Investing is a bloodsport. A full-contact, no-holds-barred game of strategy that pits highly skilled professionals against unskilled amateurs. Anyone with a few thousand dollars and an internet connection can play, but the stakes are high.
Amateur investors risk their life savings, hoping that someday their nest egg will become large enough to provide financial security and independence. At stake for the pros are multi-million dollar paychecks, a spot on Forbes’ List of The World’s Richest People, and summers in the Hamptons.
But the game is lopsided. Amateurs outnumber the pros by about 90-to-1. But the pros – thanks to better skills, superior technology, full-time research teams from top schools, and extensive industry contacts – consistently and predictably outmaneuver part-time amateurs with far fewer resources. The pros capture most of the profits, while the amateurs are left to fight over the scraps.
“But wait a second”, you say. “I’m not competing with anyone. I just make contributions to my retirement account every month. So what difference does it make if investing is a bloodsport? I’m not an active trader, so why should I care?” Here’s why.
If you’re a perfectly rational investor who always makes the correct decision about when to buy and when to sell, congratulations. You are exempt from the discussion. Do you know anybody like that? You probably have friends or associates who claim that they are killing it in the market, but they aren’t. They’re just sharing their occasional victories – their home runs – while neglecting to mention their big losers.
If you’re a typical amateur who has a full time job, a family, and a social life, and you don’t have time to watch the market all day, there are a few things you should know about the bloodsport of investing.
Every time you make a trade, regardless of what the circumstances are, you are making a prediction about the future. You’re saying to yourself that you have some kind of information advantage over the best professionals in the business. Somehow, they’ve missed something that you have figured out, and eventually they will come around to your way of thinking and start buying the stock that you found before they did. Ask yourself, how likely is it that you have better information, or a superior way of analyzing a company, than they do?
I’m not saying that amateurs always lose on every trade. Sometimes they win. But how much of that is down to luck, and how much can be attributed to real skill? In other words, how likely is it that you have an edge in a game that’s dominated by professionals?
I suggest that you do a gut check. Start by asking yourself, “who is most likely to be on the other side of my trade? And what are the chances that I know something that he doesn’t?” Remember when I said that the pros are outnumbered 90-to-1? That might lead you to believe that the person who’s betting against you is another amateur, and that you probably know more than s/he does. But that’s not how it works.
Even though the pros are outnumbered, they dominate the trading that takes place in the market. Professional investors account for roughly 93% of daily trading activity. So every time you make a trade, there’s a 90% chance that you’re going up against a professional.
Maybe the person who’s betting against you is a hedge fund trader. These are highly skilled and ultra-aggressive players who make a living by capitalizing on the mistakes that amateurs make. There are hundreds of them out there, and they are always willing to take the other side of your trade. If you go up against them often enough, they will beat you. Here’s what a typical hedge fund trader looks like:
Meet Deepak Narula, a professional trader who earned $140 million last year, largely by betting against less skilled, poorly informed investors. In other words, amateurs.
Mr. Narula, and many others like him in the hedge fund business, regularly make the Forbes list of the wealthiest people in the world. And they do it largely by (legally) taking advantage of amateurs who think they can “beat the market.” Some amateurs think they have an edge. Others know they will probably lose, but can’t resist the thrill of the game.
Do you really want to go up against a trader who has a full time research staff and billions of dollars at his disposal? Do you think you are smarter, harder working, better connected or more disciplined than he is? If not, you might want to consider taking some steps to protect yourself from predators like this.
Next week I’ll present some of the things that an amateur investor can do to level the playing field in the Bloodsport of investing. I’ll talk about skills, and the few natural advantages that an amateur has over the professional crowd.