When thinking about whether or not to hire someone to manage your money by investing on your behalf, two important questions arise:
- Does that person have an edge?
- Is the edge in question impressive enough to justify his fees?
You might have heard the term in question (edge) mentioned on let’s say financial networks but even so, most people find it difficult to pinpoint a “definition” when asked to provide one. Broadly speaking, we say that the edge or alpha (also referred to as Abnormal Rate of Return, Excess Return, etc.) tells us whether or not a certain investor/trader is able to “beat” the market and if so, by how wide of a margin.
For example, someone with a +1.2 edge outperformed the overall market by 1.2% and someone with a -1.2 edge… of course, under-performed by 1.2%.
Is the investment professional who managed to outperform the overall market by 1.2% worth hiring as opposed to simply going with an index fund, especially in light of the fact that index fund fees are on the (very) low side compared to what money managers charge?
It depends on two factors:
- His track record, with it being vital to ask for proof pertaining to the long-term performance of the asset manager you are thinking about hiring. For example, some of them might be good at investing/trading in a bull market framework but when bear markets emerge, actually do worse than the overall market
- His fees. Time and time again, studies make it clear that hiring professional asset managers represents a sub-optimal choice compared to the index fund option, not because asset managers are not able to bear the market (some are) but because a lot of times, even those that do charge fees so high that after drawing the line and subtracting them, you end up concluding that you would have been better off choosing an index fund
What about the average investor or trader?
Assuming that you decide to roll up your proverbial sleeves and invest/trade yourself, is it possible for you to eventually develop an edge?
In our professional opinion, it is best to divide this question into two distinct ones:
- Is it possible? Yes
- Is it likely? Most definitely not
To put it differently, few things are genuinely impossible. As such, yes, scenarios which involve retail traders or investors eventually developing an edge and being able to beat the market over an extended period of time have a probability greater than zero of occurring. As such, it would be unprofessional to state that it is impossible.
Unfortunately for most of those who are interested in embarking on such a journey, the probability in question (while indeed greater than zero) is depressingly low. As a bit of an amusing experiment, we would like to invite you to screenshot banners or other types of ads used by brokers who are interested in convincing traders to sign up with them. You will notice that in pretty much all cases, there is fine script involved and if you read carefully enough, you will come across messages such as “x% of retail accounts lose money” and variations thereof, where x% is a value much greater than 50%.
This happens not because the brokers themselves are remarkably ethical and generous but rather because their hands are forced, either on the legislative front (by entities such as the Federal Trade Commission or FTC over in the United States and equivalents in other jurisdictions) or by the ad platforms themselves.
Regardless of the reason, the bottom line is that potential customers have access to information which makes it clear that… well, the odds are stacked against them.
For reasons such as:
- The fact that they are competing with traders who do this for a living and for whom this endeavor doesn’t represent a hobby at best but rather a full-time occupation which has been their number one priority for many years
- Leaving experience aside, you as a retail trader who makes decision while sipping a cup of coffee are oftentimes competing with entire teams of traders, from mathematicians to economists and psychologists who specialize in market dynamics
- Furthermore, especially when it comes to certain niches such as scalping, you are also competing with carefully fine-tuned algorithms and impressive processing power, with it once again being less than likely for a two-hand-powered one-man operation to do better
- The whale dimension, with certain players being so well-funded that they can out-wait retail investors on the one hand and on the other hand, when necessary, they can also use their sheer volume to manipulate prices, primarily in a short-term manner (as explained time and time again here at ChinaFund.com)
- The ethical front, which is especially jurisdiction-dependent. In countries such as the United States, brokers are compelled by entities such as FINRA to act in an at least somewhat ethical manner but in other jurisdictions, practices such as brokers using stop-loss information and other sensitive data so as to trade against retail customers are not exactly uncommon
The list could continue for quite a while.
Suffice it to say that if you are interested in becoming a professional trader, especially on lower timeframes, the likelihood of developing an edge is remarkably low.
As such, we advise readers against this approach and, instead, recommend options such as gradually accumulating meaningfully viable Chinese assets, embracing higher timeframes by choosing to be a position trader or buy and hold investor rather than scalper and so on. Of course, should you be in need of additional hands-on guidance when it comes to your trading or investing strategy, our team is at your disposal on a flat fee basis and we will do our best to make sure the net result will lean strongly in your favor. For more information, visit our Consulting section or reach out through the Contact page of ChinaFund.com.