The stock market is one of the oldest forms of investment available to the average investor, and many people pour their life savings into it. Many investors go into the process thinking that they are going to beat the market.
In reality, the average investor cannot beat the market, especially over the long-term. Once in a while, you might get lucky and really be ahead of the market. However, over an extended period of time, it is very difficult to do this. Here are a few reasons that you can’t beat the stock market.
In today’s stock market, it is very difficult to do well because of high-frequency trading. Hedge funds and institutional traders used high-frequency trading software that has the capability of placing hundreds of trades in a second.
They are attempting to gain only a cent or two on each transaction. If they do this enough, it can really add up. This often creates false buy or sell signals for the average investor like you. Competing with million dollar computer software is not a good position to be in.
As if trading against software wasn’t hard enough, you then have to overcome the impact of commissions. Every time you place a trade in the stock market, your broker is going to charge you some kind of a commission. This means that you might have to make 5 to 15 percent on your investment just to get the commission back. Then on top of that, you have to make even more just to make a profit.
Although it is technically illegal, insider trading is something that goes on all the time on Wall Street. The SEC rarely busts people for insider trading. This means that you’re trading against people who have inside information into what a company is going to do in the near future.
Must Focus on Individual Stocks
Another reason that the average investor never beat the market is because they spend their time putting money into mutual funds and retirement accounts like a 401(k). With these types of investments, your money is going to lag behind the market a bit.
Those portfolios use a very diversified strategy to try to simply make you a little bit of money without losing anything. If you’re going to actually beat the market, you’d have to put your money into individual stocks. This means that you have to effectively choose the individual companies that are going to do well, while avoiding all the bad ones.
Efficient Market Hypothesis
The efficient market hypothesis is an idea that says all of the information about a stock is correctly reflected in the current stock price of that company. This means that it would technically be impossible to evaluate the price of the stock any differently than what the market is already doing. If a stock is selling for $50 per share, then it’s worth $50.
Anything that happens after that is based on new information or new value that the company is bringing to the market. If you believe in this theory, which many experts do, then it’s basically pointless to try to value stocks. You can still try to predict what’s going to happen to a company, but that counts on you being able to predict the future well enough to bet money on it.
Overall, the stock market can be a valuable tool when it comes to building your wealth and the value of your portfolio. Just don’t expect to beat the market on a regular basis like you’re a hedge fund manager.
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John Horner has worked in finance more than fourteen years and is happy to share bits of wisdom and tips with his readers. He has also contributed to the article, “How Do I Become A Financial Planner” for others who may be interested in starting their own career in finance.