How You Can Beat "The Street" in Today's Stock Market

Keith Fitz-Gerald
  AUG 23, 2011 1:30 PM

While most retail investors believe that they can't beat The Street because the "little guy" is disadvantaged, the fact is they can, precisely because they're the "little guy."

 


I can't tell you how many times during the ugly trading days we've seen in recent weeks that I've heard someone say that the little guy can no longer compete -- that he or she can't beat "The Street' -- in today's stock market.

In fact, I hear it all the time: Wall Street has rigged the game, has turned Washington into its lapdog, and only wants to separate the retail investor from his or her money.

I guess such defeatist sentiments are understandable -- especially on days like Thursday when the Dow Jones Industrial Average plunges more than 419 points. But they're also misguided.

You see, while most retail investors believe that they can't beat The Street because the "little guy" is disadvantaged, I hold just the opposite view. I know you can beat The Street, and beat the Big Boys at their own game, precisely because you are the "little guy."

How do I know this? Simple. I've helped tens of thousands of investors around the world do just that.

So let's deep-six the defeatist attitude and get down to business: The person who can most help your bid to outfox Wall Street is the one who's looking back at you from the mirror every morning. Just remember:

  1. The playing field is level -- even if you think it's not.
  2. Small investors can be more nimble.
  3. Professionals face risks that you don't have.
  4. A proven portfolio approach can make you steadier than the markets.
  5. You need to have the courage to participate to get started.

It's a Better Playing Field Than You Think

Yes, the Big Boys have "dark pools," exclusive trading platforms and more computing power than at any point in recorded history. But so what?

The typical personal computer available to retail investors has more power than the entire NASA Apollo Mission profile and the data you can pull off the Internet is truly stunning.

Plus, thanks to the brokerage and analyst follies of the "dot-bomb" era, the U.S. Securities and Exchange Commission (SEC) now requires public companies to disclose information to everybody equally and at the same time. So if you want to receive reports at the same time as the hotshots do -- or you want to participate in an earnings call -- this means that all you have to do is sign up.

If the insiders get it first, sooner or later they'll get caught. Just ask former Galleon Group guru Raj Rajaratnam, who last May was convicted of 14 counts of conspiracy and securities fraud as a result of the government's biggest-ever insider-trading case.

You might think that the deck is stacked, but I think we just proved that it's not.

Be Nimble, Be Quick ...

You may not think that your ability to be much more nimble than big institutions gives you an advantage in an era dominated by million-dollar -- or even billion-dollar -- trades, but it does.

Think about it: If a major institution, hedge fund or private investor wants to move into a stock, and establish a truly meaningful position, he or she has to trade huge blocks of shares. Even if you're a total amateur on the most basic of trading platforms, you can see anybody who's trading in size from a mile away.

Plus, moving big blocks of stock, bonds or options can literally move markets -- and change the price of the security that they're attempting to buy or sell. And that makes the very instrument they're trying to buy more expensive or the stock that they're trying to sell a lot cheaper.

You, by contrast, can trade blocks of 100, 500 or 1,000 shares -- and leave no trail to follow. Nobody will see you coming or going if you pick your prices and plan your trades carefully.

Then there are the expenses.

Any mutual fund or hedge fund that has to turn over 70% or more of its holdings in a given year will typically have trading costs that are between 1% to 3% of assets. Perhaps more.

Thanks to the Internet and heated competition between brokerage firms, small investors pay a lot less today than they did decades ago -- and certainly a lot less than their brokerage rivals in today's markets.

And that's like money in your pocket simply because fees you don't pay translate directly into higher profit margins. And, not surprisingly, those higher margins turn into consistently higher portfolio returns over time.

Then there's risk -- an interesting topic itself.

Retail investors have somehow come to believe that professional traders face fewer risks than they do.

Not true.

The pros are paid to take risks and they can actually be fired for not risking enough. The pressure is intense and I know from firsthand experience what a pressure cooker this can be. At the end of the day, a professional has to explain every position, every trade and every tick.

