Why day trading just doesn’t work

When you invest, you want to buy low and sell high—but what if you could buy low in the morning and sell high in the afternoon? What if you could find some way to find out when stocks will go up, and buy them before they do?
This is the allure of daytrading, and it has caught millions of people worldwide in its trap. And a trap it is; while stories of daytraders making millions of dollars spread quickly, they’re often just plain not true.
But they’re captivating, which is why they spread in the first place. When a high school student claimed to have earned $72 million daytrading, it quickly caught fire on every media outlet you could imagine. Then it turned out to be completely untrue.
Still, others claim to make a lot of money daytrading stocks, and they brag about their performance to just about anyone who will listen. More frequently, they will tell people that they can teach them how to make a lot of money daytrading—for a fee. Instead of asking why someone who can make money whenever they want by daytrading needs to sell their trading system to others, many get intoxicated with the money-for-nothing sales pitch and waste a lot of money pursuing a system that touts itself as failsafe. In the end, most of them lose money, while the lucky ones may find they just barely break even or earn about what a long-term investing strategy would have earned.
Daytrading doesn’t work—but why not?
The Goal of Daytrading
The idea of daytrading is simple: you buy shares, wait a few minutes or hours, and then sell those shares back at a premium. The problem with this strategy is that it doesn’t always work; there’s no way to tell when shares will go up or down. Some claim to have a system that can predict this, but no academic study has proven these systems to be reliable or accurate at all. In reality, buying shares in the hopes of selling them at a higher price later in the day is more like gambling than investing.
The Risks
This is why the Securities and Exchange Commission warns against daytrading, noting that it isn’t illegal or unethical, but often involves “severe financial losses.” The few successful daytraders out there readily admit that their first few years of trading involved heavy losses, which took them a long time to recover from.
The risk of daytrading is not limited to just losing a lot of money quickly. Daytrading is a labor-intensive and stressful activity. Daytraders use a variety of tools to make their trades, and they will spend hours at their desk in front of several monitors staring at charts and waiting for the move that they’ve bet on. Sometimes it happens and sometimes it doesn’t; when it doesn’t, money is lost. When it does, money is made. The job of the daytrader is to make sure they get it right more often than they get it wrong, which requires a lot of energy, focus, time, and a bit of luck.
The Long-Term Alternative
It’s for this reason that Warren Buffet warns against trading at all. From Buffett’s point of view it makes little sense to spend so much time and effort into short-term trading, which will likely lose money anyway, when you can simply put your money in a good, profitable company, and let it grow in value over time without having to think about it.
Studies have supported Buffett’s viewpoint. Brokerage firm Fidelity Investments  once did a study on which of their clients made the most money, and the conclusion was clear: those who traded the least made the most money. When a former Fidelity employee shared this anecdote to asset manager Barry Ritholtz, he was unsurprised. He had seen several investment accounts remain untouched for a decade or more that had outperformed more during that period than in periods when the same account was more actively managed.

