Schwab and baseball.

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Insights

Read how baseball relates to investing.

Patience at the plate: how investing is like baseball

By Anthony Davidow | April 13, 2016

Even the best hitters strike out more often than they hit home runs. Consider the career of Ken Griffey Jr., a former outfielder who played 22 years in the majors.

Griffey, who is due to be inducted into the Baseball Hall of Fame this summer, hit 630 homers during his career, earning him a sixth-place spot on the all-time list. But the headline number doesn’t tell the whole story. His best homer-hitting years—which peaked with two straight seasons of 56 home runs—came during a five-year streak in which he also struck out more than 100 times per season. In other words, Griffey struck out nearly twice as often as he hit home runs.

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Seeing Griffey step up to the plate during that run must have been exciting. Would he add another homer to his growing tally? Or would he fall to another increasingly common strikeout? One could just as easily have followed the other.

This kind of unpredictability can make for a dramatic day at the ballpark. It’s generally not as fun when it comes to investing.

But thinking about how a talented ballplayer could deliver both more homers and more strikeouts during a set period can help clarify the value of sticking with a diversified investing plan. It would be nice if every investment were a home run, but that’s unlikely. And strikeouts hurt. So instead of always swinging for the fences, it might make more sense to focus on trying to consistently hit singles and doubles.

Here’s why.

Thinking about the previous inning

Investors are often tempted to invest in the “hot” fund or asset class, chasing where the returns were—and achieving unspectacular results. The problem is that no investment remains at the top forever.

To continue with the baseball analogy, investing in last year’s best-performing fund or asset class is a bit like expecting a batter to hit a home run just because he hit one in the previous inning. That’s generally not how it works. As the saying goes, past performance is no guarantee of future results.

For example, the chart below shows that emerging market stocks were the best-performing asset class in 2003, 2005, 2007, 2009, and 2012. Investors who decided at the end of 2012 to overweight emerging market stocks would have been in for a disappointment: They were among the worst performers over the next three years. The emerging markets are prone to delivering both home runs (leading the pack) and strikeouts (placing at the bottom).

Help Avoid the Past-Performance Trap With a Diversified Portfolio

Help Avoid the Past-Performance Trap With a Diversified Portfolio

Striking out

Investors who pile into asset classes after they have risen, or who sell after they’ve fallen, are at risk of buying high and selling low. And that can hurt returns over time.

For example, the Schwab Center for Financial Research looked at the difference in the returns of mutual funds and investors in those funds over a 10-year period ending December 2015. It found that the funds’ annual returns were actually 1% higher than what investors in those funds earned, on average.¹ How could that be? It has a lot to do with how investors timed their investments.

If investors waited to buy in until after markets had already started rising and avoided investing when markets were down, they ended up missing out on gains. So their personal performance lagged behind the performance of the funds—that is, the results they would have achieved by staying consistently invested through ups and downs.

Singles and doubles

So what’s the alternative if chasing home runs isn’t a sound investment strategy? If you look at the chart above, you’ll notice a series of yellow boxes snaking through the middle. Those boxes represent the performance of a portfolio diversified across all the other asset classes in the chart.

If the asset classes in the top row represent the home-run investments of each year, and those in the bottom row are the strikeouts, then the diversified portfolio in yellow could be considered the product of a more balanced strategy focused on steadily knocking out singles and doubles.

That kind of performance may not be as exciting as risking everything on a never-ending—and highly unlikely—series of home runs, but over time it can allow you to steadily load the bases and drive runs in.

Or, if we reframe the baseball analogy slightly, having a diversified portfolio is like assembling a roster of different players with different strengths and weaknesses. You wouldn’t expect every one of them to hit a home run every time. Some will hit home runs, some will get base hits, and others will strike out. And some play excellent defense.

You may not know what will change with each inning—and each season—but the fate of your well-rounded team won’t hang on whoever made the last big play.

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Full count: how pitchers & traders are alike

Baseball season is here. So what does the guy on the mound have in common with the person in front of the trading screen? A lot, actually.

By Schwab Trading Services Learning Center

Baseball season is in full swing, and with it continues the ever-changing debate of dominance. Which team is best? And what is it that makes a team so great—an amazing slugger lineup, or a bullpen filled with pitchers who throw serious heat? The slugger rounds out the offense, bringing in runs and driving up the scoreboard. But it’s the pitcher who keeps the defensive game in control, handling just how easy it is for the opposing team to attempt getting on base. We’ll leave the particulars of this debate to the sports scribes, but at the very least, everyone can agree a good pitcher is invaluable to a good baseball team.

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The concept of pitching and its various terms holds closely to trading. Often, in fact, sports in general relate strongly to the stock market and the more chance-based concepts in the business world. To further explore that, we wanted to take a look at trading and see what parallels and lessons we can find when we compare it to pitching. Turns out, there’s quite a few.

