While the story of a man trading stocks actively and making huge profits is alluring, it is not a replicable one. That is a story of luck, not skill.
Success stories of day-traders are the epitome of survivorship bias. Your cousin will only talk about the investment they made profits on, and hide their failed trades. Your friend that made thousands from trading will brag about it constantly, but your other friend that lost thousands will never say a word about it.
When you look at investing objectively, through the lens of science, it becomes immediately clear that trying to actively predict individual stocks is more of a gamble than a game of skill.
Daniel Kahneman has a Nobel prize in economics, and he summarizing the research on investing in a chapter called “The illusion of stock-picking skill”
The evidence from more than 50 years of research is conclusive: for a large majority of fund managers, the selection of stocks is more like rolling dice than like playing poker. At least two out of every three mutual funds underperform the overall market in any given year.
The funds that were successful in any given year were mostly lucky; they had a good roll of the dice. There is general agreement among researchers that this is true for nearly all stock pickers, whether they know it or not — and most do not.
Although professionals are able to extract a considerable amount of wealth from amateurs, few stock pickers, if any, have the skill needed to beat the market consistently, year after year.
In fact, the year-to-year performance correlation of professional wealth advisors are only 0.01. In other words, zero. The top professionals in one year are essentially no more likely to outperform their peers the next year.
The stability that would indicate differences in skill was not to be found. The results resembled what you would expect from a dice-rolling contest, not a game of skill.
In one study: Less than 13% of the day trader population earns money .
In another study: less than 3% earn money at all .
A paper aptly titled “trading is hazardous to your wealth” studied 66,465 households with accounts at a large broker over a 5 year period. They found that the more you trade, the less money you make .
In another analysis of over 160,000 trades in 10,000 investor accounts. Stocks sold actually performed significantly better over the short term than stocks bought to replace them. The sold stocks, thought to be a poor bet for the future, outperformed the overall market by an average of 3.2%. In other words, those who frequently traded fared worse than those who only sold occasionally, even after trading costs were factored out .
The research is quite clear on two things:
- People are bad at picking stocks
- People are bad at timing stocks
And so, the antidote are:
- Hold long term:
As Warren Buffet says: All you have to do is buy a cross-section of America and hold it long term. That’s it. In fact, his investment plan for his family when he’s gone, is to invest 90% into a low-cost S&P 500 index fund.
Low fee funds. Long term. That’s it.
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