Small investors, on the other hand, don't have to face these real-time pressures, and can play against the broader scheme of time and multiple investment themes. Sure things may go against you every once in a while, but if you're executing to a carefully thought-out plan, your gains can easily dwarf your misfires.

Celebrate the fact that stocks are going down and use the fact that everybody is running the other way to your advantage. If that doesn't make sense, consider a strategy that legendary investor Jim Rogers hammers on: Sell into euphoria and buy into panic. The Disadvantaged Pros

Professionals have to adhere to "portfolio" mandates. This means that, contrary to what most individual investors believe, most pros face limited choices.

For instance, many can't go to cash when the markets get crazy; even if they wanted to do this and thought it prudent, their portfolio mandates might restrict such a move. What's more, very few professional investors actually have complete discretion in choosing the assets they invest in or the tactics they employ. Clients pay these people to invest so they're not expected to keep cash sitting around.

As an individual investor, on the other hand, you can do any damn thing you want. You have the ability to go completely to cash if the markets get too out of hand (although I don't advise this, since missing the "best days" of the market can dramatically reduce your returns ... but you have the option, which most pros don't).

But most importantly, you have the ability to construct and use an investment plan that's elegantly simple like the "50-40-10 portfolio" I created.

Even though it does come under pressure from time to time, the built-in safety brakes, high income and easy-to-use hedges will prevent investors who follow it from getting clobbered. Mutual-fund managers and other pros, on the other hand, may just have to endure the beating.

Stay Invested ... to Beat The Street


Many investors feel like running for the hills on days like last Thursday and I do not blame them one bit. It's really tough to watch the markets get carried out feet first and to watch the panic that grips the markets on days like that.

But running for cover is precisely the wrong play to make.

You actually want to do just the opposite: You want to hold your nose and take the plunge.

If you are following a well-defined plan like the 50-40-10 pyramid, you'll already be in-synch with the natural ebbs and flows of the broader market. In fact, you should always maintain a "short list" of stocks that you want to buy on a decline. That way, you can view any downdrafts as a long-awaited chance to get choice stocks "on sale."

The trick is to make sure to have a full repertoire of tactics -- much like an ace starting pitcher has a full complement of pitches -- that you can use to adapt to any given situation.

For instance, if things are relatively calm and sentiment is good, you can allocate more per trade and buy in all at once, while concentrating on profit targets to maximize the use of and return on your capital. When things get rough, you can take the opposite approach and use tactics that control risk while making sure to limit the amount of money you have on the table at any one time.

There are literally hundreds of potential tactics that you can employ.

It's impossible to know when, why or how the markets will turn. But this arsenal of investing tactics or weapons will allow you to adapt to, and capitalize on, whatever market conditions come your way. That way you can adapt your risk profile appropriately, still get the best prices and, most importantly, keep your upside in play.

Right now, things are obviously rough. That's why I think any investor should be pursuing a "safety first" approach to their pursuit of portfolio returns. One of the simplest ways to do that is to split your capital into equal chunks and invest it over a period of months. That way, if the markets drop after you purchased your position, you haven't bought in all at once, and don't suffer a catastrophic loss. In fact, if you buy in equal increments as the market falls, you're effectively buying in at lower prices.

If they rise, so what? You have a piece of the action. It may not be as large as you like, but that's moot -- at least you haven't been left at the station.

And finally, as part of the buying process, make sure you're always selling -- especially in down markets. After all, the new money you're putting to work can just as easily come from existing investments as it can from fresh contributions to your retirement funds. My favorite is to simply use "trailing stops." It's a forced discipline, and it works. If the markets force my hand, I simply take my money off the table and redeploy it with no emotional turmoil and no indecision.

I could go on. But I think I'll end here with three thoughts to help you be more effective in your bid to beat The Street:

1. The issue is never about how much you make; it's about how much you keep.
2. Investments should be based on where you are going, not where you've been.
3. Volatility is merely what happens until you get to your destination.

Editor's Note: Keith Fitz-Gerald is the chief investment strategist for Money Morning, an online investment research site.

No positions in stocks mentioned.