How the P/E ratio is trending and why

When it comes to investing in stocks, many financial advisors and analysts will warn that a stock, or a collection of stocks, is overbought or oversold. This can mean a lot of things to a lot of people, but it usually relates to an important relationship that is the starting point of all financial analysis: the price-to-earnings ratio.
The P/E ratio gives you a very simple relationship between two things: how much is a company earning and how much are you paying to invest in those earnings. The ratio is easy to calculate: you take the current price of a stock and divide it by the earnings per share of the last four quarters. For instance, Coca-Cola (KO) earned $1.42 per share in the 2014 fiscal year, and the stock is now trading at about $42.25. Dividing the latter from the former, we see that KO is currently trading at a P/E ratio of about 29.75.
Is that high or low? The answer depends on a number of things, and frustratingly, there is no perfect P/E ratio for any stock or sector. However, the market will usually price growth at a higher P/E ratio. In other words, the more a company is expected to grow its earnings, the higher the P/E ratio will be. This is why Facebook (FB) has a P/E ratio of 70 and ExxonMobil (XOM) has a P/E ratio of 12. The market believes Facebook will grow earnings much faster than XOM, and it prices the company’s stock accordingly.
Historical P/E Ratios
When it comes to the market as a whole, U.S. stocks tend to have a certain price for the earnings that American companies can expect. The S&P 500 has a P/E ratio of its own, which compares the price of the index to the total earnings of the 500 companies within the index. Interestingly, this number can be extremely volatile, as you can see from the chart on this website.
However, there is an average P/E ratio for the last 140 years (15.5), and a more-or-less normal range of P/E ratios throughout history (between 10 and 20), although more recently that range has gone up a bit and been more volatile. At the height of the global financial crisis in 2009, that ratio spiked at over 123, or over 6x its current level!
When the market began to normalize in 2010, that ratio fell down to around 16, and it has been steadily climbing as a result. Throughout the strong bull years of 2013 and 2014, the P/E ratio continued to creep up, ending last year at 19.37, and it’s stayed at about that level today.
What It Means for You
Many people will attempt to time the market by pointing out that the P/E ratio can predict a stock bubble, and when it gets too high, it’s time to sell. Some pundits have even urged investors to sell as the P/E ratio reaches 20, which is a clear sell signal, they say, and a sign to go into cash.
Here’s a typical example of this kind of reasoning, pointing to a number of charts and technical indicators urging people to go to cash. Heres another one, focusing on the fact that the P/E ratio is historically expensive at 18, far above the historical norm.
The only problem with these two doomsayers is that they were writing during the strong bull market of the last two years. If you followed the advice of the first article, written in December 2013, you would have lost the 14% gains the S&P 500 has earned since then. The second article, being later, would’ve cost you only about 10% in gains.
Instead of trying to time the market, there are other strategies that can take into account the P/E ratio and what it means. Having a plan and sticking to it is one; diversifying across asset classes, so that you are not too heavily invested in just one index, is another.

Are stockpickers back?

Wall Street has a dirty little secret: most actively managed funds underperform the market. As a result, more and more money is going into so-called passive index funds, which track an index and do not try to time or beat the market. These funds received over $166 billion from investors in 2014, while active funds actually lost over $98 billion.
More and more, investors are looking to profit from the rising tide of a growing economy, dismissing the talent or skill of picking stocks as a relic of the past. However, some analysts believe that this move towards passive index investing may not outperform as robustly as it has in recent years, thanks to one major change to the U.S. economy.
What stockpickers do
Active investing has one primary goal: to choose those investments that will provide a stronger return than the market as a whole, while avoiding those investments that will provide a lower or negative return. The methods that active investors use to make these decisions are complicated and various; many  disagree with each other on which strategies work and which don’t, so generalizations are hard.
That said, many will develop a model or method of screening stocks based on certain market characteristics, like revenue growth, dividend payment history, market share, and so on. These characteristics will then be used to decide how much of a portfolio should be placed in one stock—or whether that stock should be bought entirely. In theory, this helps investors avoid bad investments while weighing more heavily on the good ones.
Why it didn’t work
There are two big problems with stock picking: market conditions and the Federal Reserve.
Market conditions change. A company that has made a huge profit in the past may fail to do so in the future if a market suddenly changes for one reason or another. The best stockpickers cannot predict everything that will happen, so changes to a market due to disruptive technology or changing trends can catch investors off guard. A great example is Radio Shack (RSH), the once ubiquitous staple of malls across the country. The company saw its stock price rise twentyfold in two decades thanks to consistent growth and a name brand that was recognizable and reliable. Then new technologies that required less gadgets and less gadget repair meant Radio Shack’s reason for existing vanished. Now the company is expected to file for bankruptcy.
Good stock pickers can anticipate these changes to a market, and adjust their portfolios accordingly. But we all make mistakes, and so those errors from money managers will drag the portfolio’s performance down. This problem is worsened by the dragging effect of fees, which only drags a portfolio performance down over time.
Secondly, there is the effect of the Federal Reserve on the stock market. Several analysts and pundits have noticed the same thing: the Federal Reserve’s monetary policy known as Quantitative Easing causes stock prices to rise. This trend is indiscriminate, causing all equities to rise with an expanding monetary base. When this happens, it’s very hard to outperform the market, because the market is going up so much and so fast, regardless of the fundamentals of the companies inside that market. This has been a big hurdle for fund managers over the past five years.
Crucially, this monetary policy has changed in the United States, which has already caused some new trends in the stock market. After earnings season began, many companies have seen their stock prices impacted much more by fundamentals now that the Federal Reserve has stopped its QE program. As a result of this dynamic, some are arguing that stock pickers may be back—in 2015, they say, a lack of QE and high valuations in the market mean the stock picker will likely outperform the market.

