Ask not that the journey be easy; ask instead that it be worth it - Author unknown
I was having lunch with my partner and a client yesterday when the conversation turned to trading (imagine that), and in particular what keeps a trader from being consistently profitable. There are countless reasons why most people who attempt trading commodities fail, but why is it that fairly seasoned guys who have been around a while still struggle?
I have had this conversation many times with clients over the years and the feedback has always been interesting. Mostly, people think its because they did not follow a definitive game plan, they were over leveraged or overtraded, or let a few large losses take them out. Although these errors certainly exist, I think the culprits that get in the way of the more seasoned guy are different. Usually, when a trader has survived a good 5-10 years or more, he is quite aware of the basic concepts of a having a trading plan and using proper leverage. He knows he must control risk through stops and other money management techniques and stay disciplined to his approach.
So what happens? What are some of his demons? Here are my views on the subject, Im sure there are others.
I think one of the biggest concepts (virtues) that we need to really metabolize is patience.
Very few people have the patience for a long term outlook these days. I know so many situations where fairly seasoned guys were trading good reliable methodologies, controlling their risk and leverage, yet threw in the towel because The program was doing nothing. The boredom or the lure of a better grass is greener strategy begins to dominate the mind. We have to be careful not to talk ourselves out of something that is doing its job, just because we would like more from it. Dont fix what is not broken.
The more knowledgeable we are, the greater the tendency we have to take ourselves too seriously. What we think we know gets glorified at the expense of what we dont know. When weve convinced ourselves that there is a problem when in fact the problem may be our own impatience, we try and fix it. We try to make it what we would like it to be, as opposed to what it is. Its only human nature and thats why it is such a powerful problem.
The second obstacle is expectation.
This problem of attaching ourselves to an outcome is a problem in investing in general. Expectations of higher and higher returns have become commonplace in an environment of lower opportunity to do so. Generally speaking most people have no idea how to even gage expectation. Very few consider the rate of return on riskless investment (90 day T- Bills) as the benchmark for their current expectation.
Doesnt it stand to reason that if the 90 day bill rate is 15%, like it was in the early eighties, one should have a higher expectation for returns than when the 90 day bill rate is less than 1% like it is now? I think so, yet most people have an arbitrary number usually based on what they need, or would like, or heard youre entitled to in commodities. After all, commodities are risky business, I deserve a higher return. More nonsense.
Investors seem to recognize this when buying yield (bonds or CDs), but not necessarily when dealing with other asset classes like stocks or commodities. For instance, the Ten Year Treasury Note will pay 3.71% per year for the next ten years, principal returned. We accept this or we would not buy the instrument. However, its not that simple when faced with other Investments.
For example, earnings per share (EPS) in the stock market have historically grown two percentage points above inflation. So lets say annual inflation runs at 0%, we are talking about 2% earnings growth. Assuming share prices rise with earnings, you will get 2% annual gains. With The Dividend Yield around 1.88% right now, that is a forecasted total return of around 3.88%. Now, do you think that the average person has invested in the stock market for a 3.88% return?
I would guess they are looking for much more, and this opens the door for surprises. When the outcome is different than the expectation, we usually react emotionally, something that hardly ever works out.
When I ask a prospective client what he expects these days trading commodities, I routinely get answers that hover around 30%. The reality is we are entitled to a riskless 0.16% return (90 day T- Bill). Thats $160.00 on an investment of $100,000.00. It appears to me that our expectation for returns in other asset classes needs to be more realistic or you will make impatient mistakes.
The third concept I dont think we give enough thought to is the power of compounding positive returns in the long run.
I have discussed with so many traders that have no real understanding of what compounding can do for them over the long term. If you suggest that perhaps a 15% return in a reliable managed futures program might be the current expectation, you get silence.
15%, thats not that exciting. Well I think it is, right now anyway.
Lets look at an example of having patience and reasonable expectation over the long run.
If a forty five year old investor were to invest $75,000.00 in a program that compounded at 15%, and added $10,000 to the account per year, he would be able to write a check for $2,241,000.00 upon retirement (assuming a 65 year old retirement date).
How many 65 year olds do you know that can write a check for $2,241,000.00 from one account.?
So, theres my PEP talk. PATIENCE, EXPECTATION AND THE POWER OF COMPOUNDING.
Whenever you are feeling impatient or a little greedy give yourself a PEP talk.