Monday, June 1, 2009

Active trading - The key to beating the market

As everyone who has been reading this blog know I am a fan of buy and hold. You can read about arguments for buy and hold here. However some people argue that they are able to beat the market. This type of investment strategy is called active-trading.

I must be clear here that active trading is not for the novice. In order to invest using active trading you need to have a lot of experience and knowledge in the working of the stock market, So if you are new to investing for now you must stick to buy and hold and at the very most trading once in a while.

What Is Active Trading?

As you know over the long run the market go up even if from time to time in recession it goes down, However the trend is always up. Even if the market can go down in the short run, it will always recover and go up. You can see why some people prefer buy and hold. You invest and because you are sure that in the long run it will go up you just wait and watch your portfolio increase in value.

However some people cannot wait for years and they try to take advantage of the short term fluctuations of the stock market. I must say that to predict what the market will do in the short run is quite difficult but not impossible. For example a trader might feel that the price of oil will go up and as a result hedge it, or another one might feel that the shares of a company will fall in vale and short sell it. The strategies that the active trader uses are numerous. However i must say that whatever the active trader do he is increasing the probability of a gain but he also raises the probability of a loss.

So can anyone become an active trader?

I must say no. You need expensive computers and softwares to start. You also need some knowledge in the analysis of data so that you can make sense of the information available. You need to identify trends in data and identify peaks and bottom in the trends so that you know when to buy and when to sell. You need to have considerable knowledge of the factors that can influence the price of a stock and how they influence the price on a daily basis and predict the price of that stock in the short term.

Furthermore active traders used borrowed money in order to increase profit. For example someone who is sure that the price of a stock will double in the next week, might borrow money in order to maximise his gain. Many active traders have made a fortune doing this. But keep in mind that money borrowed must also be returned and if your bet is proved wrong then you might have to sell everything that you own to pay back the money.

Furthermore frequent trading, means that you have to pay commissions and capital gains tax. When taking the taxes and commissions into consideration the return that you have to make above the normal buy and hold return is considerable.

To summarize i would say that active trading is risky, difficult to do in the long run and not for the average guy. I would say that even if you have some experience, active trading is reserved for a select fews that are very good. So guys I would recommend that, as a beginner, you just keep to the buy and hold, index funds or government bonds.

Here are some post that can help you on index funds and on bonds and stocks.

Bookmark and Share

No comments:

Post a Comment