Why Active Trading Isn’t Suitable for Most Investors
What You Should Know About Active Trading
“Most people are active in the way they earn income and passive in the way they invest, which statistically is a good thing,” says Matthew Chancey, CFP. He explains that being an active investor requires “a higher appetite for risk and more emotional fortitude than every investor sentiment survey has ever suggested that passive investors can be.”
Active trading is often promoted as a way to generate higher returns by leveraging short-term market movements and price fluctuations. While this can be true, it’s crucial to understand that active trading is a high-risk, high-reward strategy that demands significant time, effort, and expertise. Chancey advises that successful traders must “learn how to let winners run, limit losses, properly position size, hedge when possible, learn quickly, and have a short memory—all at the same time.”
Pros of Active Trading
There are some compelling reasons why a savvy investor might prefer active trading over safer, more passive approaches:
- Potential for Higher Returns: Active trading can offer opportunities for higher profits by capitalizing on short-term market movements.
- Market Engagement: For those who enjoy following market trends and making frequent trades, active trading can be an engaging and rewarding activity.
- Control and Flexibility: Active traders have the ability to make quick decisions and adapt their strategies to changing market conditions.
Cons of Active Trading
However, active trading comes with significant drawbacks:
- Emotional Stress: The fast-paced nature of active trading can lead to emotional stress and decision-making influenced by fear, greed, or overconfidence. It’s crucial to remain objective to avoid costly mistakes.
- Higher Transaction Costs: Frequent trading incurs higher brokerage fees and commissions, which can erode potential profits.
The Bottom Line
“Having the skill to be an active investor is one thing, but having the emotional fortitude is something else that most people lack. Without both,” Chancey explains, “the odds of active trading working out in the long term are slim to none.” For most individual investors, passive investing strategies, such as index funds or exchange-traded funds (ETFs), are often more suitable. These strategies aim to track the performance of a specific market index or sector, rather than trying to beat the market through active trading.
