eg I could also say that you could fool yourself believing that investing in the S&P 500 index is a strategy with high-probability of performing well, with a hidden surprise of low-prob cat losses.
You ask a good question.
Consider a game like rock-paper-scissors. The goal is to predict your opponent's move. Among all possible strategies, the random strategy is unique because it can't be predicted. Any other strategy can be anticipated by a smarter opponent. Being random means you can't lose to a smarter opponent.
In trading, buying low and selling high requires prediction. Any strategy that relies on prediction becomes predictable to smarter opponents. Buy-and-hold index investing is the only strategy immune to this exploitation because you're effectively betting on everything. With passive index investing, your investments grow at the rate of business growth, making this strategy special.
And the probabilities of you succeeding won't be good, of course. But neither are the chances of a startup succeeding good either.
This dynamic is similar to gambling games like Texas Hold'em poker in a casino setting. While skilled players may consistently profit at the expense of less experienced participants, the overall wealth within the game remains constant. No new value is generated; instead, existing wealth is redistributed among the players based on their relative performance and luck. When research time and fees are added trading is largely “negative sum”.
NOTE: Some trading activities, such as market making and arbitrage, provide liquidity and help maintain fair pricing in financial markets but these operations require expensive low latency market access and are dominated by market insiders and are not possible for retail traders.
There is a fundamental difference between startups and "buy low, sell high" trading. Even if only a minority of startups succeed, they can create significant value for society by introducing innovative products, services, or technologies. In contrast, even if the majority of traders were "successful," there would be no net value created, as one trader's gain is another's loss, and the overall wealth in the system remains unchanged.
> so what if it’s a zero sum game?
While you may not initially be concerned about the distinction between positive-sum and zero-sum activities in society, studying history and economics may change your perspective. Positive-sum activities, such as entrepreneurship and innovation, contribute to economic growth and improved living standards, whereas zero-sum activities, like “buy low sell high” trading, do not.
> why should someone care?
Consider this analogy: if "buy low, sell high" trading is like playing chess, and your opponents are a collection of the best chess engines money can buy, operated by the world's top experts (think Magnus Carlsen), how profitable can you realistically expect your trading to be? The odds are heavily stacked against the retail trader. Some professional traders pay brokers to have retail orders routed to them for this reason much like how professional poker players want to play amateurs for their income.
While a small fraction of professional traders manage to beat the returns of buy-and-hold index investing, the fleeting existence of market-beating strategies is not a valid reason for the average investor to attempt them. Just as you cannot predict which lottery tickets will be winners, you cannot foresee which trading strategies will outperform. If this was possible highly paid professional traders that devote their life to it would be able to do it but only a few actually do and luck plays a big role in their success.
Markets have “seasons” and what seems to work in one season can be devastating in another. Markets also change in response to the trading strategies being used (aka “reflexivity”) and “paper testing” can give false confidence.
Right, so where do hedge funds fit in? They hire a lot of people and pay them very well; they sponsor tech events like this: https://www.man.com/pydata-london-59th-meetup. According to your rationale, they don't add any value to society?
And if you add the criteria that they should be a business - how do you think these active investors start? Do you think they just suddenly have $500m in funding and 50 people?
> how profitable can you realistically expect your trading to be? The odds are heavily stacked against the retail trader.
I'd expect it to be hard to become profitable, just like any other kind of business out there. You need to put in a lot of effort, a lot more than what people tend to expect; again, like with any other business.
> Markets have “seasons” and what seems to work in one season can be devastating in another. Markets also change in response to the trading strategies being used (aka “reflexivity”) and “paper testing” can give false confidence.
Sounds like a VC-funded startup to me :) You can make an amazing pitch deck, raise millions in funding, and burn it all to the ground when you realise there are no customers.
Hedge funds pool capital from a limited number of accredited investors or institutional investors. The term "hedge" originally referred to the fund's strategy of attempting to mitigate risk and generate stable returns regardless of market conditions. This was often achieved through a combination of long and short positions, as well as the use of derivatives and leverage.
Traditional hedge funds aimed to provide an "insurance policy" for investors, ensuring that they would be protected from market volatility. However, this protection comes at a cost, typically in the form of lower returns compared to the overall market during bull markets. In exchange for reduced volatility, investors in these traditional hedge funds would accept more modest returns.
Over time, the hedge fund industry has evolved, with many modern hedge funds focusing more on generating outsized returns rather than simply hedging against market risk. These funds employ a wide range of strategies, including long/short equity, global macro, arbitrage, and activist investing, among others. Successful hedge funds prioritize their own capital and that of their employees, rather than accepting outside investors. If a hedge fund is actively seeking outside capital, it may be a sign that the fund has not been particularly successful in generating strong returns on its own.
> According to your rationale, they (hedge funds) don't add any value to society?
