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What is Overtrading?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 09 November 2016
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Sometimes referred to as churning, overtrading is a situation that occurs when investment trading of some type is taking place at an unusually rapid pace. The term can also apply to a company that chooses to expand operations or production too quickly. In both scenarios, overtrading is usually considered an unwise practice that is likely to create problems at a later date.

When associated with investment trading, overtrading usually refers to a situation where the holdings of an investor are traded at an unusually rapid pace. At times, the broker who manages the investment portfolio for the investor conducts this aggressive type of trading activity. The combination of overtrading stocks will involve both buying and selling shares at a rapid pace, in hopes of making a quick return before moving on to the next trade. Many brokerages and exchanges have some regulations that limit churning activity to some extent, but the practice still takes place.

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For companies, overtrading is normally a phenomenon that takes place when a business enters a period of rapid expansion, but is not in the best position to manage that growth successfully. There are several identifying factors associated with corporate churning. First, the company is likely to have a smaller profit margin, which in turn impacts the amount of working capital it has on hand to finance the expansion. This one factor alone can make the expansion more of a gamble and may be a major concern to stockholders with an interest in the company.

Corporate overtrading can also involve expansion of a company that has a great deal of competition. The level of competition, coupled with the expansion of production, could lead to a situation where there is an excessive amount of finished goods in inventory. The slow movement of the inventory creates a situation of overstocking and does not begin to change unless the company successfully devises strategies to garner more consumer interest and begin to minimize the larger inventory.

In both scenarios, churning can be a risky strategy. The rapid overtrading buying complemented with the aggressive selling does have the potential to earn a return, but it can also increase the chances of the investment portfolio losing value if the constant turnover is not managed very closely. In like manner, corporate or company overtrading can quickly lead to a situation where a company is unable to meet its financial obligations and must seek outside funding or consider downsizing or even closing altogether.

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Esther11
Post 5

When a publicly owned company needs to have extra cash at its disposal, it can put more shares up for trading. The company might need the extra cash to expand and increase production.

If they put an excess of shares available for sale, they might have problems balancing funds from stock buying and sharing. This could cause problems with financing their increase in production. Overstocking by a corporation can be risky.

BabaB
Post 4

I have done a little day trading in my younger days. I came out all right. But to really make a reasonable amount of money, you have to make your trades fairly sizable.

One reason why I didn't especially like this kind of trading was because of the time it took. You had to pay close attention to stock news and do a fair amount of research to make good decision. I was always on the computer, babysitting my stocks.

Today, I much prefer to buy stable stocks that pay good dividends, and hold these stocks over time.

Charred
Post 3

@everetra - I don’t know much about stock market overtrading. But I do know something about corporate overtrading.

I worked in the telecommunications industry for ten years. That industry is very infrastructure intensive. In the early days, our company had very ambitious goals of building a nationwide network.

So they built rapidly. They did this, in my opinion, before they had any real guarantees that they would have enough customers for their huge network.

They had the philosophy, “If you build it, they will come.” I think a lot of telecommunications companies operated that way. We all know what happened.

The companies built out, but the customers never came, at least not in the droves that would have made such a build out worthwhile and profitable. Overtrading was our downfall, and the next thing you know, we were filing for bankruptcy.

everetra
Post 2

@SkyWhisperer - I’m not a fan over overtrading myself; it doesn’t matter whether you are describing day trading or the institutional type of trading that the article talks about.

In my opinion, the old buy and hold strategy is still the time honored way of making money. I realize that nowadays many people have turned against buy and hold, citing the volatility of the market as a cause for concern.

However, if you have a diversified portfolio I think that you will still come out okay in the end. You should have a mix of stocks, bonds and even precious metals to ensure that your portfolio is safe.

I have a horizon of twenty five years before I retire, so I see no purpose in constantly trading. Besides, each time you trade, you incur a fee. The fees are not as expensive as in the days before online trading, but they do add up.

SkyWhisperer
Post 1

I think that overtrading sounds very much like day trading. In this kind of trading arrangement, individual investors buy and sell stocks the same day in order to make quick profits in the market.

They usually have to invest large sums of money to make it worth their while. They can buy and sell the same security over and over again, hoping to make even fractional profits which, when executed over a large number of shares, turn into a decent amount of money.

I think that one of the things that opened the doors for overtrading in general and day trading in particular is the ease of automation. Computers have made it possible to execute trades quickly and in rapid succession. As a matter of fact, you can use automated buy and sell orders to carry out your trades when you’re not watching.

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