The “Pain Trade”

Traders have a saying that the market “tends to create as much pain as possible”.  The context which provides meaning to the statement is that traders tend to have very short time horizons.  Thus, the daily (and intraday) fluctuations that tend to be “noise” to long term investors creates very real financial consequence (gain and loss) to short term traders. Watching the melt up of stock prices as we end the first quarter would seem to indicate that the “pain trade” is higher.  How else can you characterize the slow grind up for equities when valuations are full, growth expectations are being cut, yield curves are flashing yellow, and global fiscal policy looks hindered by politics (UK Parliament’s inability to take any direction in Brexit being case in point)?  It suggests that short-term traders (whose activity makes up the majority of US equity trading day to day) were caught “short” (either being underinvested or outright short) and are now chasing the ticker tape higher.

Time is the natural advantage of the investor whose eyes are focused on the long term horizon. Trying to “trade” a market requires impossible decisions back to back. “When do I get in? When do I get out? When do I get back in again?”  As humans, the biological response to the stress of those constant decisions leads to conservatism based upon the willingness to assume risk rather than the ability. Instead, the long term investor uses diversification and time as their hedge. Expected returns smooth over time and empowers opportunistic action when markets fall and valuations cheapen. To long term investors who are properly prepared, volatility becomes a friend which brings you gifts rather than an adversary that brings you pain.