ETF Expense Ratios: Their Impact on Long-Term Performance

Exchange-traded funds, or ETFs, have become the most popular option for investors since 2008. Not only are retail investors moving to ETFs, but even institutional investors like hedge funds have been buying ETFs at a breakneck pace, leading to nearly $37 billion of large hedge funds’ money being put in ETFs by the third quarter of 2014.
There are many reasons these assets have seen more interest, but the two biggest are easy diversification and low costs. Unlike actively managed mutual funds, most ETFs are passively managed and exist only to track an index. This means they cost less than mutual funds, while providing the same broad exposure and diversification that mutual funds have always provided.
With some ETFs, the expenses are even lower than with others, even if they do virtually the same thing. A good example would be to compare the SPDR S&P 500 ETF (SPY) with funds that track the same index from iShares (IVV) and Vanguard (VOO). SPDR’s fund has an expense ratio of 0.09%, while iShares charges 0.07% and Vangurad is even cheaper—at just 0.05%.
Paying for Complexity
These expense ratios are so cheap because they are very basic products: they provide investors with exposure to all of the S&P 500, with no attempt to mitigate risk or diversify into other asset classes.
Funds that do more also charge more.For instance, Invesco’s PowerShares BuyBack Achievers (PKW) has a lot of crossover with SPY, but its expense ratio is 0.68%, almost 8 times higher. While some may recoil in horror, the reality is that the expense ratio is a result of the complexity of the fund’s strategy: which is to track and invest in companies that buyback shares more aggressively, while many companies in the S&P 500 will do little or no share buybacks at all. In some markets, a fund like PKW will outperform the S&P 500, so that higher expense is more than offset by the higher returns.
The Hit from Expenses
While a high expense ratio is sometimes acceptable because the fund’s unique and complicated strategy requires it, investors need to understand how expenses impact their returns in the long term. Expenses will impact the long-term performance of an investment because the cost will compound over time. This is because, the more you pay expenses, the less your money is going to work earning gains in the marketplace.
In one or two years, the difference that higher expenses plays in lowering returns is small. After one year of earning a 10% return, a fund with a 0.5% ratio will yield a $950 profit on a $10,000 investment, while a fund with a 2% ratio will yield an $800 profit. That’s big, but not horrifying.
What is horrifying is what happens over time. If we get that 10% return over 10 years, our 0.5% expense ratio fund will be worth $24,782.28 by year 10. Our 2% expense ratio fund, however, will be worth only $21,589.25—a difference of over $3,000!
You can see just how drastically expenses drag down returns over time with this chart—note how the effect gets worse over time, and worse with higher expenses:

How to Lower Expenses
Many investors will react to this by looking for the lowest expense funds that they can find and throwing their money into that. This knee-jerk reaction is understandable, but it comes with its own risks. Lower-expense funds are often cheap because they do not involve any kind of direct diversification or risk management strategies. Sometimes, a higher expense ratio makes sense for an investor’s time horizon, risk tolerance, and strategy. Many times, investors will want to combine lower and higher expense-ratio funds to match the diversification and investment goals of the investor.
The key here is to invest with expense ratios in mind, while being guided by a more comprehensive understanding of the market and your own investment goals.

