Market Timing: Should You Attempt It?: The more you trade, the less you earn

» KLR - The more you trade, the less you earn

The more you trade, the less you earn
Recovery's coming -- 5 reasons to buy-and-hold

By Paul B. Farrell, CBS.MarketWatch.com
Last Update: 4:31 AM ET Aug. 6, 2001


LOS ANGELES (CBS.MW) - Varoom. VAROOM! Lately I feel like a crew-chief in the Indianapolis 500 pits. Or the NASCAR 400. Heart pounding. Tension mounting. Engines revving. Pace car positioned. Starter unfurling the green flag. VarooOM!

Investors are impatient, idling, anxiously waiting for "The Recovery" to begin. Have been for some time. Spanking's strong. But little new investing. Investors are getting real antsy.

Well actually, only certain kinds of investors - the active-investors are anxious to leap back into action and race full-throttle around the oval track, adrenaline-pumping. At 200 mph! Marking time is no fun for these macho guys. Active-investors miss chasing the bulls. Racing makes you feel alive.

Especially the high-octane NASCAR Qubes - ooops, sorry, I meant the NASDAQ Qubes (QQQ). They're tuned, greased, gassed and ready to roar. In fact, all the exchanged-traded funds (ETFs) are at the gate, revving up, ready to kick in high-gear, waiting for the flag, hoping to accelerate back into the good-old-days of a nineties-style bull market.

Successful traders win in bear markets too

Of course, if you really are one of the million or so ultra-sophisticated traders who know how to successfully make money in bear markets as well as bull, you've been selling short, trading ETFs and their derivatives since the tech crash, over the past eighteen months. Zipping in-and-out of those 15-minute spins around the track. And not just Qubes. Other indexes are also burning rubber.

For example, look at the volume of the S&P Midcap 400 (MDY), the DOW Diamonds (DIA), as well as the SPDR 500 (SPY). They're up quite a bit. So is the hot iShares Russell 2000 Value Index (IWN). In fact, the Qubes' volume is up considerably for a bearish 2001 compared to the bullish go-go days of 1999 and the red-hot Nasdaq. Same with the Diamonds and Russell.

Why is active-trading a losers game?

However, if you're one of the vast majority of investors - the other 82 million of the total 83 million fund investors who are basically passive, buy-and-hold investors - the start of "The Recovery" race hopefully won't convert you back into an active trader, trading ETFs, chasing hot stocks and searching for the next triple-digit fund.

Hopefully you learned your lesson, especially if you had a tech-heavy, misaligned portfolio that dropped 25-50 percent in the tech arena, trading is a losing game got the average passive investor. Yes, I know, there is a small - very small, less than a million - number of active-investors in America who may make money trading. But just in case you ever think of jumping into trading, here are five powerful reasons why it's a bad idea:

Fact #1: The stock market is irrational

Economist Jeremy Siegel studied 120 of the biggest up and biggest down days in the history of the stock market. And guess what, in only 30 of the "big-move" days could he find any reason for the action.

In other words, 75 percent of the market's big gyrations are irrational and unpredictable, which makes market-timing so hazardous, except for an elite group of maybe a half million, or less, full-time professional traders. So you're better off not trying to guess the unguessable.

Fact #2: The more you trade, the less you earn

That's right, passive investors win the race, like the slow-moving tortoise. Behavioral finance professors Odean and Barber of the University of California Davis researched 66,400 investors between 1991 and 1997.

They concluded that two things resulted in substantially reduced returns - lousy stock-picking and transaction costs. In fact, the most active traders (averaging 258 percent turnover) earned 7 percent less annually than buy-and-hold investors (2 percent turnover), That's 18.5 percent for the gunslingers versus 11.4 percent for the sideline-sitters.

In addition, the professors' research also showed that another group of investors who converted to online trading say their returns drop from beating the market by two percent before going online to falling under the market by three percent once online. In short, the Internet makes it easier to lose as well as win, too easy.

Here's even better proof. Joe Ricketts, Ameritrade's founder once told Fortune: "The best thing, really, for an investor to do is buy a good company and hold it ... Trading often and heavy is not something that makes you a lot of money. That's contrary to my own interests, but it is the truth."

Fact #3: Investors buy "buy-high, sell-low" - and lose

You heard me, that's the conclusion of a Morningstar research study, most mutual fund investors got the investment advice of the old masters upside-down, they "buy-high, sell-low." Mutual fund investors are bad at market timing, they go in at the wrong time (the top), and get out at the wrong time (the bottom).

First greed creates a buying frenzy, at the top of a cycle. Then fear grabs the sellers, triggering sales at the bottom. They react at the worst possible times. Either way, they lose. Leave market timing to the so-called experts in that voodoo game - for the average investor, it is a waste of time, and your money.

Fact #4: Overly-confident, we deny and lie about losses

Not long ago Money magazine reported on a behavioral finance study that 88 percent of all investors experience a phenomenon psychologists call "optimistic bias," too much confidence. As a result, we often make bad investment decisions - then we hide the facts and lie to ourselves about how bad it is.

More specifically, over half of these overly-confident investors in the study who believed they were beating the market were actually trapped in a game of self-deception. It turns out they were, in fact, under-performing the market by anywhere between 5 percent and 15 percent below the S&P 500.

Fact #5: Even winning traders don't win much

Trading isn't the get-rich-quick scheme that the Wade Cooks of the world would make you believe. Oh sure, you can go online and trade for seven bucks a pop, maybe even zero brokerage fees, if your account's active enough. But we already know, the more you trade the less you earn.

But suppose you are one of the lucky day-traders who's making a living at the game. Be ready to give up your day job that may have a 401(k) and a vested pension. It takes full-time concentration. The successful ones live, breath, eat trading. While the average passive long-term investor need only rebalance, buy and sell every 15 weeks, a short 15 minutes will seem like an eternity.

And successful traders who do it make the commitment full-time rarely make more than $100,000 a year, as I recall from a study a couple years ago. In fact, the average is under $50,000 annually. Moreover, it's a solitary life. Addicting. Easy to burn out. And easier to make mistakes and lose it all fast in one slip-up, after building a sizeable nest egg over time.

Bottom line - the more you trade the less you earn

"Market timers, if they don't die broke, rarely beat the market," says David Dreman, author of the New Contrarian Investment Strategy. "Why don't more people beat the market? The answer is simple," says Dreman. "They lack discipline ... and love to follow the crowd ... almost always persuaded that they have seen clearly into the future ... Most of the time they prove wrong and it costs heavily."

There is a better answer - buy-and-hold. So when "The Recovery" does finally start, don't even think about trading. Instead, stick to your buy-and-hold strategy. Rebalance your portfolio every 15 weeks rather than get caught us in the insane world of trading, where 15 minutes is an eternity

-- posted by KLR