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Hindsight Is The Perfect Investment Tool

I got bounced the table below the other day for comment which is interesting because my comments are generally so what. I have no idea where it came from so cannot vouch for its veracity. So treat it with the usual caution you apply to something you have not generated yourself.

Asset comparison

I am not certain what the value of such tables is unless it is to convince us all to put our energies into investing a time machine so that we can go back in time and load up on Bitcoin, although this in the manner of all paradoxes would probably remove the value of the event. However, the table does serve some instructional value in that it only tells part of the story – so I have redone the chart and added in the MaxDD for each instrument over this time frame.


For shits and giggles I have also added to the table the total Division One Prizes for Powerball since 2010, as you can see it is a very tidy sum. There are two issues that need to be addressed. The first is the obvious statement that the past is not the future. The failure to understand this is a mistake I used to see brokers make all the time. Periodically our research department would produce a list of the best performing stocks on the ASX, the dealers would then be encouraged to get on the phones and sell these stocks on the basis of what they had done in the past. Clearly this reflects a breach of the past is not the future doctrine and is something that is even reflected when performance results are presented to retail investors. These investors are constantly warned that past results may not be reflected in future results and this is a reasonable warning.

The other point that needs to be made about this sort of table is that the trajectory of the price of an instrument in obtaining those returns needs to be considered. You have to ask yourself whether at any pint during your investment in Bitcoin whether you could stomach an 80% drawdown. My guess is that most would not be able to hang on through this sort of event, even if they were informed that price would recover.

Compounding – if you live long enough to enjoy it.

I have just finished reading Edward O Thorps autobiography A Man For All Markets which is an excellent little read and a good addition to any traders library. In the book Thorp talks about he value of compounding returns. There is no doubt that success is trading or investing is based upon compounding your gains over the long term. Compounding is a wonderful tool in that what seem to be small quanta of difference can over time lead to an enormous difference in returns. For example an investment with a return of 10% compounded annually for 10 years yields $259,374 whereas the same investment compound at 11% yields $283,942. Extend the holding time to 20 years and the figures becomes $672,750 and $806,231 respectively. Time is the key to compounding and this is a point Thorp makes, he also makes the important point that most lack the patience to do this.

However, there is a sting in the tale of compounding that I have noticed that those on the sell side of the business either abuse or simply do not understand and that is one of scale. You will often see very long term charts of an index or an instrument and it shows a wonderful upward trajectory (well you wouldn’t show things that didn’t work) and the message is that you simply have to hold for whatever the requisite time is and you will eventually have a small pot of gold. The key word here is eventually because what is often overlooked is the time to achieve these mythical gains. There is no doubt at all that compounding is a very powerful tool and when combined with consistency and patience achieves remarkable things.

However there is always a but we need to be aware of. To demonstrate this I found a centuries worth of data on the All Ords and using $1 as the starting investment plotted what the return would be over the next 116 years.


If you had started with $1 in 1900 and simply let the compounding returns of the index take its course you would have $487,801.23. At first glance this is quite impressive – the markets very long term rate of return sits at about 9% and if you let it do its thing for a long period of time then you get an impressive number at the end. However, there are two things to be aware of in viewing this data. Firstly, the time taken to achieve your goals, not only is the time itself a problem but the erosion of the value of your investment over time is a problem. I had a cursory look for long term inflation data but couldn’t find much dating back beyond the 1940’s but if you assumed an average inflation rate of 4% then this puts a large hole in the real end value of your investment. The second issue that is not addressed is the trajectory of the journey – the chart above is not of a capital guaranteed term deposit but of an index. The somewhat linear trajectory of the graph is deceiving since it does not take into account the extended and deep bear markets that were experienced. There were years when the market went nowhere and these events are testing for even the most hardened buy and hold advocate.

Time is both the ally and enemy of those who understand how to use compounding and it is this dualism that we need to be aware of. The practical implication of this is to leave your money in your trading account for as long as possible before taking it out and spending it. The impact of large withdrawals is quite remarkable in the damage it does to accounts but some people cannot resist spending in the short term to ensure they live in poverty in the long term

The Year In Money

Bloomberg have been busy – click the image below to be taken to the full infographic.



