Short-term investing: Why it is the wrong strategy

“Fairy gold is wealth or prosperity that may vanish as swiftly as it is acquired: precarious or illusory wealth” – US Merriam-Webster Dictionary

Stock markets celebrated the start of 2013. It was a typical reaction to the signing of a bill by the US Congress in the last few minutes of 2012 that delayed the discussion of the budget deficit by a further two months. Short-term speculation is now the investment game.

Risk-on risk-off trade

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It was also apt that in those same closing days of December the 200-year-old New York Stock Exchange (NYSE) was bought by IntercontinentalExchange (Ice), an eight-year-old electronic market based in Atlanta, Georgia, and unknown to most private investors.

Trading in actual securities, whether bonds or shares, has declined and become more competitive, while Ice specialises in contracts tied to commodities, credit, interest rates and derivatives. It is the Euronext futures business Ice wants, not the traditional activity of the NYSE or the European stock markets it owns. These are the services institutional investors desire, as their investment horizons have shrunk from years to days – or even seconds.

However simple in hindsight speculation may look, it is in fact extremely difficult to make such profits, especially when economic, political and financial policies are as intertwined as they now are. It is not only private investors that have suffered psychological trauma over the past 12 years. It has been even worse for professional managers.

Two major market crashes, doubts over the efficacy of the efficient market hypothesis, the realisation first-world government bonds are no longer safe-haven investments (and that the issuers are bankrupt in all but name), have utterly destroyed the consensus that propelled the world from 1950 onwards.

High-frequency trading

The result is that the adviser to JPMorgan’s fund of hedge funds has had to confess to clients that the sector has been disappointing, admitting “the vast majority of all hedge funds worldwide have well underperformed virtually every major stock or bond index for some four years”.

As profits have become harder to find, dealers have handed over trading to computers. Many believe these high-frequency trading activities are predatory, flooding markets with orders to detect interest and then withdrawing them fractions of a second later just as soon as genuine buy or sell interests appear.

Larger, more staid traditional institutional investors are the most disadvantaged by this practice as a recent joint study between regulators and academics shows.

Based on actual trading data from individual firms, it was the most aggressive firms that earned the biggest profits at the expense of everyone else, including less-aggressive high-frequency traders and, of course, the private investor.

Managing money

Bankers deal in credit. They lend long to businesses, borrow short from everybody and rely on their reputations to square their books. Crises of liquidity and solvency were, and are, recurrent. Margins were low but secure and, until 1973, the bigger commercial banks were regarded as a high-quality utility, with shares safe for widows and orphans. Then Walter Wriston, head of Citibank, declared his firm should in future grow its earnings at 15 per cent a year, making its shares ideal for executive stock options.