Wednesday, June 21, 2006

Playing It Safe is the Riskiest Strategy

In my post on "what you know can hurt you", I made the point that markets reward the assumption of risk, not the pursuit of the familiar.

Here's another case in point.

Since January, 1997, we've gained 50+ points in SPY, or the equivalent of over 500 S&P points.

So you'd think it was a reasonably good market for daytraders over that time.


Daytraders like to close positions out by the end of the day to avoid overnight risk. But markets don't reward the avoidance of risk.

From the close to the next day's open, from January, 1997 to the present (N = 2402 trading days), SPY gained a total of over 139 points. During that same period, from the day's open to the day's close (the daytrading market), SPY *lost* a total of 88 points.

So, in other words, daytraders who bought the open and sold the close every day during a period of rising market prices lost about 880 S&P points.

But maybe you're thinking this underperformance was just a function of the 2000-2003 bear market.

From 2003 to the present (the most recent bull market), SPY from the close to the next day's open gained a total of almost 36 points. And the daytrading market (open to close)? During the entire recent bull market SPY gained a total of four points. In 2006 thus far, SPY has gained about 6.6 points from the close to the next day's open. During the daytrading market, we've lost about 6.1 points.

It's awfully hard to find *any* recent time period in which the "safe" strategy of closing positions at the end of the day provided traders with opportunity.

Markets are a lot like relationships: Playing it really safe is often the riskiest strategy.