How Oil Influences Different Market Sectors

Oil has made a lot of headlines lately, and it’s no wonder. After steadily rising and peaking over $100 per barrel, oil fell 55% in half a year, an unprecedented decline that almost no one expected:
Source: Nasdaq.com
The fall in oil was caused by a number of developments, which The Economist summarizes as follows:
1. Low demand from lower economic activity and greater efficiency
2. Geopolitical turmoil is relatively low, causing output to stay strong
3. America is producing a lot of oil, rising supply further
4. Saudi Arabia and their allies have not cut production to cause prices to rise
These developments have had a huge impact not only on the oil market, but for related industries as well. What many investors don’t realize is that changes in oil prices have an impact on virtually every industry and market sector, meaning that every portfolio is exposed in one way or another to oil. Let’s take a look at how some sectors are impacted by changes in oil, and how investors can harness these trends to their advantage.
The Theory
The relationship between oil and other sectors of the U.S. economy depends upon whether oil is supportive or not supportive to that industry. In other words, sectors that profit from rising oil will benefit from a rise in oil, and sectors that profit from falling oil will benefit from a fall in oil. The most obvious example are energy producers like Chevron (CVX), Exxon (XOM), and ConocoPhillips (COP), which tend to see higher earnings for some of their operations as oil prices rise, since they are oil producers.
Less clear are sectors like alternative energy, especially solar power. Solar is considered a more expensive energy sector that will eventually replace oil when it becomes too expensive or simply when oil runs out. Therefore demand for solar is likely to rise with oil prices; falling oil prices will be negative for solar.
Then there is the demand part of the equation. Higher oil prices mean more money spent on energy and less money spent on things like clothes, gadgets, vacations, and so on. Travel, technology, retail, and consumer discretionary can see some relationship to oil prices, especially in one way: when oil gets cheaper, people will likely have more money to spend on alternatives, so these companies will see higher revenues on falling oil prices. Additionally, these companies depend on oil to transport goods, so falling oil prices will lower their costs, too.
The Trend
Some of this theory has played out very clearly in the last six months. First, we see that falling oil has been seen as broadly a good thing for the economy, with large-cap stocks (DIA) and small-cap stocks (IWM) rising when oil began to fall. The broader group of U.S. companies (SPY) was also seen to benefit:
Source: Google Finance
However, the inverse relationship between oil prices and company stocks was much more acute in some industries, as we see here:
Source: Google Finance
The biggest beneficiary from the fall in oil was the utilities sector (XLU), a usually conservative and low-volatility sector. The idea here is twofold: utilities companies pay for energy, so lower costs equal greater margins. Additionally, utilities companies will see more demand for energy, as lower prices encourage more energy consumption.
Close on the industry’s heels is the retail sector (XRT), where the  higher consumer spending theory played out. With gas prices falling by over half and going below $2 per gallon in many states, it’s easy to see why investors would get giddy about people spending less at the pump and more in stores. Also, retailers will need to spend less on transport to get goods into stores. Both ideas were great for the retail sector, helping it post 12.8% gains in half a year.
Shortly behind were both consumer discretionary (XLY) and transport (IYT) stocks. Both are theoretically likely to benefit from more money in consumers’ pockets, just like retail will—so the gains are to be expected. Additionally, the transport sector, which includes airlines, package delivery companies, and trains, spends more on energy than almost anything else, so a fall in oil prices is a bonanza for them.
Finally, technology (XLK) saw a modest gain, but much less so than other sectors. While some tech companies use oil to produce and distribute goods, it is a far lower concern than in other sectors, so oil’s impact on the sector is likely to be more muted. Thus it gained only 4.2%, less than half the gains of any of the other sectors.
Diversification is Key
No one can time when oil is going to rise or fall—or even if it will. Investors cannot avoid the volatility of oil prices altogether, since it has a direct impact on so many asset classes. At the same time, investors will not always profit from a rise or fall in oil. The key is to diversify across industries, so that your portfolio will be protected from a steep rise or fall in oil prices.

