Stack to Investors: Stop Trading!

06/17/2010 12:00 pm EST

Focus: MARKETS

James Stack

President, Stack Financial Management

James Stack, president of Stack Financial Management and editor of InvesTech Research, warns investors that becoming traders will be dangerous to their wealth.

Having just returned from giving a keynote speech at The MoneyShow Las Vegas, I am convinced that investors have learned indelible lessons from the past decade. Unfortunately, they were the wrong lessons!

There’s no denying the past ten years have proven both challenging and painful for the average investor’s portfolio. In historical terms, it was the worst performing decade in Wall Street history, with a net loss of -9.1% (after including reinvested dividends). That was even worse than the 1930s.

With back-to-back major bear markets, investors have discovered that a blind buy-and-hold approach is not always the best strategy. Unfortunately, instead of learning that “risk management” is a vital part of any investment strategy, many investors have jumped to the conclusion that short-term trading is the answer. The resulting short-term, day trading mentality has changed the investment landscape.

When done with a substantial investment, even a half-dozen trades a year can be gut-wrenching and challenge the limits of one’s objectivity. [When I did it,] I found myself spending 80% of my time worrying about less than 20% of my portfolio.

And therein lies the major fault for retired or seasoned investors who are considering short-term trading as an alternative to their market frustrations of the past decade.

Short-term trading is not a prudent or safe strategy for the bulk of an established retirement portfolio. Yes, there are spectacular profits available. There’s no denying that possibility. However, there will also likely be some semi-spectacular losses. And the path will most certainly involve volatility extremes that cause sleepless nights.

But don’t expect the fervor or the sales pitches to fade any time soon. The enticing profits of short-term trading can be addictive. Just one 100% gain—even if followed by a 50% loss, which gives all the gains back—gets the adrenaline flowing. And believe me, there’s no incentive in the industry to discourage such volatile behavior.

With [many recent trading] days experiencing over a 1% closing move in the major averages, this market is offering lots of trading opportunities. Yet there’s an important distinction between a “trading opportunity” and a “profit opportunity.” In a trendless market like this—the current net DJIA change since January 1st is less than 100 points—volatile whipsaws are a lot more common than profitable trades.

This does not mean we want to discourage [people who are] experienced and successful at short-term trading from doing what they enjoy doing. But if you’re thinking about changing investment tactics for your established retirement portfolio by focusing all your efforts on aggressive short-term trading, then we encourage you to think again.

A valuable truism I first heard almost 30 years ago goes something like this: “There are old traders and there are bold traders, but there are no old, bold traders.”

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