The fallacy of a “stock-picker’s market” - MoneySense

The fallacy of a “stock-picker’s market”

Trading securities doesn’t create wealth, it merely re-distributes it


Investors might find this hard to believe, but there is no such thing as a “stock-picker’s market.” When one stocker-picker “wins,” the investor on the other side of the trade “loses” by an identical amount. It’s a basic concept that many in the financial services sector have trouble grasping, so let me put it in terms terms that are easy to understand. 

Let’s say there are eight buddies who play poker every Friday night. At the start of the game, each player brings $100 to the table and they play until someone wins it all. At the end of the night, has any wealth been created? Obviously not. The participants entered with a collective $800 and left with a collective $800, the only difference is seven players walk away with nothing. Trading securities works the same way. It does not create wealth, it merely re-distributes it. 

In spite of this, one of the phrases I hear often is that we are in a “stock-picker’s market.” There’s simply no polite way to say this: it’s impossible. 

Win some, lose some

Let’s look at this logically. The first thing that you need to understand is that capital markets are made up of two primary groups—indexers (market replicators) and active managers (stock pickers). Indexers generally buy all the stocks in a benchmark index in their proportionate amount to replicate that benchmark, while stock-pickers trade with one another in an attempt to beat it. The problem for the second group is that it is impossible to have winners without having losers.

READ: A defence of active investing

If one person sells 400 shares of XYZ Corporation, then the person on the other side of the trade buys 400 shares of XYZ.  No matter how lucky one trader is, the counter-party is equally unlucky.  

If winners equal losers 100% of the time, then the notion of striking now, while the iron is hot, is particularly foolish. Have you ever noticed stock pickers are the only ones who say we’re in a stock pickers market? If there are times when stock picking is particularly fruitful, it logically follows that there must also be times when stock picking is not particularly fruitful. 

Control your costs

In fact, no time is any better than any other. Investing is a zero-sum game before costs and a negative-sum one after costs. All else being equal, an investor’s expected return is the return of the benchmark minus all associated costs. The lowest cost produces the highest return. 

In some ways, it’s like going to your local lottery kiosk and being told: “it’s a lottery number picker’s market.”  Would you believe it?

John De Goey is a portfolio manager with Industrial Alliance Securities Inc. and the author of The Professional Financial Advisor IV. Industrial Alliance Securities Inc. is a member of the Canadian Investor Protection Fund. The opinions expressed herein are those of De Goey alone and may not be aligned with the opinions and values of Industrial Alliance Securities Inc.  or any of its affiliated companies.