Why civilians shouldn’t pick stocks

As a former trader I always find it amusing how many (otherwise intelligent) people think they can pick stocks successfully.  I will lay out an argument that I have made many times before that suggests that the only reason an individual should ever pick stocks themselves is for entertainment (or some other perverse incentive).

Let’s consider two strategies side by side: ‘Picking Stocks’ and investing in a stock ‘Market’ index. The market index reflects the asset class as a whole. When comparing ‘Picking Stocks’ to the ‘Market’ asset class, ‘Picking Stocks’ becomes a zero-sum game.  Now let us consider the market dynamics.

Let’s further split investors into two categories: professional and individual.  As professional organizations, strategies or investors become successful, their allocations of capital grow (both externally and organically). In short, the better traders/ strategies/ investors have more capital under management. By definition then, there are more, smaller, investors losing out relative to the market index.  This seems quickly forgotten in a bull market.  The smaller losers are individual investors or professional investors who will soon go out of business.

Picking Stocks is like playing against the casino with the odds against you.  If you are doing it for fun, great. As an investment, it is an awful idea.

The only two exceptions/counter arguments that I give any weight to are: insider trading (illegal, last I checked) and Random Walk Hypothesis (which I don’t personally subscribe to, but is credible and suggests that you are equally well off picking stocks as investing in the index).

No comments yet

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: