By a trading-oriented market, I mean one where:

–the indices generally move sideways within a narrowly defined range, and

–individual stock price movements are strongly influenced by traders who have short-term holding periods–a day, a week, even a few hours–and who buy and sell very rapidly.  As a result, both individual stocks and the markets can exhibit sharp up-one-day, down-the-next patterns.

Why should a market like this persist? 

Five reasons:

1.  The economies of the developed world have slowed a lot and are no longer providing clear up or down signals.  And, at the moment, the EU’s continuing bungling of the situation in Greece is producing alternately hopeful and despairing news headlines that short-term traders are using to help them ply their trade.

2.  Pension plan sponsors continue to shift money from traditional investors to “alternatives” like hedge funds, many of which are run by traders and employ a short-term trading style.  This shift continues despite the fact that alternative managers are more expensive and in the aggregate have produced inferior returns pretty continuously for almost a decade.  Don’t ask me why.

3.  Fundamental information about individual companies has become harder to get.  Over my thirty years in the business, brokerage houses have become progressively more dominated by traders.  During the 2007-2009 market downturn, they gutted their research departments as a way to cut overheads.

Also, the shift by individual investors from mutual funds to ETFs and by institutions to alternatives means the research budgets of traditional long-only institutions are not what they once were, either.

4.  Discount brokers offer mostly trading tools and technical analysis to their clients.  Why?  They make most of their money from customer transactions, not from clients outperforming the market.  Also, setting up a research department is complicated and expensive, and it potentially exposes the firm to lawsuits if investment recommendations go awry.

5.  Many mutual funds still have big accumulated losses–both recognized and unrecognized.  In large part, these losses come from individuals buying mutual fund shares at high prices in 2006-07 and then redeemed them at much lower levels in 2009.

As counterintuitive as it sounds, these losses are a big asset to current shareholders.  They allow a manager to change the structure of his portfolio without generating net taxable gains.  This fact also permits–and, in my opinion, should encourage–mutual fund managers to take a more aggressive trading stance to use the losses more quickly.  This maximizes their value to shareholders.  And some newer funds may have years and years worth of losses to avail themselves of.

The result of this is that even the most buy-and-hold-oriented taxable investors may be trading much more than usual.

investment implications

One of the first pieces of Asian investing lore I encountered years ago (and one of the few I’ve found useful) is that the daily market action is like a rapidly turning wheel.  You can stay away from the wheel and not be hurt.  You can jump on the wheel and not be hurt.  They only way you can be severely injured is to try to jump on and off.  In other words, if you dabble in trading and don’t devote your life to it  you’ll get your fingers badly burned.

For the vast majority of us, as individual investors, the best approach is to take a longer investment horizon than the market does–to endure short-term volatility rather than try to profit from it.