I have been an active share investor for over a decade now, and I have yet to make any meaningful return from the market. In fact, I don't actually rely on the market to provide me with a return, and don't expect one for a long while yet, if ever. And yet, I continue to buy stocks on a regular basis. Either I am a sucker for punishment, or there is something else going on.
It may sound like mere semantics, but the truth is that it is not the market that provides returns for true investors; it is the companies that you invest in. When I buy shares I am literally buying a part ownership in a business, and hopefully a sound business with attractive prospects. As an owner I am entitled to share in the profits of the business and the value of my ownership will rise as the business grows. The share market itself, like any market, is merely a mechanism for exchange.
The market is of use to me only in the sense that it can put me in touch with people who want to sell me their shares or who want to buy the shares I own. Outside of that it serves no useful purpose whatsoever, other than perhaps giving me an idea as to how the collective consciousness is currently valuing things.
The other thing to understand about the market is that participation is purely optional. That may seem obvious, but as an investor I am only going to participate when it seems attractive to do so. Contrast this with a trader that relies on buying and selling to generate a return. For them it is indeed the market that provides the return, not the underlying companies, and if you don't trade you can't make any money.
But me, I am under no obligation whatsoever to buy or sell on any given day, or indeed even over a period of weeks and months. If for whatever reason the market happens to be overly pessimistic, and share prices are depressed, I may certainly consider snapping up a few bargains (logically, as prices fall, investment return prospects rise). Of course, when the market is optimistic and prices are high, I may then consider selling (although I rarely do). I certainly will be less inclined to buy, and in all cases, the option to do nothing is perfectly justified if you have any reason for doubt.
However, this is precisely the opposite of what many people do. They buy only after a sustained rise in prices, believing the trend will continue, and they sell when prices fall for fear of losing more money. They are ‘investing’ with their emotions, not their heads. In fact they are not investing at all; they are speculating on price movements. And there is a world of difference.
As far as I am concerned, when your strategy is based on the expectation that you can sell assets to other investors for a higher price than what you paid for them, you are implicitly assuming that you have a better judgement of value than the market as a whole, and moreover that the market will soon agree with your value appraisal. History does not reveal this to be a safe assumption over shorter time frames.
So if you were to follow a strategy based on the rapid exchange of shares you can see that you are not investing in the underlying business at all. You are instead speculating on price movements, and you are doing so in competition with people and institutions that are better resourced, better funded and vastly more experienced and trained. Not only that, but you are subjecting yourself to unfavourable and unpredictable short term factors that are beyond your control (sovereign debt problems in Europe, collapsing property markets in the US, terrorist attacks, freak weather events etc). You may well have what it takes, and it can be a very profitable endeavour, but understand that high returns are always associated with high risk. This is a fundamental and immutable law of investing.
So when you next approach the market, ask yourself whether you are seeking to make an investment, or whether you are making a gamble on price fluctuations. If indeed you are there for investment reasons, understand that your returns will largely be delivered by the financial performance of the underlying business, and that ultimately this is the basis for valuation in the market over the long term. All else is just a distraction.
Make the markets work for you