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The Great Idiot Tax Continues

It is at this time of the year when superannuation funds crow about how good they have done and of their inestimable benefit to mankind in general and this year was no exception.  So as is my now annual tradition I thought I would have a look at how good they have done and compare that to the real world where delusions about how good you think you are dont exist. From the article I linked to I took this table which looks at the average return of a a growth fund since 1993.


Source – Superannuation returns above 10% for the June Year

This piece acts as a good starting point for comparison with the market. For this I used the All Ordinaries Total Return index which used to be known as the Accumulation Index. It includes not only the price movement of the index but also folds back in the dividends of the index components so it is a good benchmark for simply passively holding an index fund or ETF.


When the chart of the average return of a growth fund is first viewed it does create an overall favourable impression – there are only three negative years and returns seem overall to be quite robust. It is only when you compare this active management with a passive benchmark that you realise how poor local managers actually do when compared to the index. Remember these are people who are paid to beat the index and as we will see they are paid staggering sums of money. Looking at annual percentage returns is quite crude and does lack a bit of fidelity, you dont actually know what the true performance differential is so I looked at the value of $1 invested into an average growth fund and into the index and got the following.


The market leaves the industry for dead – the market investment would now be worth $9.87 versus the industries $5.91 and for this privileged investors have been ripped off handsomely. The chart below looks at what my guess of the annual fee intake of superannuation funds is. For this I have assumed an average fee of 1.5% to cover not only management fees but also advisor commissions.


So to produce a theoretical return of slightly better than half what the market produced  in the period above the superannuation industry has collected probably close to $310B in fees. So to once again steal from Winston Churchill – never in the field of human endevour has so much been paid to so few for so little.

Investor Sentiment….Who Cares….

This is a chart of investor sentiment as produced by the American Association of Individual Investors. Each week the association polls its members with the question where do you feel the stockmarket will be in the next six months. The results are tallied to give a percentage bullish, bearish or undecided. These sorts of metrics are given great status in certain parts of the investing community and I have to admit when I first entered this business back when we all rode dinosaurs and wrote on slates I spent many and evening looking at sentiment indicators trying to work out exactly what they actually did, if anything.


A simple maxim when looking at  survey data is to look at the population that is generating the results you are looking at. In this instance individual investors are being asked their perception of the market over a given time period. It is important to note that investors are being ask to rate what is effectively and emotional response to the market – do they feel bullish, bearish or disinterested. They are not being asked a quantitative question. A quantitative question would something simple such as how tall are you? A sentiment or emotional question would be how tall do you feel? Such questions can be considered context questions and are such are dependant upon circumstance. For example I stand about 1.93 metres tall and yesterday I attended a 10 year birthday party so my perception of my height is that I am  giant. However, if I was playing in the NBA where the average height is over 2 metres then I would be less cocky about my height. To put it into the context of this survey around 10 year olds I am bullish about my height, around NBA players not so much. My height has not changed, what has changed is the context of my height. The same is true for these investors when polled, there is no context given to the circumstances that generated their response. For example if you have just come off a winning trade then you are apt to be bullish about the future. If you have just come off a losing trade then your confidence would be shaken and you might be more circumspect about the future.

However, there is a further point to be considered and that is the somewhat blunt one of who cares what average investors think about anything? The narrative fallacies of individuals is of no concern to any other market participants. But more importantly it is of absolutely no concern to the market. There is no way to communicate either the perceptions of individuals or the results of their collective perceptions to the market and given that average investors are consistently wrong in their perceptions it doesn’t seem to matter what they think.

This does raise the question of what about the polling of professional investors  and professionals are often surveyed about their perceptions of the market and people attempt to divine something from this sentiment. However, this approach also runs into problems. Consider the table below which was drawn from the Investor Intelligence Database. The table operates on a simple maxim. When fund managers are bullish they move out of cash and into stocks. When they are bearish they do the reverse. This cash/asset ratio was measured and then compared to the Dow to see whether the move was prescient in any way. Unfortunately, it wasn’t. The professionals managed to be correct in their interpretation of sentiment on only 7 out of 33 occurrences. You would have been better off tossing a dart.

