Tuesday, December 04, 2007

It's Not Enough to Beat the Indexes

This past weekend I got together with a trading buddy and we were talking performance. Like many are apt to do, he excused average performance with the "but I beat the indexes" cliche.

That is one of my biggest pet peeves. The idea that I could be down three percent but feel good about it because the indexes had done worse is foreign to me. If that is your thought process, I doubt you will ever become an exceptional trader. Sure, you may become a consistently average trader, but is that really why you put in all the time and effort, to be average?

I'm in it to make monster profits. I know the fact that I am an individual investor, who can move in and out of positions with ease, both to the long and short side, gives me a huge advantage. I am not satisfied with average performance, and neither should you.

5 comments:

nodoodahs said...

Um, what's ... "average?"

Got an annual percentage gain in mind?

The Market Speculator said...

Hi Bill,
I don't have a hard and fast percentage that I use as a benchmark. However, anything less than 50 percent is not acceptable.

nodoodahs said...

With 50% annually, I expect that after 3 or 4 years of barely acceptable gains I'll be reading about you in the next "Market Wizards" book? Turn a $100,000 second mortgage into $5.8 million in a decade? In twenty years, be trading a stake of $333 million?

What kind of drawdown is acceptable?

What do you think is an acceptable gain for someone who isn't a full-time, highly active trader, without using leverage of more than, say, 1.5 to 1?

The Market Speculator said...

Bill,
Since 2006, I've turned $25,000 into over $100,000.

I do trade aggressively. There are many instances that I am 2x margin and risking over 5 percent(based on where I place my stop loss).

I don't buy into alot of the conventional market wisdom, such as diversification or risking only 1 percent on a trade. For example, my FSLR trade this morning. That one position is taking up around 40 percent of my account and 20 percent margin availability. My stop is set at a point that would give me a 4 percent loss (the target would give me an 8-10 percent gain). I expect that I will win more than I lose.

Note that I am not saying I will continue to make 50+ percent gains. My post was about the *mentality* one should have. Don't use the indexes as an excuse. If I lose 3 percent while the market is down 10, that should not make me excited. I should be questioning why I did not make more money off shorts.

I also feel using the indexes as a benchmark limits momentum traders. I trade momentum stocks that are making big gains. Most of the stocks on my watchlist whallop the indexes. Not keeping up with these stocks means I am doing something wrong.

If I was trading an account as big as you mention, I wouldn't expect the same type of gain. As noted in the post, that's the advantage of being a small, individual investor like myself.

nodoodahs said...

I (*almost*) totally agree about using the indices as a benchmark. Two exceptions, one is when trading the index in a market-timing method. The other ... would you be happy with a 50% year if the S&P 500 made 55% that year?

I've been thinking about benchmarking myself, and it occurred to me that the proper benchmark has to take into account trading size, average leverage, activity level aka account turnover, and acceptable variability of returns.

As an example of "glass half full," I'm biased towards strategies that are lazy, close-of-day data, inventory turnover of maybe 100% in three months, rarely using margin. In that context, I'm aggressive and looking to maximize returns. An extreme is the pattern day trader whose turnover may be 600% per trading day and who uses 4:1 margin on a regular basis.

What's fascinating to think about is that both plans might have the same expectancy, but the day trader will have a far better CAGR, based solely on inventory turnover. Activity level counts.

Risk is another thing entirely.

Your buddy that you were talking to: same style as you (activity, leverage, size, risk tolerance)?

How much drawdown are you willing to handle? Lose half of it and keep going?