We’ve had some choppy markets and that’s fine by me. Great investors love uncertainty because volatility equates to opportunity. Selling or shorting into volatile euphoria and buying into panic is a time-tested, wealth creating strategy. On the other hand, when everything is consistently moving in one direction, either upwards or downwards, investing can be an easy and straight forward momentum game.  Buy something and watch it go up…short something and watch it go down.

In tough, choppy, trendless markets, identifying trends by active traders becomes more challenging. During tricky markets like we’re in now is when the wheat gets separated from the chaff. Day traders and speculators act on a zig one day and are forced to zag the next. Because of the volatile, whippy market dynamics, this type of active trading by individuals rapidly destroys portfolios, not only because of the transaction costs and taxes, but also due to impact costs and spread losses (i.e., bid-ask).

Often, the greater losses come from the behavioral aspects of active trading. Performance chasing and/or the pursuit of overzealous loss mitigation frequently are driven by the destructively entrenched emotions of fear and greed. In the past, I can’t tell you how many times I have rushed into a highflying stock, only to see it pull back down -15-20%, in short order. On the flip side, how often have stocks bounced significantly, after I’ve made a panicked sale? Too many, unfortunately. Most investors don’t take to heart the fact that whenever you initiate a trade, you need to be right twice to optimize your profits. In other words, the security you initially sell needs to go lower (i.e., you should have kept the original investment), AND the security you subsequently buy needs to go higher (i.e., you shouldn’t have purchased the new investment in the first place).

Even in the cases in which the balance of the buy/sale trades becomes a wash, the trading costs and taxes will eat the active trader alive. Unfortunately, the other outcome of losing on both sides of the trade (the purchase goes lower and sale goes higher) is all too common. For example, the purchase you bought falls by -3%, and the investment you sold climbs +10%. Doing nothing would have been the best outcome!