The Myth: "You can't beat the market."
The Truth: "Research proves that many traders consistently outperform the stock market."
"You can't beat the market" is a common stock trading myth. Most people are convinced it is practically impossible for individual traders to earn more than the stock market in general. Financial advisors and index fund salesmen will even tell you that you can't trust anyone who claims otherwise.
Maybe the skeptics should talk with researchers at Ohio State University in Columbus. Their work suggests that a large number of traders do indeed beat the market. They found that the top 10 percent of investors studied made about 38 percent more than the market average each year. Overall, about 20 percent beat the market consistently.
"Individual investors are often regarded as at best uninformed, or at worst fools. But our study suggests that there are a few sophisticated traders with genuine ability to pick winning stocks," said David Hirshleifer, co-author of the study and a professor of finance at OSU's Fisher College of Business.
Professor Hirshleifer conducted the study with Tyler Shumway of the University of Michigan and Joshua Coval of the Harvard Business School. The three reviewed the trades of over 113,000 accounts at a large discount brokerage firm between January 1990 and November 1996.
To make sure that some of the winners didn't just get lucky with a few trades, the researchers also looked closely at a subset of the larger group. This smaller detachment was made up of 16,668 accounts that completed at least 25 trades during the study period. The results were comparable to those of the bigger group.
The researchers also found that those who did best during the first half of the time period also tended to do best in the second half. This too suggests that they really did have superior trading ability and weren't just lucky. In addition, the researchers used a number of methods to insure that the best performers didn't have insider information that allowed them to make profitable trades.
The study results challenge the efficient market hypothesis - EMH - a theory that financial researchers have argued about for years. EMH proponents believe that since all traders and investors theoretically have access to the same information, it must be impossible to consistently beat the market average.
Bottom Line: A large number of investors and traders DO have the ability to outperform the stock market. Unlike gambling, trading is a type of speculation where education and skill can dramatically shift the odds of winning into your favor. RightLine suggests that you focus on what you need to know and what you need to do - the money is just a byproduct of wise action.
Editor's Note: A special thanks to Jeff Grabmeier at Ohio State University. Portions of this article were taken from his writings.