Editor’s note: This article was first published in April 2014. Its “these 14 years” of the author’s experience (since about 1999-2000), Buffett’s compounding “for 57 years”, and its views on high-frequency trading and The Wolf of Wall Street (2013 film) are as of that date.
To be honest, my positive track record in the stock market is down to the decades of experience of other investors, whom I have learned from and whose advice I have taken on board.
In fact, in 1999 it was my colleague Victoria Bernal who stopped my first big investment from going into the US tech stocks that, shortly afterwards, would take an almighty tumble. Likewise, it was a 78-year-old investor who told me: “Never forget that anyone who tells you how much money they make on the stock market every day is losing money by the end of the year.” Over time I have found those words to be right in most cases, and Victoria B. certainly kept me from making my first big mistake right at the start.
Stock market investing is still the same now as it was 100 years ago. True, there are more products now, and any retail investor can access the markets from a computer. Whatever your situation, if you are thinking of getting into investing, you should know the only types of investors who make money in the stock market, before moving on to those who don’t. In these 14 years I have found that, in the end, there are no magic methods: every magic method only creates a short-term illusion of magic that, in the long run, brings the person using it back down to earth.
1. The long-term investor.
Those who follow Buffett’s methodology may not get astronomical returns, but they will rarely lose money. In fact, Buffett’s fortune is simply the result of investing and reinvesting at modest but steady returns, with the magic of compound interest at work for 57 years.
Buying solid companies when they are cheap, buying again when prices fall and adding the dividends to our investment capital is a slow but sure way to multiply our money. And if you also feel able to take on the odd risk, or you are lucky enough to buy shares in a market that has just collapsed in a severe recession, the odds of extremely high returns are on your side.
2. The one who buys and sells shares in millionths of a second.
It is said that the future of investing will be a computer, an investor and a dog. The computer will run software that buys and sells according to complex algorithms. The dog will make sure nobody touches the computer, and the investor’s only job will be to feed the dog.
High-frequency trading machines have more than proved their effectiveness. They have generated billions in profits for their owners. These machines achieve those astronomical returns thanks to all the other traders, who kindly hand over their small losses. So if you cannot place an order and a counter-order in less than a second, trading is not for you.
3. The cheats.
After The Wolf of Wall Street, I think many people still have not understood why Jordan Belfort was arrested. He was not arrested for what he did, but because they found out what he did. And what did Jordan Belfort do? Nothing more and nothing less than what is still done today, only in a more “camouflaged” way.
Likewise, Wall Street’s open secret is the “pacts of titans”, in which the main hedge funds agree not to sell their stakes in a particular company. That way they make sure they don’t get in each other’s way in certain stocks.
Manipulation of low-liquidity stocks is still the order of the day, and inside information is sold, whatever anyone says.
Bernard Madoff himself said that nobody gets rich on Wall Street without cheating.
Of course, if you invest with a clear long-term view, none of this should worry you: however much a stock swings during a trading session, the market puts it back where it belongs in the long run.
What about trading, and people with proven investment systems?
I have heard of some investment methods that claim you can make 300 dollars a day in an hour and a half (around the Wall Street open). That is outrageous and, of course, practically impossible.
In my whole life I have only known 2 people who have made a living from trading on the stock market for more than 10 years. But they work almost 20 hours a day, and even so, they both agree that it is now practically impossible to keep doing it, because high-frequency trading is wrecking the market for traders.
(Read: How to build a stock market strategy based on dividends)
Some of you might think this is because I know very few traders. That may be true, but some of my friends know hundreds of traders and say exactly the same as I do: apart from the odd enlightened soul, the rest do not make money consistently from trading. Remember that famous case of an investigation into a broker, which had to make its users’ profits and losses public. If I remember correctly, more than 75% of the users who used to boast on forums about the large sums they were making had trading accounts in the red.
The secret of trading is supposedly consistency, and having more winning trades than losing ones on average. That is not true either. Take a screenshot I came across of one trading account: the user had 240 winning trades and only 169 losing ones.
Even so, their average loss was bigger than their average gain, which means that over the previous 3 years they had lost money on average, because, as luck would have it, they had more money riding on the losing trades than on the winning ones. Had they simply put that money into the rising market, they would now have a positive return with much less work.
Why does this trader have losses despite having more winning trades than losing ones?
Although I don’t know whether this broker had already deducted commissions from the average return, the fact is that a stock market gain is the gain minus the commission, and a loss is the loss plus the commission. Also, when we sell at market, we always get the bid price, not the ask (and the bid is always below the quoted price).
Stop-losses are not exact either. You can set a stop-loss so as not to lose more than 1% on a trade, but if someone dumps a large block of shares, or stop-losses start being swept one after another, you may find that your stop-loss is triggered but the price at that moment is well below it, so you can lose 3 or 4 percent.
As a general rule, though, the main mistake is holding on to losers and selling winners, breaking a basic principle of trading and investing: let your profits run and cut your losses quickly.
In this particular case, looking at this person’s trades, let’s say they put more money into trades that seemed safer because they were forming well-known technical patterns, and which, by some Murphy’s law, inexplicably went wrong.
In short: if you want to make money from intraday trading, write a book explaining to others how to trade, and let them be the ones who fight that battle of David (the individual trader) against Goliath (high-frequency trading), with the difference that this time it is Goliath who has the strength, the brains and the sling.
Featured image: H. Zimmer, CC BY 3.0, via Wikimedia Commons.
