My brilliant sell-everything trade

(MONEY Magazine) -- Some people are born to be traders. Others have to be taught how do it. And then some of us wake up one day and find we are too white-knuckles, sweaty-palms scared to resist screaming, "Sell!"

On July 26, I took every nickel of stocks in my 401(k) and switched to the safest, most cash-like account on the plan's menu. At 40, this was the first time in my life I had ever made a real trade -- that is, a short-term move designed to put myself one step ahead of the market.

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Setting aside occasional rebalancing and streamlining, I've been a steady buy-and-hold investor. I even held fast during the worst of 2008.

Not only have I doubted my own ability to pick the right times to buy and sell, but I haven't seen much point paying a professional to try either: In my 17 years covering mutual funds as an analyst and journalist, I've interviewed way too many hot managers who were later proven to have glass jaws.

My investments were in cheap index funds that mirror the entire market. Until I chucked them all.

I'm not using a figure of speech when I talk about white knuckles. When I put my mind back to this summer, I can feel the bolts of anxiety that ran through my body as I thought about the crash I feared would come if Congress didn't raise the nation's debt ceiling. And the tightness in my shoulders I felt when I actually made the trade.

To click a button and instantly move most of my family's savings -- at once more money than a guy like me could possibly command and so plainly not nearly enough -- was almost more than I could take.

Investing in 2012: Resolve to keep it simple

And then -- go figure -- my bet on disaster paid off. The very next week, the stock market had the biggest one-day loss since the 2008 financial crisis.

The numbers have bounced around wildly since, but as I type this, I've still managed to sidestep an 8% loss on stocks. And in a market where 3% and 4% daily swings have become common, I haven't had to worry whether an uptick in Italian bond yields or the failure of some French bank will cost me $20,000 before breakfast. I felt like a genius for a bit.

"Sleeping any better now?" asks Zvi Bodie after I explain to him over the phone what I did. Bodie, an economist at Boston University, is well-known for his warnings that stocks are even riskier than most people think; his arguments were on my mind when I made my decision. (More about those in a bit.)

I told Bodie I was getting an easier night's sleep. That's not quite the whole story, though: I'm a lot less fretful about the market, but I now find myself up at midnight running financial calculators and scribbling on the backs of envelopes to figure out what hope I have of getting a decent retirement if I don't get back into the market.

Like many spooked by stocks -- 23% of fund investors are unwilling to take even average risk, up from 14% in 2008, according to the Investment Company Institute -- I'm not sure what I'm supposed to do now. Thanks to my job, I got to pose that question to people who would never take me, with my tiny nest egg, on as a client.

Warning: Decisions in rearview mirror are less clever than they appear

Acting on a forecast and seeing it quickly proved true is, well, exhilarating. Maybe I should keep this up. I could watch the latest emanations from European Central Bank headquarters to decide when it's safe to put a toe back in the market. But I'd be ignoring an awful lot of evidence that the world isn't that predictable.

In a 20-year-long experiment, Philip Tetlock, a psychologist now at the University of Pennsylvania, asked 284 recognized experts to make predictions about world events, ranging from the fate of the Soviet Union to the level of the Nasdaq.

The experts barely beat a simple formula that assigned equal probabilities to each possible outcome. That's one reason to be humble about my ability to pull this off again.

It's not even clear that I was as good a forecaster as I thought. "Most people think they're pretty smart," says Tetlock, and behavioral research has found that they'll cherry-pick the evidence to prove it.

I can remember vividly that I saw a crash coming. When I more carefully reconstruct my trade (and ask my wife, Kathy, what I said at the time), I see that what actually happened was this: I was driven to distraction by the debt-ceiling news and wanted to take our money off the table until this one-time event was settled.

Of course, the debt ceiling was raised. A related event, the Standard & Poor's downgrade of U.S. Treasuries, did hit the market hard a few days later; then stocks rallied. What's actually kept the market on pins and needles since July has been the unfolding crisis in Europe, which Kathy reminds me had nothing to do with my decision. And because I was scared about what the failure to raise the debt ceiling would do to Treasuries, I dumped all my bonds too.

Maybe not so smart: The bond funds I sold have gained almost 4% since then. And our money is still off the table.

Nice work, but you can't do it

It's easy to be overconfident in your investing abilities, but the odds are stacked against you. The market doesn't move because the economy has been bad, or because the political mood has been sour -- whatever is in yesterday's headlines is likely reflected in prices.

"The market moves because something surprising happens," says William Bernstein, a Portland, Ore., adviser who has written three very level-headed guides to the art of investing. "In order to be a successful trader, you have to be able to predict surprises."

What's wrong with a stock-heavy mix?

For most people, trading turns out to be just a reliable way to erode returns over time. From 2000 to 2010, equity funds earned an annualized 1.6%, but after accounting for asset flows in and out of those funds, the researchers at Morningstar found that the typical investor captured a 0.2% return.

And even if trading might work out better for some, I'm clearly doing it wrong. I know because I asked a real trader.

"To succeed in trading, you have to be the person who can buy when people are terrified and sell when people are complacent," says Robert Arnott, paraphrasing Warren Buffett. Arnott is chairman of Research Affiliates, a money-management firm that uses number-crunching strategies to shift funds among asset classes. He adds, "The mistake you made was selling without posing to yourself the question, Under what circumstances would you buy back in?"

I clearly had no real plan.

"[Since] you sold in July, you can now buy back in at a lower price," writes Bernstein in a follow-up e-mail. "Consider it found money and promise yourself you'll never do it again."