Stupid but essential question

[eastbay]

I have read countless times that traders can't beat the market. You're better off buying an index and holding, because this is the best you can do. Every trade is simply throwing money away on commission from this baseline return.

True or false?

If true, why do investment banks employ traders? Sure they should know better if it is not possible to "win"?

If false, why is this claim made so consistently?

eastbay

[RacersEdge]

Coming from the University of Chicago - the bastion of tne free market economy thinking - I can say the idea of not being able to beat the market as an personal investor is one taught there. Things like market timing, asset allocation, etc can get lucky in the short run but have no long run validity by this theory.

But this theory rests on the idea that markets are what's called strongly efficient - i.e. all available information about a stock is alrady contained in the price of the stock - so a stock picker can have no additional knowledge over the market. Obviously, this concept is debatable. So if you buy into the idea that guys like Peter Lynch can process knowledge differently than an average person, than you might invest in his funds.

One difference though - and someone who works closer to I-banking can give more specifics - but the trading that analyst do for an I-bank is a little different than an everyday consumer trading. The professional traders are using models to detect the slightest discprepancy in prices and trading in huge volumes that would offset any transaction costs that exist. IOW, when you take a job as a trader for an I-bank, you are in a different world than going into investment management for a company like Fidelity.

[parttimepro]

Two reasons:
1. Pro traders have a huge information advantage over retail investors. They know who else is in a market, what their strategies are, etc. Some them get inside information from brokerages, so they can see movements before their competitors do (Steven Cohen's hedge fund is well known for this. While most heavy traders demand volume discounts, he doesn't. In exchange, he gets information about who's buying what). Arbitrage opportunities exist, but they're exploited very quickly by pros. Trying to trade on a retail level is like playing poker where you don't know who else is playing or how many people are playing, and you can only see one of your cards.

2. A smaller advantage: Institutions have the resources to move markets, when appropriate. They can stage bear raids or short squeezes to exploit vulnerabilities that you don't even know about. Small investors can only try to ride the waves generated by these moves.

[OrangeCat]

There are many kinds of traders. Investment banks and brokerages make a ton of money trading for their own accounts. If you are talking about individuals, yes they certainly can do better than the S&P 500. However, most individual investors/traders end up losing money but I think this is because they are usually looking for a quick score and fail to put the in the effort to learn how to trade/invest well.

Like RacersEdge said, the idea that trying to beat the market is futile stems mainly from the efficient market theory. The EMT has some logical flaws, such as , (1) traders do not always act rationally and (2) traders do not always reach the same conclusion from a given piece of info.

Warren Buffet doesn’t think much of the EMT either. He said, “Investing in a market where people believe in efficiency is like playing bridge with someone who’s been told it doesn’t do any good to look at the cards.”

Contrary to popular opinion, doing well in the stock market does not require inside info. A lot of things are fairly obvious and the trends have been going on for years. For example, war in Iraq (oil stocks go up), people are getting older (HMO stocks go up), gambling is booming (casino stocks go up), low interest rates (housing stocks go up), etc…

[eastbay]

[ QUOTE ]

Contrary to popular opinion, doing well in the stock market does not require inside info. A lot of things are fairly obvious and the trends have been going on for years. For example, war in Iraq (oil stocks go up), people are getting older (HMO stocks go up), gambling is booming (casino stocks go up), low interest rates (housing stocks go up), etc…

[/ QUOTE ]

That sounds pretty woefully inefficient, kind of like your basic mid-stakes poker game where most players haven't done their homework and don't really care to - they just want to play cards.

I have seen numbers that show that most mutual funds don't beat the S&P 500. This does seem like powerful evidence that an individual investor would have an extremely difficult time beating the S&P 500, since they probably have a day job and don't have the tools available to the professional fund manager.

Is there some reason this should not be as persuasive as it sounds?

eastbay

[Paluka]

[ QUOTE ]
I have read countless times that traders can't beat the market.

[/ QUOTE ]

This is obviously a gross overgeneralization. I think this is usually said when referring to quasi-professional day traders, who are basically paying commissions to gamble. There are obviously plenty of professional traders who make money, but I'm not sure what they do is considered "beating the market". Most professional traders do not do the same sorts of trades that someone would do in their personal account.

[eastbay]

[ QUOTE ]
There are obviously plenty of professional traders who make money,

[/ QUOTE ]

Who make more money than they could have made just riding S&P 500?

To show you how truly insulated I am from this entire culture: I would suspect so but don't actually know it to be true.

[ QUOTE ]

Most professional traders do not do the same sorts of trades that someone would do in their personal account.

[/ QUOTE ]

What do they do, then, and why can't it be done in a personal account? Is it a matter of volume?

eastbay

[Paluka]

[ QUOTE ]
[ QUOTE ]
There are obviously plenty of professional traders who make money,

[/ QUOTE ]

Who make more money than they could have made just riding S&P 500?


[/ QUOTE ]

I don't think you understand the difference between trading and investing.

[eastbay]

[ QUOTE ]
[ QUOTE ]
[ QUOTE ]
There are obviously plenty of professional traders who make money,

[/ QUOTE ]

Who make more money than they could have made just riding S&P 500?


[/ QUOTE ]

I don't think you understand the difference between trading and investing.

[/ QUOTE ]

You're right. I don't see a difference. Maybe you can correct me. Isn't investing one possible (minimal) trading strategy?

In any case if you have X dollars at your disposal, you could trade with it or you could plunk it down in the S&P 500. My question is: do professionals routinely beat the latter with the former?

eastbay

[Paluka]

[ QUOTE ]

You're right. I don't see a difference. Maybe you can correct me. Isn't investing one possible (minimal) trading strategy?

In any case if you have X dollars at your disposal, you could trade with it or you could plunk it down in the S&P 500. My question is: do professionals routinely beat the latter with the former?

eastbay

[/ QUOTE ]

These questions don't really make sense. It should be obvious that professional traders get a better return on capital than investing in the S&P, but I don't really think you have any idea what a pro trader on wall street does. How can there be a huge amount of traders employed at banks and hedge funds if they don't get a better return on capital than the S&P.