Reject Your Inner Trader

Instead of trying to pick winners and dump losing stocks, resist the impulse to trade.

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It would be difficult to find a less reliable source of investment advice than Breakout, often hosted by Jeff Macke. Macke has featured guests extolling the virtues of market timing, stock picking, and espousing the silly notion that “buy and hold is dead.”

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While this advice would be difficult to top for its potential to harm investors, Macke may have succeeded. His recent column, Embrace your Inner Trader, features an interview with Jared Dillian, author of Street Freak and editor of The DailyDirtnap.com. Macke introduced Dillian as someone who can help you day trade if you are a trader and assist those who invest by providing insight that can “help you get better entry points and fills.” I don’t believe following his advice can do anything but harm. Here’s his advice and a brief review of the data that demonstrates the folly of his investing wisdom.

Dollar cost averaging. Dillian and I agree that dollar cost averaging may not be a good strategy, but for sharply different reasons. He thinks it is “a fancy way of adding to a losing position.” But your chances of adding to a winning position are about the same as adding to a losing position over time. No one can predict future prices of stocks. The idea that regular investing is necessarily a loser’s game makes no sense.

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Dollar cost averaging can be an intelligent way to build up your nest egg over time if you are committing yourself to investing your assets as you accumulate them. However, dollar cost averaging a lump sum does not deliver on its promise to always permit you to purchase more shares when the price is low and fewer shares when it is high. No one can predict the highs or lows of the market. Statistically, dollar cost averaging will result in lower returns about two times out of three, as demonstrated by a calculator you can find here.

Value investing. Dillian advises investors to “double down on their winners and “let ‘em run until they start dropping.” But exactly how are investors supposed to know when a particular stock is about to start dropping?

Dillian worked as a trader at Lehman Brothers. With his intimate knowledge of that investment bank, did he predict Lehman would end up filing for bankruptcy? Wall Street is littered with investors who try to call the highs and lows of individual stocks. If anyone had a methodology that worked, evidence of it would be found in a peer reviewed financial journal. Trying to pick stock winners using any system is just speculating. The expected return of speculation is zero, or less if you include transaction costs.

Selling stocks. Dillian advises investors to “be a quitter” and sell out losing positions. You would be far better off being a “holder” and investing in a globally diversified portfolio of low management fee index funds in an asset allocation appropriate for you. Trying to figure out when a stock has bottomed out is nothing more than a wild guess.

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The concept of giving advice on how to trade is highly suspect. A report by the North American Securities Administrators Association found that 70 percent of the customers at one day trading firm lost money. Other studies validate the view that day trading is extremely risky and generally a loser’s game. Instead of embracing your inner trader, you should be rejecting the impulse to trade. Trading advice is simply irresponsible.

Dan Solin is a senior vice president of Index Funds Advisors. He is the author of the New York Times best sellers The Smartest Investment Book You'll Ever Read, The Smartest 401(k) Book You'll Ever Read, and The Smartest Retirement Book You'll Ever Read. His new book, The Smartest Portfolio You'll Ever Own, will be was released in September, 2011.