Your Greatest Risk is Misconceiving This

What’s the fastest thing you can think of?

Perhaps it’s a living creature — like a cheetah or an Olympic sprinter. Or maybe you’ve gone for something with jet propulsion. You might even be thinking of a flash of light.

But I know something that can go even quicker.

Do you know what it is?

I’ll tell you: time.

This week I’m going to talk about the perception of time in the markets. You’ll see how two decades can pass in a blink. I’ll also explain the danger of misconceiving time.

But first, I want to briefly tell you what got me thinking about this topic. This is something you may be able to relate to yourself. It’s a case of time moving quicker than light.

Selective focus

Friday, 16 December, was a big day in my house. It was the end of a chapter — one that I didn’t think would end so soon. You see, my eldest child had his last day at primary school.

I remember his first day. We took a photo of him at the school gate. He was holding a sign that said ‘First day of school! 29 Jan 2010’. That was seven years ago — but it could have been last week.

The final assembly was an emotional experience. My wife and I got to watch our son give the closing address to students, teachers, and parents. We couldn’t have been prouder.

Our son will remember his speech as a high point. It will be a core memory of his primary school years — the centrepiece of an overall positive experience.

But it wasn’t seven years of highs.

School can be tough for a youngster. His friendship groups were often shifting. Failure and frustration also had a place. Then there was a broken arm on the last day of year five.

But do you know what? All the struggles are a distant memory. While they were a big deal at the time, they’re now just a footnote to a wonderful seven years.

And that’s how it is with many people — we tend to focus on the good bits. Our triumphs stay with us, while the intensity and duration of setbacks fade with time.

So, should you approach the market in the same way? Is it best to mentally filter the losing years and just focus on the successes? That’s the question I’m going to answer now.

Dwelling on setbacks

OK. Let’s start with a performance chart.

Check this out…

Click to enlarge

This shows the hypothetical result of following a strategy for 23 years. The simulation starts with $50,000 of capital and ends with $1,098,392. I’ll give you a few more details in a moment.

Now, suppose you could go back in time. Would you put $50,000 into this system?

I’m sure you don’t need to think too long. The prospect of a 2,097% return is hard to resist. I know I’d want to be a part of the action.

The strategy you’re looking at is a variation of my algorithmic trading system, Quant Trader. I’ve made a few minor changes to simulate an everyday portfolio. I want you to picture this as your own account.

Let me tell you how it works. The system invests 4% of capital in each trade (this allows for a portfolio of up to 25 stocks), and it only acts on signal 1s, the first round signals in the full system. All the other variables are the same as in Quant Trader.

Another point to note is that there’s no allowance for costs. This is because brokerage can vary greatly depending on your trade size. The simulation also excludes dividends.

Now, without looking back at the chart, what do you recall?

I’m betting you remember something like this: A relatively smooth rise from $50,000 to over $1 million. It may also seem that 23 years fly by in a second.

The reality is a bit different. It wasn’t all plain sailing — there were tough times as well.

Have a look at this chart…

Click to enlarge

This is an excerpt from the previous chart. It shows a period when the markets didn’t suit the strategy. The account drops from $132,354 to $108,048. A fall of 18.3% in 11 months.

Chances are you didn’t pay this much attention on the earlier chart. It barely rates as a blip in the bigger trend. This is a reality of trading which many people overlook.

Imagine this was your account. Could you handle such a setback? I’m sure many people would be quick to say the strategy was no longer working.

People tend to approach the markets as they do life in general. They’ll focus on an overall positive outcome, and gloss over many of the setbacks along the way.

But this can lead to trouble.

You see, traders often underestimate the tough times. They look at a performance graph (or a stock chart) and only see the big sweeping upward trend. This can hide a multitude of corrections.

Another issue is time compression. This happens when you look at a long-term chart. It’s easy to think the setbacks pass quickly. But an 11-month correction moves much slower in real-time.

The example above is not unique. There are several challenging periods in the opening chart. Each of these test a trader’s discipline and resolve. This is when many abandon their strategies.

I have one more graph for you…

Click to enlarge

This is the same chart you saw earlier. The only difference is a series of red circles — these mark the toughest times. Each period lasts around 12 months (the second circle is the above example).

Now, think about this: During a highly profitable 23-year period, roughly nine years (or 40%) were what I’d describe as ‘tough’. And this doesn’t include the many shorter setbacks only lasting a few months.

Trading can seem easy in theory. But it’s much harder in real life. One of the biggest challenges is dealing with the inevitable lean times. These periods never pass as quickly as they do on a chart.

Study the graphs closely. Pay close attention to the corrections. You’ll see they come and go, but they take time. Understanding this reality puts you a step ahead of many.

Until next week,

Editor’s note: Are you falling short of your goals? Do you find it a struggle to consistently make good profits? Don’t worry, you’re not alone. The stock market can be a tough place to navigate on your own.

Here’s something you should do — check out Jason McIntosh’s Quant Trader advisory service. It’s a fully algorithmic trading system for ASX stocks. Quant Trader scans practically every company. It then tells you when to buy and sell. I can just about guarantee you’ve never heard of some of the stocks it identifies.

Try it. See if it makes sense to you. It could change the way you trade forever.

Quant Trader sources all graphs and images above.


Two Other Stories in Money Morning This Week

On Monday Jason Stevenson let readers know that from 3 January he’ll be writing for Markets and Moneyalongside Vern Gowdie. But the focus of Monday’s piece was that gold has been struggling since Trump won the US election. It’s down 11%. It could nosedive even lower. And if it does, Jason thinks he’s got the perfect play for it, by shorting gold and buying a particular kind of gold stock.

On Wednesday Jason followed things up with a simple question. Should you buy or sell stocks? As Jason says, the US is on a seven year bull run. The ASX is up (albeit not much). Yet there’s still plenty of money on the sidelines. Jason thinks a correction is on the cards. Vern Gowdie is calling a crash. Phil Anderson and I both think you’re crazy if you don’t own stocks. Who’s right? I guess we’ll find out next year.

Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read.

Money Morning Australia is published by Fat Tail Investment Research, an independent financial publisher based in Melbourne, Australia. As an Australian financial services license holder we are subject to the regulations and laws of Corporations Act and Financial Services Act.

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