When I first started trading, I spent years trying to find the ultimate trading/investment method.
Eventually, I realized that long term investing is the most profitable strategy in U.S. equities. My colleagues and I created a model to trade the S&P 500, and to this day I only trade UPRO (3x ETF for the S&P 500). My trades/investments typically last 6 months – 4 years. Here’s why.
The stock market has a strong bullish bias
The U.S. stock market is different from all other markets in this respect: it has a natural long term bullish bias (until the day aliens come and annihilate the U.S.). This means that if you just buy and hold a basket of stocks for 50 years, you will make money (after inflation). The S&P 500 goes up more often than it goes down (up on 58-60% of days, down on 40-42% of days). The stock market spends much more time in bull markets than in bear markets.
The same cannot be said of other markets. If you buy and hold a currency for 50 years, you will lose money (accounting for inflation). If you buy and hold commodities for 50 years, you’d probably only breakeven (accounting for inflation).
This means that in the U.S. stock market, you always want to be playing from the long side and not the short side. Given enough time, the long side will always win and the short side will always lose. That is why I am always 100% long or 100% cash – I never short. I have seen too many traders get killed by strong trends such as 2009, 2013, 2017, etc.
There’s another important phenomenon in the U.S. stock market: there’s too much dumb money. I don’t mean this in an arrogant sort of way – it’s just a matter of fact. For example, the U.S. economy was clearly sinking by the end of 2006: there were too many warning signs. However, the U.S. stock market kept going up until October 2007!
That’s why I never short the stock market, even if I see a problem that’s clear as day. It’s ok to miss out on part of a rally. It’s not ok to be too early and lose a lot of money (i.e. imagine shorting the S&P in December 2006, 10 months before the market topped). The natural bullish bias and dumb money phenomenon are too strong.
The big money is in the trend
Most of the short term price fluctuations (day to day, week to week) are random. But the longer your time frame (e.g. month to month), the less random those price fluctuations become.
Most short term stock market traders go long and short. They are ecstatic if their account is up 20% a year. Why? Because if most short term fluctuations are random, then it’s very hard to significantly outperform 0% a year! (That’s basic statistics). They don’t allow the stock market’s natural bullish bias to work for them. By going long and short, they’re fighting the stock market’s natural bullish bias.
20% is a bad year for me. My strategy averages 45% per annum. If I cut my exposure by 1/3, my average return would still be 30%, and my risk would shrink drastically.
I’ve told a lot of hedge fund managers that if they stopped shorting and only played on the long side, they would make a lot more money. I literally took them through the exercise: compile your trades over the past 20 years and eliminate the shorts. Of course, this means that they don’t make money in bear markets (sitting on 100% cash). But in the long run, their performance significantly improves.
I’ve tried multiple long-only trading strategies via backtests, but I always came to the same conclusion.
Trading in and out of the market cannot beat “buy and hold”, because the market’s bullish bias is too strong. The rallies that you miss > the small corrections that you catch.
When you think the market will make a 5% decline, there’s a >50% chance that it will first rise 5% before falling 5% (thanks to the natural bullish bias). So from a mathematical perspective, it’s better to just buy, hold, and ignore the 5% decline.
I will sidestep significant corrections and bear markets
I have no intention of buying and holding during significant corrections and bear markets. UPRO (3x ETF for the S&P 500) will fall 40%+ during a significant correction. UPRO can fall 90-95% during a bear market! A 40% decline isn’t fun. A 90% decline will put me out of business.
Here’s UPRO in a significant correction.
My model has been able to accurately & timely sidestep every single bear market, and has sidestepped all but 3 significant corrections (with no false positives).
Every country is different, but the majority of countries treat “trading” and “investing” differently.
Buying and holding typically has significant tax advantages over trading. Here’s an example. Let’s say buy and hold is taxed at 25%, and trading is taxed at 50% (because trading is often seen as “business income” in the eyes of the law).
- Let’s say Buy and Hold makes 7% a year.
- Let’s say Trading makes 10% a year (which is what a lot of traders average).
- After tax, Buy and Hold makes 5.25%. Trading makes 5%!
In other words, a trader can work hard and end up worse off than someone who does nothing but buy and hold. The effort-reward ratio is terrible.
Trading is a terrible lifestyle
I could never do day trading or short term trading as a full time profession. I’d probably ruin my health. Wealth means nothing if you don’t have health.
Long term trading/investing requires a lot less time than day trading.
Learn how to invest and trade here.