64 ATaleofTwoMarkets
to murder the money day trading and then attempt to murder his
wife (he wound up in a South Carolina prison).^22
Hardly tales of high rationality, and the woeful tales of these
hapless folks are not isolated examples or aberrations. A Senate com-
mittee held hearings on day trading in early 2000 accompanied by
a blistering report cataloging its numerous plagues. The report fo-
cused on the industry that supports day trading and emphasized the
need for greater industry ris kdisclosure, licensing, and minimum
financial requirements for traders. But it is also a brief against the
sagacity of the pernicious practice.^23
The most compelling conclusions of the report are that 75% of
day traders lose money and that a typical day trader has to generate
gains of $110,000 a year just to brea keven after costs! That figure is
breathtaking, but the idea is not new. Classic studies have shown
that someone who tries to time the market and move in and out of
it quickly to exploit its gyrations has to be right 70% of the time to
profit. Do you know anybody who can perform that well consistently?
Even the best hitters in baseball—say, Rod Carew, George Brett, and
even Ted Williams—bat at most .400 (the equivalent of “being right”
only 40% of the time).
An equally important—if slightly more benign—source of trader
volatility is the practice of “rebalancing.” Ironically, this practice was
promoted mainly by those who use modern portfolio theory and be-
lieve in market efficiency. Rebalancing goes something like this: If
you start with ten stocks each bought for 10% of the total cost of
your portfolio, some will rise in price and some will fall. The re-
balancer says that after a year or another arbitrary interval, loo kat
the new pricing. Suppose five went up and five went down, both in
proportion. Now your portfolio has five stocks constituting 75% of
the holdings and five stocks constituting 25%. The rebalancer says
you should shed some of those in the 75% group to reduce their
role in the overall holdings.
This must ran kamong the dumbest things people could do with
investments, yet it is very prevalent. You end up selling the stocks
that seem to be performing relatively well and keeping those which
come up behind. Why would you do that?
It may be rational, but not because your portfolio is somehow out
of balance. It makes sense to sell the good performers only if you ex-
amine the business fundamentals of the companies and decide that
they no longer meet your requirements for holding them: the price ex-
ceeds the value by large amounts, there are clearly superior opportu-