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.
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.
