What does a typical stock portfolio look like?
Well, it’s apparently not too flash.
According to Openfolio — a network of 70,000 members who share their portfolio data — the average US investor made less than half the S&P 500’s return in 2016.
And it’s not surprising…
Financial giant Credit Suisse says the average holding period for shares is around four months. That’s hardly enough time to make double digit returns, let alone get individual gains in excess of 100%.
What’s more, a 2004 study found that many people only owned a few stocks. The typical portfolio had four holdings, while one-quarter of accounts held just one company.
The average trader certainly has some challenges. They suffer from poor stock selection, quick turnover and a handful of big bets. It’s no wonder many portfolios underperform.
In a minute, I’m going to show you some data from my personal portfolio. You’ll see the individual profit and loss profile for all my open trades.
But first, let’s discuss what makes a winning portfolio.
I often talk about running winners and cutting losses. They’re the most important things I can tell you about trading. This is how strategies like Quant Trader make money.
Take Quant Trader’s uncapped portfolio (which include every ASX stock that meets the entry criteria) for instance…
There are currently 381 open trades. These range from a gain of 544% to a loss of 24%. The average annualised gain is currently 18%. (All figures are for COB 9 March 2018.)
Now think about these figures for a moment. The best result is more than 22-times the size of the worst performer.
What do you think causes this lopsided outcome?
Well, it’s quite simple: Quant Trader runs profits and cuts losses. The key is to keep your upside open, while minimising downside.
So how do the rest of the trades stack up?
Check this out:
This is the distribution of the uncapped portfolio’s open profits and losses. The bottom axis ranks the trades from best to worst, and the vertical axis shows the current results.
You may notice that the biggest winner on the graph is only 180% — not 544%. I’ve removed the top three trades (544%, 248% and 204%) to keep the graph’s scale easier to read.
Now have a look at the shaded area on the left of the chart. This contains the top 25% of all open trades. The average gain for these 94 stocks is 63%.
This sort of distribution is typical of trend-following strategies. They make money by letting winning trades run. And some of these run a very long way.
The concept of holding your best trades is easy to grasp. Yet relatively few traders manage to maximise the potential of big trends.
You see, many people are quick to lock in modest gains. They like the security of banking a profit. It also makes them feel like they’re winning.
But this comes at a cost: An early exit caps a stock’s potential — it can never become a big winner.
Imagine this graph without the top 25% of trades. The profits would largely be off-set by the losses. Like many everyday portfolios, it would be a lacklustre result.
Quant Trader also has a smaller capped portfolio with a 100-company limit. This is for people who prefer to choose from fewer stocks.
Do you think capping the portfolio will reduce its effectiveness?
Have a look at this:
The capped portfolio has the same distribution pattern. Despite its smaller size, the strategy of running winners and cutting losses leads to a similar outcome.
To optimise the scale, I’ve removed the top three trades of 434%, 350% and 274%. The graph includes every other open position and excludes short trades.
You’ll see a shaded area on the graph. As before, this shows the top 25% of trades. The average gain from these 53 stocks is 67% — not far off the uncapped portfolio’s 63%.
My own portfolio
Some people worry that they don’t have enough money for a big portfolio. Their main concern is they’ll miss the top quarter of trades and buy all the duds.
Sure, that could happen. But I believe it’s unlikely.
You see, Quant Trader’s performance isn’t due to one or two stocks. It’s the result of hundreds of individual trades. These combine to produce the previous charts.
Now here’s the thing: You don’t need a 100-stock portfolio to get similar results. Statistically, you could achieve the same sort of outcomes by following a sample of signals.
I generally believe that a portfolio of 20–30 stocks works well. This increases the odds of buying some of the best stocks — the ones that could give you above average performance.
Let me give you an example…
Just like you, I have capital limits to consider. I also don’t have the time to manage a 100-stock portfolio. This means I don’t follow every signal my system produces.
But that’s not a problem. I know it’s possible to outperform by following a sample of signals.
So is this approach working?
Take a look for yourself:
The graph shows the profit and loss for all my open trades.
And again, it’s the top quarter of trades that really matter. This group of stocks is ahead by an average of 96%. These are the trades that deliver the bulk of my performance.
The other thing to note is the distribution of results. You’ll see that it’s like the much larger Quant Trader portfolios. A sample of trades is all I need.
My aim is to help you achieve a similar outcome. I see no reason why your portfolio should resemble those at the beginning of this article.
The key is to maximise profits from your best trades. These are the ones that can really boost returns. It may only take one big trend to make all the difference.
Until next week,
Editor, Quant Trader
Editor’s Note: Are you maximising profits from your best trades?
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All graphics produced by Quant Trader unless otherwise noted.