Pimp My Trade

How to Beat the Stock Market - It’s a Trading Paradise

Posted on February 3, 2009 by Adam

Welcome, traders, to the recession. I’m sure I didn’t need to remind you of that, but it needed to be said. I wanted to take some time to talk about beating the market and why it’s so difficult. Bear markets are notoriously difficult to trade, and the last six months are a prime example of that. I’m here to help you figure out how to win during these times of economic strife, or at the least, how to stay in the game.

Did you know that most mutual funds fail to outperform the S&P 500? That may come as a shock to many pensioners who trust their life savings to experts who erode their money and charge to do it, but it is true. How could that possibly be? After all, the fund managers are experts. They have access to the best tools, education, and information available, but year after year, you could do better by just buying and holding shares of the diamonds.

It is possible to beat the stock market. That is known as alpha, or market-beating returns. But I won’t lie to you. Outperforming the stock market is extremely difficult. In bull markets, real wealth is built, and it is abundant. Anybody can be a winner when the stock market is consistently shooting higher. Since all stocks are appreciating in value, it’s as simple as buying low and selling high. When stocks depreciate in value, wealth is lost. That’s when traders come in and play the market, using their wits and grit to scrape by, making small profits here and there. During bull markets all you have to do is hitch a ride and the market will do the work. During bear markets, the only ones who win are the nimble ones.

Why is that? The answer has to do with the efficiency of markets. The efficient markets hypothesis states, basically, that beating the market is impossible. It theorizes that the financial markets, due to their immense scope and liquidity, are the most efficient means for pricing securities. In that view, the only way to beat the market is by having some sort of knowledge that the broader market players are unaware of. Essentially, it says that the market is smarter than you.

I am a big believer that the efficienct market hypothesis is partly true. Yes, markets are efficient. I can’t deny that. Financial markets are extremely efficient at pricing their goods. That is why fund managers fail to beat the S&P. During bull runs, they make big gains, but when stocks depreciate in value, they are not able to effectively trade the market, and they lose more than the market. But, they are not perfect.

Markets are smart, probably smarter than me. But they aren’t perfectly efficient. A good trader doesn’t need to be smart enough to predict the fundamental balance of supply and demand in the future, he or she need just identify inefficiencies in the market. It is essentially pattern recognition. Price patterns are a great example. So are support and resistance. By systematically identifying points of inefficiency in the market, you can get alpha trading in any market climate.

That’s what I will try to teach you on this site. This is a trader’s market. Only the strong will survive. If you can make it through these tough times then you will surely see massive profits in the next bull market. I always say:

Live to trade another day.

Over the next few weeks, I will be introducing some trading strategies and talking about trading price patterns and other inefficiencies. I hope I can help you be a better trader.

Good night, and good luck! See you tomorrow.