Chasing Returns for Fun and Profit

Theoretically, disciplined traders do very well in periods of extreme volatility.  I am told that steely-eyed professionals can make money even in a down market.  The Crash of 2008 was special (not in the good way) and took its toll on trading desks around the world.  Frankly, I’m surprised the hedge fund industry didn’t completely disappear during the crisis. 

Trading is synonomous with gambling and speculating.  It’s not a nefarious activity.  In fact it helps markets work smoothly (despite the protestations and finger-wagging of economically inept Congressmen).   Traders are professional risk-takers that add a lot of value and liquidity to the market.  But their strategies should not be a part of an individual investor’s investment plan.  It’s like letting your eight year old play poker at the adult table.  Despite the advertisements on television touting the benefits of engaging in this activity, the vast majority of individual investors that trade actively lose money (greater than 80%, some say closer to 90%).

Traders chase returns for fun and profit.  Sometimes they buy in before the asset starts to appreciate, but mostly they are jumping on the band wagon and betting with the herd.  Each trader has his own exit strategy or system that he employs to judge the right time to sell.  His time horizon is usually very short (seconds, minutes, hours…).  It is costly in time, energy, and financial resources to be a successful trader.

We are in a trader’s market.  The major indices are trading in a range and the professionals are jumping in and out in an effort to recoup what they lost in 2008.   Individual investors, who have no business trading, are also attempting to make up the ground they lost in 2008.  Many sold at the bottom in March and subsequently watched their portfolio components bounce up 2o% to 40% since then.  They’re wondering if the train has left the station without them.  They piled into gold and commodities and financials in an effort to recoup.  Gambling with what is left of one’s retirement assets is not the way to recover from the crash.  Being properly diversified with the best components (indexes and mutual funds) in each asset class is the least risky course to pursue.  Dollar-cost-averaging into the market over the next year would be a wise way to re-enter the stock market.

I know that diversification didn’t work during the crisis, but we have seen significant stabilization since then. I am anticipating a return to asset class correlations that resemble our historical experience.  We will likely see choppy markets through the end of the year and several quarters of mediocre earnings.  This will be an improvement over what we have experienced recently, which should have a positive impact on global asset values. 

In the immortal words of Mark Twain:

There are two times in a man’s life when he should not speculate: when he can’t afford it and when he can.
– Following the Equator, Pudd’nhead Wilson’s New Calendar

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