For those who are not up with the current vernacular FoMO apparently refers to Fear Of Missing Out. According to Wikipedia FoMO is defined in the following way –

Fear of missing out or FoMO is “a pervasive apprehension that others might be having rewarding experiences from which one is absent”.[2] This social angst[3] is characterized by “a desire to stay continually connected with what others are doing”.[2] FoMO is also defined as a fear of regret,[4] which may lead to a compulsive concern that one might miss an opportunity for social interaction, a novel experience, profitable investment or other satisfying events.[5] In other words, FoMO perpetuates the fear of having made the wrong decision on how to spend time, as “you can imagine how things could be different”.[4]

In the somewhat demented and narcissistic life of your average millennial FoMO is somewhat of an artificial construct since you can never be certain that you have missed out. All your fears of people having a better time than you are largely imagined. In trading you definitely know that you have missed out and missing out can have serious consequences both financially and psychologically.  What prompted this exploration of missing out is that I was reviewing my universe of tradeable instruments and noticed that for some reason Robusta Coffee had dropped off the list for reasons I cannot fathom. This is particularly annoying when you look at the chart of Robusta Coffee and realise it is one of the best performing commodities of the year.


Experience now largely insulates me from the effect of seeing this. The problem is rectified by simply adding this entity back into the trading mix and moving on knowing that somewhere at sometime something within my universe will exhibit the same magnitude of move. It is simply a matter of time and it is this notion of time that catches traders out – trading success is dependent upon longevity not lottery winning luck. In fact in the list of things I wish I had known before I started trading high on the list would be a better understanding of the probabilistic nature of trading. When you start trading you have the perception that you will make money all the time and that your time making money starts the moment you do. What does take time to get a grasp off, particularly emotionally is that trading is a simple probability exercise. If your system makes on average $X dollars per trade then that’s what it will do over time and it is this notion of over time that catches traders out. They simply dont hang around long enough to see this occur.

Implicit within this discussion is the notion of actually taking every trade that the system generates because you do not know where the returns are going to be generated. My own observation has been that the majority of money is made each year by a handful of trades and if you miss out on any one of these then the results suffer accordingly. To give you a broad sense of this consider the chart below which is the year to date returns from a variety of commodities.

All Commodities YTD Return

It is obvious that throughout the course of a year some instruments will do better than others. What is perhaps not so obvious to traders is the dichotomy between the commodities that do well and those that have average performance. Outliers are the bedrock of the performance of any trading system – they do all the heavy lifting, all the other trades are simply there to make up the numbers. To give you a very ugly and basic indication of the impact of missing these outliers consider the chart below which looks at the average performance of this basket of commodities with the best performers removed.

Average Returns

What is interesting in this instance is the disproportionate impact of removing the best two performers from the mix. Implicit within this discussion is also the understanding that no single trade sends you broke and this reflects the truncated distribution of returns. Trades that go wrong are quickly closed whereas those that go in the right direction are left alone. But without the having the good trades in the mix because they have been missed the returns of any system are muted. We can see this when we look at a hypothetical system. The equity curve below represents a hypothetical system that is coming out of a drawdown. I selected the notion of a recovery from loss because it is often in this sort of market phase that traders begin to second guess themselves and in doing so they begin to ignore trades that they would have otherwise taken.

Taking all trades

What I have done in constructing this curve is to look at the impact of removing the best trades as the system recovers from its downtrend, the system then continues to trade as normal post the removal of the trades. As such you can see the long term impact of missing strong trends. The idea of missing out has at once a strong financial impact but it also has an emotional effect on the trader. Regret is often a companion of every trader, somewhere at sometime there will be a trade that you miss. This is the nature of the game and it is this treating trading as a game that keeps this event in perspective, this combined with a knowledge that trends are constant and ever repeating can help mitigate the feeling of having made a catastrophic error. But the overriding lesson is that you must as a systems trader take every trade because you do not know which one will be this years big winner.

Starting Dates

When I was banging on about EFT’s last week I made the point in passing that when you are looking at trading systems that the start date is everything and it is the point at which most of the fudging of results occurs. As an example I took a hypothetical passive system and began to change the starting date of the system to highlight this problem. The chart below shows a series of start dates counting down from ten years ago to today. So if I had started this system and traded it for ten years its annualised return would be 3.6%. Whereas if I had started the system seven years ago my annualised return would only be 1.1%.ReturnsAs you can see changing the start date changes the annualised return that is generated by the system. The worst returns have occurred in recent times with the best being five years ago. It doesn’t take much to work out which you might include in your marketing material if you wanted to cast yourself in the best light. This problem can occur on even shorter time frames such as moving the start date from one month to another.

