Investing 101: Stock Picking and Active Trading Don't Work

NEW YORK (TheStreet) – If you're, like me, a number cruncher, analyzing the six-month performance of some of the most closely followed equities and industries in the stock market can be a fun exercise.

Breaking down company report cards of names that were overhyped or unloved at the beginning of 2014 has yielded some interesting results. BlackBerry  (BBRY) year-to-date gains of 53% certainly stands out. On the overhyped side, Twitter's  (TWTR) 40% year-to-date decline qualifies.

Both of these names were consensus picks for a dog or a winner when the year started. But they've gone in opposite directions. Don't discount for a second that the second half of 2014 will be any different. There will be plenty of loved/hated names that will emerge as strong surprises while some will wallow in disappointment.

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In this article, we're going to look at the often fruitless exercise called stock picking, which often fails because investors forget that the market is inefficient. Not everyone thinks the same. Nor do they share the same values principles.

In fact, for the same reason that some predicted BlackBerry stock would tank based on fundamental analysis, there were others using technical data to argue against it. Same goes for Twitter.

Human factors such as fear, greed, emotional attachments and rumor mills can drive stock prices in either direction. And we haven't even mentioned the law of supply and demand. Still, over the past decade, so-called “genius stock pickers” believe they have a fail-proof system. Yet, their results have not fared any better than the broader market.

Stock picking brings to light another strongly debated topic between “active vs. passive” investing.

Some investors believe that unless they are churning their own portfolios they're missing out on all of the excitement. But this only matters if an investor believes she/he has exploitable information that may not be yet priced into a stock. Even then it would require the perfect timing and the right reaction to profit when that information is made known to the market.

It's also important for investors to understand the differences between growth and value investing. The investor should incorporate the qualities that she/he likes into her/his own investment strategies.

Along these lines, I will concede that growth stocks like Salesforce.com (CRM) and Google (GOOGL) have become the trendy picks. But in my opinion, constructing a winning portfolio requires a blended approach between value and growth.

With 2014 already halfway gone, many investors will still insist they can beat the market by successfully picking and selling the right stocks -- at the most opportune time. But time and time again, regardless of what period/decade you research, there is plenty of evidence showing the active pickers consistently underperform, say, the S&P 500.

When factoring things like commission fees, cash/equity requirements for servicing the account, stock picking is not a worthwhile endeavor. Not to mention all of the time spent to only produce (at best) average results.

And we've only discussed the stocks that have been selected. We haven't even touched on criteria that forbid picking certain stocks, some of which were said to be "untouchable" due to (among other things) concerns about valuation and poor profitability.

Today, we've come to know some of these companies as Amazon  (AMZN), Netflix  (NFLX) and Chipotle Mexican Grill  (CMG) -- some of the best performers over the past five years. They were at one point considered "too expensive." But their dominant performance served as an expensive lesson to those who didn't buy.

I'm not yet ready to make any predictions about the winners and losers for the second half of the year. But there's plenty of empirical evidence that shows that if I were to just hold on to, say, three to five value stocks and do nothing else, my chances of beating the market will fare much better than if I were to actively trade in and out of them.

At the time of publication, the author held no position in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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