Many individuals believe they can make significant quantities of money by stock trading. Much of the financial services industry wants the public to believe that it can take our savings and, by the application of investing skill, make better returns than the market average. Much of the advertising for mutual fund investment vehicles in the UK touts superior past performance despite the (legally mandated) small print asserting that past performance is no guide to the future.
For example, a UK mutual fund house, Jupiter, describes it mission thus:
We are an active fund manager seeking to add value for our clients through the delivery of investment outperformance over the medium to long term.
There are even two major schools of thought about how to achieve good returns:
- technical analysis which focuses on historic patterns of price movement, and
- fundamental analysis which focuses on analysing the underlying economic performance of the firm.
The problem is this: there is a solid body of financial theory that asserts that long term outperformance based on any form of market analysis is impossible. The Efficient Market Hypothesis asserts:
one cannot consistently achieve returns in excess of average market returns on a risk-adjusted basis, given the information available at the time the investment is made
(unless, it is worth adding, you have inside information on which it is illegal to trade in most markets). Burton Malkiel's famous book on the topic, A Random Walk Down Wall Street, is a very readable introduction.
As a test of investing skill more than one experiment has been conducted pitting the professional stock pickers against random choices (often vividly illustrated by having a monkey throw darts at the Wall Street Journal to select a portfolio). Experts often don't do significantly better than random. As a Forbes article reports, when the Wall Street Journal did the random-selection experiment:
On average, investors following the experts’ recommendations lost 3.8% on a risk‐adjusted basis over a 6‐month holding period.
Both the theory and this experiment seem to defy common sense. How can people who a skilled and well paid for their skill not actually consistently beat a random number generator? How can such a large industry exist when the skill they assert is impossible to demonstrate?
So the question here is: is there evidence that experts can consistently beat the market? Are there demonstrable strategies to make returns ahead of the market average?