Paying for What’s Yours: Do Mutual Fund Fees Hurt Your Retirement Dreams?

If you want to retire, you need to invest. And if you want to invest safely, you need to diversify. For diversification, many turn to mutual funds as a low-cost and easy way to ensure that a retirement fund is sufficiently diversified to weather whatever financial storms may come. However, they’re probably doing it wrong.
When it comes to retirement, fund fees are an essential concern when choosing where and how to invest. While fees are always an expense, the magnitude of this expense grows over time, making fund fees a crucial issue for any retirement portfolio. This is because the impact that fees have on your returns will grow over time. This means lower fees are an easy way to improve the performance of your portfolio. But just how big is the fee impact? Huge, especially when it comes to mutual funds. Let’s take a look at this in more detail to get a clearer sense of just how much money those mutual funds might be costing you.
The Expense Ratio
When it comes to assessing how much mutual funds cost, you need to look at the expense ratio. This is a simple number to calculate, being the cost that the mutual fund company charges to pay for that mutual fund. Funds will usually express their expense ratio as a percentage, and the they usually vary from between 0.5% and 2%, depending on the fund and its operator. Some funds will have much higher expenses, which is why you need to be careful and pay attention to this number when shopping for mutual funds.
One of the interesting features of the expense ratio is that it incentivizes companies to get more assets under management—in other words, it motivates them to attract more money from more investors. The best way to do this is to outperform the market, but of course that’s hard. As a result, many mutual fund companies choose instead to advertise aggressively, which costs money and which is paid for by your expense ratios. Management bonuses, office space, research, and other costs all come out of your expense ratio, which is why there’s a limit to how low they can go.
How Much of a Difference is 1%?
Expenses can dramatically impact returns, even if the difference seems small. You might think there’s little difference between a 0.5% and 1.5% expense ratio, but that difference grows over time. For instance, imagine you can put $10,000 into two different funds, with expense ratios of 0.5% and 1.5%. The first fund will cost you $50 in annual fees, and the second will cost you $150 in annual fees.
That $100 difference doesn’t seem like much, but it compounds, meaning its severity will worsen over time. If your fund gained 10% per year, that $10,000 would be worth $61,159 in 20 years in the 0.5% expense fund and $52,736 in the 1.5% expense fund. That’s a difference of $8,423, or $421 per year. All because of compounding.
What makes matters worse is, just as management gets more fees the more you invest, the more you pay as well. The cost of this investment in terms of fees and lowered returns will only get larger the more you invest, making high fees a losing game. Investopedia has a nice chart on the topic, and you can calculate how much your fees are costing you with Vanguard’s customizable calculator.
Why Fees at All?
As mentioned above, fees are necessary in mutual fund companies because of the way they operate. A mutual fund pools together a lot of capital from different investors into one big pile, and then invests that in a diversified portfolio of stocks and/or bonds, in most cases. That administration costs money.
But, of course, there are more costs involved than just that. To ensure the fund outperforms, many mutual funds are actively managed. This means analysts and portfolio managers spend long hours doing research on different companies before deciding which stocks and bonds to buy. That expertise must be remunerated, and that comes from fees. Additionally, those people need infrastructure—reports, secretaries, computers, offices, and so on. Again, this is all quite expensive and comes out of expense fees.
One popular way around this is to invest only in passively managed funds, which have much lower expense ratios. The problem there is that many investors will invest in just one passive fund tracking one index, or they will mix different funds that give the illusion of diversification, without any real protection. While this strategy works in clear bull markets, at the moment of a downturn the investors will find themselves surprised to learn that their safe, low-cost approach may have cost them money.

