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.

From a February 2017 titled “Fleeting Alpha: Evidence From the SPIVA and Persistence Scorecards” by S&P Global, concluded:
“…out of 1,034 large-cap funds that existed in the universe as of Sept. 30, 2013, only 19.73%, or 204 funds, outperformed the S&P 500. In the following year, 15.69% of those 204 funds outperformed the benchmark. By the end of the third year, none of those original 204 funds were able to outperform the S&P 500 on a consecutive basis.”

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.