Mutual Fund Record

At the heart of much of this surveying is an attempt to generate some sort of predictive modelling about markets. I note that the current fad is to look at social media tools such as Twitter to see if they tell us anything about the underlying emotional intensity of the market. Whilst I sympathise with the need for the average investor to try and predict where the market is going for the time being trading remains a reactive profession that is best served by simply looking at price, making a bet and managing the trade. Despite what many would have you believe it is not rock science.

A Short Lesson In Compounding

A conversation arose recently regarding the idea of taking funds out of your trading account as a mechanism of providing yourself with a buffer. I have to state at the outset that I am diametrically opposed to taking funds out of a trading account except in the direst of circumstances. The reason for this is simple – compounding. Compounding is that old boring concept that traders in their fervour to be as modern and innovative as possible forget, yet it is the oldest of all the quantitative rules relating to trading and it is the most powerful.

In very simple terms taking money out of your account for whatever reason is the equivalent of giving your overall rate of return a haircut. Consider the table and chart below – these look at the long term growth of $100,000 at three differing rates of return, 20%, 22.5% and 25%.


It is obvious that the longer you leave the funds in at a given rate of return the more you make. But think of this in terms of taking money out. Whenever you take money out you are doing the equivalent of dropping back your rate of return. It might not seem as if the difference between 22.5% and 25% is that much but over time the difference is extreme. And this differential will only grow. However, there is a wider application to this notion and it applies to the holding of individual positions which often offer the opportunity for extreme compounding.


The chart above is of ALL with the 52 week new highs, a simple ATR stop and volume plotted – it is hardly rocket science. However, you will see that price has had an unbroken run from around a $1.00 to the current mark of around $22 – this run has taken about four years. If you look at volume you can see that it ebbs and flows but it is a constant – there are always people buying but more importantly there are always people selling. Whilst, it is impossible to divine the motivations of those selling it is fairly safe to say there has been no technical reason to sell this stock at any point in the past four years. The perfect world strategy would been to have simply let it compound (there is that word again). The mental gymnastics traders go through in justifying their decisions for selling is often extreme but in the end it often comes down to boredom – traders irrespective of their ilk have generally short attention spans and cannot stand the thought of being in a position for very long. Yet intriguingly this is how the true wealth is created.


How to Lose $3 Million in 1 Second

Losing money is one of the loneliest feelings. It was Oct 22nd, 2008. Lehman Brothers, the investment bank, had filed for bankruptcy the month before. The markets were panicking. A thousand people surrounded me, almost all of us slouched in our seats, staring at computer screens. I had eight, all flashing prices of assets that I couldn’t touch, but, oh, I could feel.

I myself was waiting for one price to flash, an interest rate in Brazil. I had bet that rates would lower over time, from 15.10% to 14.50% or so. The size of my bet was 20,000 USD for every one hundredth of a percent (or 20k per basis point). A move from 15.10% to 15.00% would make me 200,000 USD. A move to 15.20% would lose me the same amount.

I sat with a knot in my stomach, nervously chewing a swizzle stick, waiting for the markets to open in Brazil at 7 am. I jotted down worst-case scenarios, and then turned them into doodles. The default of Lehman had unleashed market hell. I closed my eyes. You could hear the markets, a trading floor filled with murmurs and sighs, the cumulative sounds of disappointment.

The Brazilian rate was a tiny yellow box on one of my screens. I had been in the office since 4 am, waiting, trying to extrapolate from other prices, from other assets how much money I would lose (or make). The price the following day had closed at 15.90%.

This day all assets, stocks, bonds, commodities, interest rates, everything, were trading in two distinct camps, going opposite ways. Most prices were falling, dramatically. A full-on Guppy Suck: Prices were spiraling lower like dead fish flushed down a toilet. Money was going into a few lucky assets, safe havens they were called, things considered having no market risk. Short maturity US bonds. Cash. The correlation between assets was approaching one or negative one.

My Brazilian rate started trading. It blinked 17.40%, 1.50% wider than the prior day. I was out 3 million dollars, and I had no chance to trade. No chance to get out at 15.50% or 16.00%. The market had gapped. I got up, shot a bird at my screen, punched it, and then walked to the bathroom.

More here – Scientific American

Would You Take The $10M

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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

General Advice Warning

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.