An Eye On DC: How Stocks Perform When The Fed Raises Interest Rates

One of the biggest risks for stocks in 2013 was the fear that the Federal Reserve would stop quantitative easing and raise interest rates. This was the so-called “taper tantrum” that caused some volatility in late spring, although that bit of history is easily forgotten after the S&P 500 returned over 30% for the full year. It’s also easier to forget after 2014, when rates kept going down just when the market was expecting rates to go up.
Even if Wall Street’s memory is short and the idea of raising rates has receded amidst hotter issues like falling oil prices and a possible tech bubble, it’s still an important issue to keep in mind. The Federal Reserve has made it clear that it plans on raising rates later this year, even if many in the market don’t believe them. We can’t predict the future, but it still makes sense to consider how stocks are impacted by raising interest rates, just in case the Fed goes through with its plans and we see higher Treasury yields later this year.
The Theory
The Federal Reserve sets a target for the Federal Funds and adjusts its open market operations to ensure that the rate hits that target. When the rate rises, at least theoretically, we should see interest rates for all U.S. Treasuries rise as a result. When rates for bonds get high enough to attract risk-averse investors, they will pull money out of stocks and into bonds, causing stock prices to fall.
This is the general idea, but like any theory, it’s much simpler and cleaner than messy reality. There are three periods in recent history when the Federal Reserve caused the Federal Funds Rate to rise considerable: in 1988, in 1994, and in 2004. Each interest rate hike was short-lived, the longest being the most recent and lasting about four years. You can find a detailed history of the Federal Funds Rate, both annually and on a more frequent basis, on the Federal Reserve’s website.
Bond Impact
According to the theory, a rise in interest rates will bring risk-averse money to the bond market. At the same time, rising rates also negatively impacts pre-existing bonds, because the rate of return they offer is lower than the new bonds which are issued at a higher rate. Therefore raising rates are bad for bonds in the short-term, which is partly why low-risk government debt was hit hard in 2013 when the fear of rising rates hit the market hard.
This is especially true for long-term debt, which loses its value the most when rates rise. The iShares Barclays long-term bond fund TLT was one of the hardest hit during 2013:
Meanwhile, the supposedly higher risk junk bonds fared much better, even if they were initially hit hard in the taper tantrum. Both the big high yield bond ETFs JNK and HYG ended 2013 flat:
That’s how the market anticipated a raising interest rate to impact bonds, but how did long-term government debt fare during an actual rate hike? If we look at the period 2004-2007, when rates were rising steeply, we see that TLT actually did fine:
In other words, the rise in interest rates was nowhere near as awful as the market anticipated it would be in 2013—and in actual fact, that interest rate hike never even arrived. The market, in all its wisdom, was completely wrong in two ways at the same time.
Stock Impact
The impact on stocks from rising rates is much more complicated and harder to understand. This is mostly because rising rates are not the only thing that impact stocks and, in markets where other factors are more important, the impact can be minimal. Additionally, the Fed will only raise interest rates in an economy that is seeing positive growth, and that the Fed believes will continue to grow at a healthy rate for some time. Strong economic growth is good for stocks, so even if rising rates are bad for stocks in a direct way, the indirect contributors that make rates go up will be good for stocks.
In other words, the relationship is much less clear-cut than with bonds.
For instance, when interest rates rose in the mid 2000s, stocks were on a massive tear that seemed unstoppable at the time:
Of course, now we know this was the result of an unsustainable housing market. At the time, though, the idea of shorting the market or even seeing a fall in stocks because of the Fed’s movements was considered absurd—even if it was the right call just a few months later.
The same is true for the rate hike of 1994-1995:
And again true for 1988 (I’m using the S&P 500 index here instead of the SPY ETF):
In each case in history, the theory that funds will leave the stock market on rising interest rates had little impact on the bull market for stocks because other factors—namely the strong economic growth that caused companies’ revenues and earnings to rise—were much more important.
This doesn’t mean that we can dismiss fears of an interest rate hike when allocating funds to stocks. In fact, we need to remain keenly aware of the possibility that the Federal Reserve will raise interest rates in a relatively weak economy. This is a particular risk now, as changing demographics and technologies mean the economy is fundamentally different than during the interest rate hikes of recent history. Therefore, a careful consideration of time horizon, risk tolerance, and Federal Reserve expectations need to guide your decisions when it comes to building a portfolio.