You vs. the Big Guys: How Can You Compete?
I'm convinced that far too few Americans invest in the stock market, and one reason seems to be the widespread sense that the game is rigged--that it's impossible to compete with the pros, who just eat ordinary investors for breakfast. It is true that pros have big advantages over ordinary investors like you and me. They have greater resources and better connections. (Note that I didn't say better training or more intelligence; there are many bloggers and CAPS players who display superb domain expertise.)
The biggest of them have whole teams of researchers, access to proprietary algorithms, etc. For example, when Bill Ackman of Pershing Square Capital Management launched his highly publicized short of the company Herbalife, he relied on the year-long research of an analyst in his company named Shane Dinneen. Ordinary investors don't enjoy the services of a highly trained professional like Shane Dinneen. Pros have infinitely better connections, too. They have dinner with all kinds of fancy people and get information before the rest of the world. I'm not necessarily alleging insider trading; I'm just saying that they hear more and know more than ordinary investors, and that information can be very valuable.
So how can you possibly compete from your desktop at home? Ordinary investors have one big advantage over pros that I don't think they always appreciate: they're not beholden to clients. If there's one recurring bad habit that I notice among ordinary investors, it's comparing their returns to the market averages. Why should you care whether you beat the market? If the market goes up 20% in one year and your return was just 19%, wouldn't you still be happy? If the market goes down 10% in one year and your return was -9%, wouldn't you still be disappointed? Comparing returns to the market makes sense only when you're evaluating the pros. If a hedge-fund manager is collecting two-and-twenty, investors naturally want to see whether he has been beating the market handily and consistently, because otherwise they'd be well advised to save their money and just invest in an index fund instead. But unless you're collecting fees from clients (in which case you're not reading my blog), your performance relative to the market is a statistic that doesn't do much for you--except possibly induce anxiety in the case of underperformance, and overconfidence in the case of outperformance.
Why is this such a big advantage? Because you're not obliged to chase. I suspect that most pros were prepared when the market lurched forward in 2013 (after all, throughout December, the best ones had been advising anyone who cared to listen that it made sense to buy on dips), but I'm sure that some of them were not. Presto, within a week, the market was up over 4% (SPX at 1402 at the open on December 31, and 1466 at the open on January 7), and suddenly they had to chase in order to justify their lofty fees. That can lead to rash decisions, to paying more than you should. I wouldn't put it past some of them to go on TV and present a big scary bearish case just in order to slow down the markets so that they'd have a chance to get in too. (Not naming names. Just saying.)
You win by not competing with the pros. It's usually not a good idea to bet against them, because, again, they have all those resources and connections at their disposal. A better approach is to try to get ideas from them. By studying their positions (for example, by sifting through their 13F's), you can infer a great deal about what they're thinking. But don't worry about beating them; just do your best to profit alongside them. There's plenty of room at the table.
And then you can always take solace in the fact that even the most respected managers don't always beat the market. The great David Einhorn of Greenlight Capital trailed the S&P by a solid 8.3 percentage points last year!