Investment management is not about gambling but about quality of life!
For someone who’s spent the past 26 years as a market analyst, researcher, trader and hedge fund manager, it might come as a surprise that I actually mean it when I say that I hate trading. I explained why I fell out of love with trading in “Mastering Uncertainty in Commodities Trading.” These experiences led me to entirely quit discretionary trading some 20 years ago and switch 100% to systematic trading.
I started trading actively in 1997, and it soon became clear to me that I had a significant tendency to lose money. For an aspiring hedgie, this was very disturbing and I tried to uncover the errors of my ways by keeping a trading journal.
Easy in, messy out
One of the insights I gained was that each trade actually consisted of two separate decisions: the decision to commit to a trading position and the decision to uncommit. Generally, getting into a trade was easy. It was the getting out that tended to get messy; regardless of how clear-headed I wanted to be about formulating trade ideas and executing them, once there were profits or losses involved, I ended up veering off plan and pulling the trigger for reasons I couldn’t easily explain to myself.
Closing a trade with a profit was satisfying, but this satisfaction would quickly fade if it turned out that I would have made more money had I stayed in the trade. Next, I’d find myself scrambling to reopen the position, but doing so at a price less favorable than the price at which I closed the last trade seemed unbearable. Closing a position at a loss was even more unbearable, and I realized that this activity came with a disconcerting dose of stress.
It was mostly stress…
Over time I found that satisfaction in trading was relatively rare and usually short lived while stress fouled up most of the time I spent trading. There were days when I spent most of my time glued to the screens, watching numbers and charts blinking in front of me, setting up trade orders and price alarms, revisiting my analyses, second and third-guessing them, cancelling my trades then putting them on again.
At times I was turning down lunch invitations and drinks with friends because I didn’t want to be away from the screens. I had to ask myself if I really wanted to spend my life in this way, obsessing over something that had a tendency to make me miserable most of the time. The answer was clearly, no. That in itself was one of the most useful lessons I gained from trading.
It’s about mastering yourself, not the markets
Another lesson was the realization that this game was not so much about mastering the markets or statistics or even the charts as much as it was about mastering oneself. In speculation, markets are the external reality, but what decides the game’s outcome is the inner process that determines one’s actions.
It wasn’t that the challenge of investment management was trivial or unimportant. Managing our wealth is very important and it should be high on the list of priorities – right up there along with maintaining our health. Because inflation predictably eats away at our savings (even during the best of times), we’ve no choice but to seek investments that can generate positive returns. In that sense we have to speculate, face uncertainty and take risks.
Investing should be about the quality of life
When I launched my “Markets Trends and Profits” channel on YouTube, its stated purpose was to help investors bring strategy and discipline to their portfolio management and turn it into a life-long pursuit that should improve their investment performance with less stress, while helping them enhance their quality of life and their liberty. That may sound lofty, but I strongly believe that investment management should serve precisely those objectives.
Your wealth, however large or small, should serve to improve your quality of life, enhance your options and give you greater choices and freedom of movement. But the pursuit of wealth can also become its own end, and we must recognize that something about our nature makes us susceptible to allowing that pursuit to become an obsession. Trading, like video-games and gambling, can become a destructive addiction.
Hernando de Soto’s pursuit of wealth
Back in the days when the plunder of silver and gold from South America’s native civilizations was Spain’s biggest industry, one Hernando de Soto returned from Francisco Pizarro‘s 1532 expedition to the Inca Empire (present day Peru) with a large share of the loot. In addition, he and the five Pizarro brothers were rewarded by the king of Spain with lands and titles. De Soto became one of the wealthiest men in Spain.
But rather than settling down to enjoy a good life, de Soto used all of his wealth to finance another expedition. He mobilized a private army with 700 men and 240 horses and sailed back to the new world. However, after five years’ expedition through the present day Florida, Georgia, Alabama and Mississippi de Soto and his men found no gold, not even an ounce. The quest ended with De Soto’s bankruptcy and death. Of his 700 men only 311 survived and in the process, they utterly destroyed the native societies wherever they passed, killing thousands.
Like smoking crack cocaine?
The story of Hernando de Soto should be a stark reminder that the quest for wealth – particularly when it’s had some success – can become an obsession. As the former hedge fund manager Bill Browder wrote, “For those who don’t know, the sensation of finding a ‘ten bagger’ must be the financial equivalent of smoking crack cocaine. Once you’ve done it, you want to repeat it over and over and over as many times as you can.“
Indeed, such passions easily draw us into risk-taking that can have unforeseen consequences and lead us astray. They may affect our outlook and even our personality in ways that defy the very reasons we desired wealth in the first place. I believe that most people’s core motivation is to attain security, a more comfortable life and the options that wealth can afford, but somewhere along the way, the quest for wealth can displace those ends and become an all-consuming addiction.
The odds are against you
If you manage your own portfolio, know that you have the odds stacked against you. A large-scale, 11-year study conducted by the British market regulator, the FSA (now renamed FCA), published in 2016 found that about 82% of all retail investors tend to lose money. This is consistent with the disclosures by retail brokers in jurisdiction where they are obliged to disclose the percentage of their clients who lose money: these figures range from mid-70s to more than 87%!
Note the caption: 87.41% lose! The reason most traders lose is that they either use a flawed strategy or more likely no strategy at all. So make sure you do have one.
The sanity framework
I am strongly in favor of systematic trend following, and here’s why:
- Trend following is the most effective way to navigate the unpredictable market fluctuations over the long term, and
- Trends are far and away the most powerful drivers of investment performance.
I have elaborated both hypotheses in linked articles. But even if you subscribe to other kinds of strategies like arbitrage or value investing, it is best to formulate such strategy explicitly and as specifically as possible. That should be your sanity framework. Also…
The 20% speed limit
As I suggested in various articles and videos, you should regard 20% as your performance speed limit. Given the volatility in today’s markets, 20% may seem low, but keep in mind that very few among the professional investment managers can achieve this return with any consistency. Over the long term, top hedge fun managers tend to deliver about 16%-17% returns after fees, which implies gross returns in the neighbourhood of 20%.
Now, all these professionals are incentivized to deliver the highest rate of returns possible, and they all like ten-baggers just as much as Bill Browder does. Of course, at times they do find them – they really have been everywhere in the recent years. But for every ten-bagger, many investments will flop and in the end, few investors exceed that 20% gross return over the long term.
It should be a lifelong pursuit
My strong suggestion would be to have a strategy, grow your wealth slowly but steadily and treat it as a lifelong pursuit – almost like growing an orchard. If you start with a small seedling, it may take a while, but with discipline and patience it will grow and compound…
You might also want to check my seven simple do’s and don’ts of trading.
Meanwhile, rather than wasting time in front of computer screens, it would be better to focus on finer arts of living. As W. B Yeats said, “Life is full of magic things, patiently waiting for our senses to grow sharper.” Obsessing over trades may not be the best way to sharpen our senses. As far as I know, we only get one ride here – it would be a shame not to enjoy it for all that it can offer.
Alex Krainer – @NakedHedgie is the creator of I-System Trend Following and publisher of daily TrendCompass reports, covering over 200 key financial and commodity markets – probably the best trend following daily newsletter on the market today. One month’s test drive is always free of charge – no strings attached!
For US investors, we propose a managed inflation/recession resilient portfolio covering a basket of 30+ financial and commodities markets (more information at link).