You May Be Overlooking This Key Factor When Investing
Can you name the fastest thing on Earth?
Maybe your thoughts turn to the natural world — something like a cheetah or a flash of light. Or perhaps you’ve gone for a fighter jet, or even a rocket ship.
But I know something quicker.
Any guesses what it is?
Well, let me tell you. It’s 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.
Our triumphs stay with us, while our setbacks fade
Wednesday, 19 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, our second child had his last day at primary school.
I remember his first day so clearly. We took a photo of him at the school gate. He was holding up a piece of paper with the words: ‘First day of school! 31 January 2012’.
That was seven years ago, but it could have been last week.
The final bell was an emotional experience. With music playing, and the whole school lining the main pathway, the year six kids left the playground for the last time.
Our son will always remember this week’s celebrations. They 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 their place. Finding his way wasn’t always easy.
But do you know what?
All the struggles are a distant memory. While they felt like a big deal at the time, they’re now just a footnote to a wonderful seven years. Most of the troubles barely rate a mention.
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.
How you should approach the market
Ok. Let’s start with a performance chart.
Check this out:
This shows the hypothetical result of following a strategy for 25 years. The simulation starts with $50,000 of capital and ends with $1,311,863.69. 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 strategy?
I’m sure you don’t need to think too long. The prospect of a compound annual growth rate of 13.4% (or 2,523% in total) 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 Quant Trader. I’ve made a few minor tweaks 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 20 stocks), and it only acts on signal 1s. All the other variables are the same as 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 a quarter of a century passes in a blink.
The reality is a bit different. It wasn’t all plain sailing — there were tough times as well.
Have a look at this chart:
This is a snapshot from the previous chart. It shows a period when the market 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’s barely a blip in the larger trend. Many people only recall the big upward advance.
But here’s the thing. Periods like this are a reality of trading. If you’re going to own a portfolio of stocks, then you should expect your account’s value to fall at times.
Now, imagine for a minute this was your account. Could you handle such a setback?
The fact is that many people can’t. They’ll happily play along when their portfolio is rising. But they’ll quickly say a strategy no longer works during the downturns.
People tend to approach the markets as they do life in general. They’ll focus on an overall positive outcome, and gloss over the many setbacks along the way.
But this can lead to trouble.
You see, people often underestimate the tough times. They look at a performance graph (or a stock chart) and only see the big sweeping upward trend — not the 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 isn’t unique. There are several challenging periods in the initial 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:
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 9–12 months (the second circle is the previous example).
Now, think about this…
During a profitable 25-year period, roughly 10 years (or 40%) were what I’d describe as ‘tough’. And this doesn’t include the many shorter setbacks only lasting a few months.
Sure, trading may seem easy in theory. But it’s much harder in real life. One of the biggest challenges is dealing with the lean times. These periods never pass as quickly as they do on a chart.
Study the graphs in this week’s update. 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, Quant Trader
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