your career, your family, your friends. That comes with a real cost to your career path and your relationships. It also encourages you to take financial risks and spend more and more money on it.
I strongly encourage anyone who tries self-directed online trading to set up some “walls” around it. Give yourself a block of time each day where you’re actively involved in trading and research, and outside of that block, leave it entirely alone.