The (Whole) Truth about Trading Performance

I bump into my friend this morning while having breakfast. She is now working in a local bank as a private banker.

We had some small talk, and I mentioned to her that I am doing some trading on the side, and if things work out smoothly, than within the next 2-3 years, the income that I generate from my trading should be about the same or even exceed my pay. She is curious if I will just quit my job and do trading for full time.

I told her that it depends if I am happy at that time with my company and boss. If I am happy (or at least able to take the nonsense from my boss), than I just stay put. At the end of the day, I am like getting paid 2 salary (one from my normal job, and another from my trading). Moreover, I developed a trading methodoloy where by it does not depend on the direction of the market, which somebody call this market-neutral trading. The good thing is that it requires very little attention from my part, the bad thing is that I will not be able to generate super normal profit (hey, you need to give and take). But if I can make it, than at least I have a choice, and to me, such choice is very important in this day and age whereby you do not know when you will be axe...

From my friend's expression, she is as if asking me what sort of return I am making. I told her that I started trakking the performance from Jul 2007. I benchmark my performance against the exchange traded fund SPY (this is an exchange traded fun that track the performance of the S&P 500). Since Jul 2007, SPY return is -5.54%, while my trading performance is +11.67%, thereby outperforming the SPY by 17.21%.

My cumulative return on a month-to-month basis is as follow :

Date SPY S&P Return Fund Return
7/31/2007 145.72 (SPY) (in USD)
8/31/2007 147.19 1.01% -4.52%
9/30/2007 152.58 4.71% -3.04%
10/31/2007 154.65 6.13% -1.10%
11/30/2007 148.66 2.02% 0.64%
12/31/2007 147.10 0.95% 1.36%
1/31/2008 137.37 -5.73% 1.12%
2/29/2008 133.82 -8.17% 6.32%
3/31/2008 131.97 -9.44% 5.32%
4/30/2008 138.26 -5.12% 7.09%
5/23/2008 137.64 -5.54% 11.67%

My trading performance seems to be very good compared with a passive buy-and-hold strategy (compared with buying the index fund of SPY, whereby the return is -5.54%), however, I told my friend this is infact a little misleading. The reason is that before Jul 2007, I have been losing money. I gone through a period of trial and error, research etc. to find a trading method that is suitable for me, and only than I started to turn in some profit.

And this bring me to my topic today.

As one can see from above, my trading underperform from Aug to Nov, but outperform from Dec to May. If I want to mislead people, I will simply show people my trading performance from Dec onwards.

Many times, one read from the papers about courses that teach readers how to trade FX or options, and the advertisements are full of testimonials from students that make tons of money. Is that the truth? The Straits Times wrote an article 1-2 months back. One reader wrote in to the forum and said that his friends lost alot of money. So why the difference?

I think the answers are as follow :

1) the advertisement told the truth, but not the whole truth.

For example, in an advertisement of option trading, the student claim that he made 1000%. While I have no doubt that this is true, however, that trade may be the ONLY trade that he make money. That is to say, he can be making 20, 30, 50 trade, but only one trade happen to make 1000%, and overall he still lose money.

Another possibility is that the student just buy a very cheap option, like $0.10 per contract before the earnings result. It happen that on that particular quarter, the results beat expectation by a wide margin, and the stock price went up. The option than jumped from $0.10 to $1.00. The result is that the student make 1000%, but in absolute term, only make $0.90!

So what's the point, you may ask, for making 1000%, when in absolute term he only make $0.90 (or $90 per contract)?. This has to do with the "Option Competition" organised by the trainer. The trainer organised an option trading competition, and will give out awards to student that make the most in term of percentage gain. In order to "make it", students can make many small bets by buying very cheap option, like the $0.10 option. If the trade gone wrong, he loss $0.10 (or $10 per contract), but if things gone right, he can boast about the 1000% gain.

2) unrealistic expectation.

One must realised that trading is just like any other profession, to be good at it, you need constant learning and practise to improve your skill. A doctor taks 6 years of medical school to get to where he is, ditto for dentist, architect etc, so what makes one think that he can master trading just within a 3-4 day seminar?

3) the trainer himself is questionable.

Will you want to learn from Warren Buffett (the richest man who make his money fromm investing), or will you want to learn from a Mr. Tan Ai Kou who you have never heard before? The answer is obvious. However, there are many traders out there that can and had make their money, but is not as well known as Warren Buffett, so the only way to be sure is to ask them for their trading account. If he can produce his trading account and show that he can consistantly make money in the past, than you will be more comfortable learning from him. One should ask for the statement for at least 18 months to be certain, if not, the trainer can simply show you a very short period of time that he happen to make money (like if I only show others my "track record" from Dec to May).

4) Failed to understand own personality and style.

There are many trainers out there that are true trader that make their money. unfortunately, their methd f trading may not be suitable for you. Take an extreme example. Warren Buffet is well known for his buy and hold style. He identify solid companies and hold it for years and decade. Now, if one day, Warren Buffett knock on your door and offer to teach you everything he know, will you become Warren Buffett the second? if you are one of those that itch for action and are impatient, you cannot even hold the stock for 3 days, not to say 3 months or 3 years. Than you will end up making losses eveytime the market is against you and you just get out of your position. The stock may ultimately goes up, but you are not there to take advantage already. Warren Buffett's method work-- for him, but unfortuantely, it does not work for you.