Hedge funds can help provide liquidity in financial markets. Their trading strategies, while risky, can aid in price discovery but their activities don't produce anything tangible and mainly just shift money around between participants, as opposed to creating real economic value. Hedge funds are also criticized for increasing market volatility and systemic risk in pursuit of short-term profits.
> how do you think these active investors start? Do you think they just suddenly have $500m in funding and 50 people?
How do tobacco companies start? Just because smoking has the effect does it mean there can not be large tobacco companies employing lots of people? Yet the trend for tobacco companies is clear. So what is the trend between active vs passive trading? In 2000, passive funds accounted for about 12% of the U.S. stock market. By 2020, this figure had risen to over 50%. Why do you suppose this trend exists?
If you think smoking is fine you are free to smoke. You can also show off your large bank balance and argue that tobacco products “generated wealth” for you. However if you advertise smoking as being good for society expect to be challenged about your claims.
>> The odds are heavily stacked against the retail trader.
> I'd expect it to be hard to become profitable, just like any other kind of business out there. You need to put in a lot of effort, a lot more than what people tend to expect; again, like with any other business.
If you attempt to make it your business and heavily invest into it you are no longer a retail trader.
Is it a profitable business? The distribution of those who can earn an income with “buy low sell high” trading tends to follow a power law or Pareto distribution, where a small percentage of top performers earn a disproportionately large share of the total income. Unless you rank among the top few you are the source of income for those that do.
In competitive tournaments like chess / poker a small number of elite players consistently perform well and earn significant sums while the majority of players earn little or no income. The number of top spots is very limited and the competition is fierce.
When it comes to “buy low sell high” trading:
(1) the income is being earned is not from advertising sponsorships but only from other active traders who you can out predict.
(2) active strategies are not useful against index funds that buy and hold much like prediction is not useful against a rock paper scissors random strategy.
(3) As investors educate themselves the fraction of active traders is shrinking much like the pool of people that buy tobacco products is shrinking
> Sounds like a VC-funded startup to me :) You can make an amazing pitch deck, raise millions in funding, and burn it all to the ground when you realise there are no customers.
It may be con artists selling snake oil. It may be honest people trying their best. Time helps tell the two apart however you do not need time to understand that the tobacco industry is not a good industry but exists for legacy reason. Yes it can be profitable but consider where those profits come from and what the future looks like as more become educated.
After two years of research, you have developed a trading strategy that, compared to the S&P 500, "has underperformed, especially the way the market has been"? If your strategy depends on buying / selling it will trigger taxes each time this happens, yes? Short term gains taxes? When people switch from sp500 to your strategy how much less will then earn over a decade? Yet you claim your strategy "works"?
> The expected performance of the strategy is somewhere between 10% and 30%, but it is not clear what exactly.
If a profitable pattern exists, what makes you think nobody else has found it and that it will continue to exist in the future? Is it because few look for these profitable patterns? Are they poorly funded? Do they lack incentives to do it?
> I don't think it's necessarily fair to call others "dumb money". They can hold for longer and still profit with the market.
"Dumb money" refers to hobby traders who believe stock trading will make them rich. Some rely on gut feelings, while others use advice from astrology or technical analysis. Why do you suppose professional traders pay for order flow from such traders?
> The market is not a zero sum game because the market capitalization is several multiples of the total invested funds. The market is a money printer in its own way.
For every trade, there is a counterparty on the other side, and your gain is their loss and vice versa. This makes trading a zero-sum activity. Furthermore, for every trade, there are middlemen who charge fees, making trading a negative-sum activity.
Long-term buying and holding is positive-sum investing and does not require a trading strategy or searching for profitable patterns.
> Precious metals as a currency do not work because the government doesn't have the freedom to mint an unlimited supply of hard assets.
The purpose of a currency is to facilitate transactions and maintain stable prices in the short term while losing value in the long term to discourage hoarding. Gold cannot achieve this because the amount of gold cannot be adjusted to match the size of the economy as it grows or shrinks. When the economy grows, using gold as money will cause it to stall because people will save up gold as it becomes more valuable instead of spending it. Deflationary currencies like gold are detrimental to economic growth, which is why modern countries no longer use them.
> The government holds a gun to people's heads, locking them up if they don't use the highly inflationary national currencies.
Are you surprised by inflation? Saving your wealth using a currency does not make sense since it is designed to lose value over time.
If you prefer precious metals, what prevents you from keeping your wealth in gold (a negative-sum asset) and converting it to fiat currency only when needed?
> Countries are run by politicians, bureaucrats, and armed police mafia who care about their paycheck and pensions which wouldn't be so big if not for free moneyprinting at the expense of the citizenry. The people do not have freedom of their choice of money.
Countries are "owned" by their voters. Government debts are your debts. Inflation is just another tax like other taxes. If you are dissatisfied with the current situation, get involved to change it.