The problem is also has nuance that catches the unwary; annualised returns are simply a nonsense measure when viewed in isolation because of problems with the construction of averages. For example imagine you invest $100,000 in a fund that in the first year generates a 100% return and then in the second year losses 50%. How much have you made, if you were to a look at the yearly average return you would calculate that 100%-50%/2 = 25% and the fund manager could rightly claim to make this average figure. However, your true return which is the only one that matters is zero.

True returns are given by an equity curve with as much data as possible – this gives you some idea of the trajectory of an account under a variety of conditions. This is then supplemented by looking at the drawdown curve of the system to give you an idea of how rough the ride. So for our hypothetical system above if I take the start date of 10 years ago I get an annualised return of 3.6% but a maximum drawdown of 44.5% because the system is caught by the GFC and being passive it takes no defensive action. Yet if I take our preferred kick off date of five years ago I get a drawdown of only 20.8%. So my system at this point has nearly twice the annualised return and half the drawdown.  Yet the ten year figure is the more complete since it also includes a global shock so it shows the true performance of the system whilst under pressure.

This leaves us with the problem of how to deal with this in a real world situation where this data might not be forth coming. Fortunately we can reduce this problem to a simple rule. If a system does not immediately show a drawdown or has a smooth equity curve something is not right.

I Played Blackjack With the World’s Best Card Counter

It’s 10 p.m. on a Saturday, and the low-fare overnight buses in Chinatown are idling in rows. Markets have long ago pulled down their metal gratings and thrown bags of pungent trash onto New York’s curbs. And directly under the Manhattan Bridge, on a desolate corner, here’s an unusual sight: men in sequined sports coats and women in Oriental dresses, streaming through a set of sunken double doors.

Inside, in a lobby encircled by shuttered shlock-shops, this dapper group is grabbing $500 Monte Carlo casino chips and gliding up a wide marble staircase. At the top, Vegas showgirls—dripping in feathers and sequins—await with drinks and drawled greetings.

On the second floor, a dim sum palace unfolds. Red and yellow swirl together on the carpet; heavy curtains and fake bouquets adorn the walls. The tack complements the gambling den this eatery has been transformed into for one night only. Black-vested dealers hold dominion behind half-moon blackjack tables and shake dice out over craps boards. Bartenders dole out Tom Collinses and martinis while a band fills the room with jazz.

We’re at the Art of Cheating, a gambling ball hosted by the Obscura Society, the events arm of oddities website Atlas Obscura. It has brought together a handful of the world’s best card counters and cheats to transform the novices into card sharps.

More here – The Daily Beast


We are a few days removed from the shenanigans of last week, which isn’t to imply that they are over but a little distance is a good thing. Much has been made about the falls in the local market but this commentary lacks context and if we simply look at falls on the local market in the form of drawdowns then the market didn’t look too healthy last week.

Screen Shot 2015-09-01 at 9.39.21 am

The chart above looks at drawdowns on the S&P/ASX200 since the unfolding of the GFC and it looks pretty shitty. The fall of last week was spectacular in its speed and volatility but it needs to be viewed within the wider framework of what has happened to the market post the GFC. Looking at the market post the GFC shows something that every investor should already know – the performance of the local market has been ordinary. A quick comparison between the S&P/ASX200 and the S&P500 highlights this marked gap in performance.

Screen Shot 2015-09-01 at 10.06.06 am

There was a brief period post the GFC where the local market outperformed the US but this outperformance evaporated quite quickly. This chart does highlight that market performance is everything in the world of stock selection – there is little point in persisting with a market that generates so little upward momentum. This brings me back to the performance of the local market last week – consider the chart below and then reflect upon whether the fall of last week was out of character for the local market.

Screen Shot 2015-09-01 at 9.49.16 am

As can be seen the market dropped out of its upwardly drifting channel a few months ago and was drifting down without the added impetus of the panic of last week. All last week did was add a little spice to proceedings.

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The Trading Game Pty Ltd (ACN: 099 576 253) is an AFSL holder (Licence no: 468163). This information is correct at the time of publishing and may not be reproduced without formal permission. It is of a general nature and does not take into account your objectives, financial situation or needs. Before acting on any of the information you should consider its appropriateness, having regard to your own objectives, financial situation and needs.