A successful self trader – Rule # 5
Many brokers and traders talk about their success percent. This is an absolute myth and can mislead you. It hardly matters if your calls were right on 80% of the occasions but your strategy did not treat the winners and losers differently. Secondly, success percent is based on the assumption that all your calls are acted upon. That is impractical. At the end of the day, the performance of the portfolio is what matters!
The myth of success percent
The next time any trader, analyst or dealer talks about the success of calls given please take it with a pinch of salt. In isolation, the success percent is just a mathematical number. It conveys nothing about the ability of the analyst, the skill of the fund manager or the alacrity of a trader. At best, the success percent is a crude measure of success. Let us understand why!
Back in 2004 two very smart analysts had claimed that their success ratio was 80%. Effectively it meant that in 8 out of 10 cases their calls resulted in profits. However, the salivating success percent they were talking about was not translating into returns for investors. That forced me to dig a little deeper and it turned out that they were technically right but realistically wrong.
During the same period, another low profile analyst with an extremely humble success percent was doing very well for his clients. The reasons were simple. He focused on large stocks, gave fewer calls, exited losers and held on to winners. The moral, “It does not matter how right or wrong you are in the market. But it matters, what you do when you are right and when you are wrong”.
3 POPULAR MYTHS OF SUCCESS PERCENT
Percent success is not percent return…
Most investors tend to confuse these two. Percent success is largely an academic measure. Percent return also calls for identifying stocks, holding on to winners, sticking to the liquid space and considering trading and executions costs.
Don’t forget to consider risk…
Most people forget to consider the risk per unit of return. A simple example! A 10% return on Sun Pharma is more valuable than a 10% return on Bhushan Steel. It has been generated on a lower risk per unit of return.
Past is not a guide to the future…
Let us give the benefit of doubt to the success percent. It is still historical and not predictive. An analyst with an 80% success this year need not repeat the performance next year. Focus on strategy more than return percentages!
“The stock market is full of people who know the price of everything, but know the value of nothing” – Phillip Fisher
6 REASONS WHY RETURN PERCENTAGES ARE MISLEADING:
- Cost of trading is a major culprit. Most success percentages do not consider the cost of trading. If you add up brokerage, STT, service tax, stamp duty and the liquidity premium, a few percentage points get chopped off from the stated returns. Over a period of time, the cost of trading really adds up.
- Return percent is a mathematical measure and does not typically consider risk. There is a risk of liquidity, a risk of cyclical downturn and the risk of valuations. These risks, when they manifest, can make a vast difference to your actual return vis-à-vis the stated returns.
- More often than not, traders become their own enemies. When a broker gives a call and investors rush to buy that stock, the resultant liquidity surge pushes the price up. This will ensure that you will buy well above the stated price, or sell well below the stated price. The return percent does not consider this.
- Resources and mental capital make a lot of difference. Let me explain. If the analyst gives 10 calls in a day, the investor may not have the resources to keep so many positions open. When you pick and choose, your returns can differ substantially from stated returns. This is a common problem for investors.
- A trader or an investor, at the end of the day, is a human being and not a machine. They have their own fears, their prejudices and their own preferences. It would be ridiculous to expect that a person will be able to overcome all these emotions and execute the calls given by an analyst. It just doesn’t work!
- Lastly, a return percent sheet can never simulate a real trading environment. You have stop losses; you have profit targets, margin calls and requests for MTM margins. It is much easier to talk about stop losses and targets but in the real market, there is many a slip between the cup and the lip.
WHAT YOU SEE IS NOT WHAT YOU GET:
That is a reality of any success percent sheet put out by a broker or a trader. There could be a variety of reasons. The lack of liquidity may be making it impossible for you to execute the transaction. The statutory and brokerage costs may be shaving off more returns that you had imagined. Of course, once you have two stop losses triggered in your first two trades, enticing a trader to put more money is almost impossible. Try breaking that mental barrier.
So what is the way out? Do not overtly focus on success percentage. Rather focus on portfolio returns. Most importantly, ensure that you start the entire evaluation with a finite capital. Nobody trades with a blank cheque. What is more important in this entire game is that you cut your losses fast. Don’t try to hold on hope and of course, don’t try to average. But above all, hold on to your winning positions. Make your winners count. After all, they have to make up for your losers.
TAKEAWAYS FROM THE “RETURN PERCENT” DEBATE…
Some of the finest traders in the market like George Soros and Peter Lynch have reiterated that your success percent does not matter. Ideas and strategies are only a starting point. Eventually, it is what you do with these ideas that really count. Like the famous initial owner of Apple Computers who sold off his entire stake in Apple for $1000 some 30 years back. Had he held on, that would have been worth $50 billion today. That, probably, best explains why you must focus on the execution aspect!
The next time an analyst or broker or trader advertises their success percent, learn to restate it. Rework the trading and execution costs, provide for liquidity risks, and admit that you are dealing with emotional humans and not with automatons. Once you are able to put a number to these ideas, you get a success percent that is more realistic. Remember, you have to make your winners count. There has never been a better way to make money in the stock market. There, perhaps, never will be!