Fastballs and Going Long

In baseball “going long” means “hitting a home run.” It’s not something any pitcher likes to see when he or she is on the mound. But in trading, “going long” is a pretty close equivalent to a pitcher’s fastball. Fundamentally, it’s the simplest and most common trade, just as it is the simplest and most common pitch.

The main point of the fastball, of course, is to be fast. And in being fast, the hope is that the pitch will be too quick to hit, earning the pitcher a strike. Going long has an equally simple premise: buy a security at one price, and try to sell it at a higher price in hopes of executing a profitable trade.

Fastballs and going long are actually so fundamental, that even when they’re not used, the trade or pitch actually still operates in contrast to it.

Changeups and Short Sales

A fastball is not only effective in that it can blow right past a batter, but it sets the batter’s expectation. In other words, batters can adjust their timing and swing earlier to more effectively hit fastballs. That’s when the “changeup” comes in. Pitchers who throw in the high 90s or low 100s of miles per hour are considered fast. So it would seem counterintuitive that a 75 MPH pitch could be effective. But it can be. Very much so.

Going long is a focus of many traders and their many trades. Again, the idea is to buy low and sell high. So, like the changeup, it seems counterintuitive that a trade can actually make money off a stock that plummets. But like the changeup, it’s possible.

A well-timed changeup fools the batter who’s ready for a blazing fastball—by the time they swing, the ball hasn’t even reached them yet.

Now imagine the trader is the pitcher. They’re going for a changeup of their own. In this case, it’s called a short sale. Rather than looking for a stock with growth potential, they look for a stock that they believe is going to fall. Their broker allows them to borrow shares of that security and sell them. Ideally, they’re selling high. Then, if the trader is right, the stock will fall, and the trader buys those shares back at a lower price, and those shares are returned to the broker. But since the trader sold the shares for more money than they bought them for, they’ve actually made money on a stock that’s decreased in value. Talk about a changeup.

Of course, sometimes a pitcher throws a changeup, and it’s like batting practice for the batter who promptly “goes yard.” Similarly, a short sale is not a guaranteed profit (nor are all stocks available to sell short). A trader who is wrong about a stock may find himself selling a stock at one price, and then having it to buy it back at a higher price. In that case, they don’t even get to keep the shares. It’s safe to say the market’s “gone yard” on them. (It should also be noted that 1) not all stocks are available to sell short, 2) that short positions subject traders to risk of capital in excess of investment, and 3) the trader may be subject to a buy-in and forced to close his/her position at any time or price.)

Of course, sometimes that’s how “the game” goes. Not every pitcher can throw a no-hitter every time they hit the mound. And not every trader can expect to make a profit on every single trade. Which brings us to…

Calling for Relief

It happens to the best pitcher. They get on the mound, and they get hammered. But the good news is that, in baseball, there’s no rule stating the pitcher must continue pitching. A few bad innings does not mean a bad season, or even a losing game. Instead, the coach calls for relief, and the pitcher heads to the dugout to sit the rest of the game out.

Likewise, traders may find themselves in a trade that goes against them. It happens. Sometimes it’s best to minimize your losses and get out of the trade before the losses get even worse. Your “season” as a trader is not defined by a single trade. So don’t be afraid of closing out your position and taking a cool down. Like pitchers and their game, being frustrated isn’t going to help an already bad trade.

But getting relieved doesn’t mean you take your head out of the game. Pitchers and traders use their downtime to evaluate their performances.

Mechanics, Mechanics…

Unlike the apparent chaos of (American) football, many would argue that baseball is a game of precision. Pitchers, like traders, may have different styles (sidearm versus overhand, for instance), but quality pitching comes from strong mechanics. And even the highest paid professionals in the sport have dedicated coaches helping them to perfect their mechanics. A pitcher may be able to throw a ball faster than you’ve ever driven your car, but if he moves his body a particular direction just slightly before the release, the pitch will end up going the speed limit, not to mention way inside on a righty. Accordingly, a pitcher’s bad game is seldom due to them facing superior batter after superior batter. Rather, it’s because their mechanics need adjusting.

Traders can be strikingly similar. A trader who’s executed a string of successful trades may find himself or herself operating more on “feel.” But without fundamentals or technicals (the equivalent of mechanics), traders may find themselves getting into positions that move against them.

This is why getting yourself out of your losing trade and taking a break can be so valuable. They offer an opportunity to go back and research. Why did your trade move against you? How did it defy your expectations? Looking back at it (and the news, and/or the technical data), does it still seem surprising that the stock did not move in your favor? And how might you apply this knowledge to the next trade?

When professional athletes perform poorly, they often talk about “going back to the tape” to review the game. It can be difficult to relive your worst performances. But it can also be highly instructive. So don’t be afraid to go back to the tape, or to the trade. You might just learn from what you see.

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