Why Active Traders Fail: Really, They Mostly Do
My preferred investing style leans towards the buy-and-hold style. On the other end of this spectrum are active investors. The goal of the active investor is to pick winners by timing their purchases and sales. The flaw with the methods employed by active investors is that markets are moved by news. And this news is rarely predictable and quite random. As a result, the movements of stocks are also equally unpredictable and random.
Markets are also generally considered to be efficient. That is, information spreads so quickly that the latest news is accounted for in the current price of a stock long before the average active investor has a chance to react. For these reasons, it is highly unlikely that an active investor will be able to consistently make the right decisions enough of the time to offset the losses from all of the wrong decisions.
Another statistic to consider is that only 3% of stock pickers beat their benchmark. Most stock pickers invest in stocks that have done well recently. But that’s exactly the wrong time to buy in to a stock and most of these investors find that the stock does poorly in subsequent periods.
Lastly, since very few people have been able to pick the right time to be in the market and the right time to be out of the market, many biggest up days in the market are missed. A study in which 32 newsletters that attempted to time the market found that over a 10-year period, all the newsletters failed to beat the S&P. One big reason for this is that there is a high concentration of returns and losses that occur in periods of time lasting only a few days. More specifically, in a 10-year period, about 88% of the total gain was concentrated in just 40 days. How could it be possible for someone to pick those 40 days ahead of time?
The alternative then is to aim for long-term returns through a buy-and-hold strategy in which there is up to 80 years of historical precedent on which to expect continued returns.