5 TIPS NOT TO SUCK AT THIS GAME.
We publish 5 tips on how to succeed at the game of generating extra returns. These rules, in our opinion, apply to long-term investors looking to outperform benchmarks.
Rule #1: Be reasonable.
A near-certain approach to getting wealthy is to generate excess returns; either you exponentially raise your capital or find a sponsor and receive a percentage pay-out of huge profits.
But it's not quite that easy. You must maintain reality.
First, commissions and other frictional expenses eat up a portion of your profits. After these frictional costs, you must be able to provide extra profits.
Second, virtually every investor aspires to the same result, making it almost a zero-sum game.
Third, remember that most investors who lend you money want you to produce excess returns that have been risk-adjusted. They are concerned about the fluctuations in your performance and the setbacks you experience. It is insufficient to increase the risk to increase the return.
In the end, be reasonable. It's a difficult game, and where possible, use accumulation plans to manage the risk of buying too high.
Rule #2: Create chances with skewed risk-reward ratios.
One of the most important things to realize while investing is that you won't always be correct.
You'll make some profitable transactions and some terrible ones.
Whether you are Paul Tudor Jones or someone who trades in their spare time, your P&L will look somewhat like this at the end of the year: P&L is calculated as follows: (% winning trades * % winning deals) - (% losing trades * % losing trades).
If your losses are manageable and the P&L of your select few profitable transactions is high enough, you can theoretically make money by being correct around 50% of the time.
How can you be certain about that? You concentrate on possibilities with unbalanced risk/reward.
Rule #3: Minimize your losses and maximize your gains.
This is essential "grandma advice" for producing alpha. Ask a few seasoned traders on the trading floor what they do before setting up a trade. I can almost assure you that the response will be, "I set my stop loss."
This is the best advice I've ever received, in my opinion.
If you are successful in doing this, you won't be trapped in that one poor investment choice that will damage your ability to take risks and wreck your entire year's P&L., handle each trade similarly, and exit when the timing is right. No ill will exists.
Rule #4: Be sure to size your positions.
Most people would use the same size for each trade, regardless of the type of instrument: EUR/USD, a short-term bond, a utility stock, or Private Equity.
The size of your position and the location of your stop loss should be proportional to the recent market volatility and the volatility of the underlying asset.
The first thing to consider is how much I am willing to lose on this deal. Your remaining capital, which should be a modest percentage, should be the solution.
The next stage should be: given this instrument's volatility, how large of a move do I need to make it to strike my stop? Let's adjust the position's size as needed.
Avoid using stop losses of 1% on Private Equity and invest 20% of your remaining balance in each round. That is gambling, not investing.
Rule #5: Be wary of proxy hedging and diversification.
"My portfolio diversifiers are going to protect my downside risk, so I don't utilize stop losses," the investor said.
This has been said a few times and may be effective for a while if (negative) correlations persist. However, these accounts frequently disappear when correlations begin to decline.
But you don't necessarily need the correlation to reverse course and shift direction. The correlation coefficient must only begin declining for the first cracks to appear.
Diversification and proxy hedging are crucial in a portfolio strategy, but they should, in my opinion, support stopping losses rather than replacing them.
Selling your risk is the best strategy for hedging your exposure.
The last pieces of advice:
Never let your emotions get involved with an investment or a way of looking at the world. Stop the trade and stop your ego, too. Be flexible; your opinion must alter if the facts do.
Your investment will not succeed if you have a compelling macro thesis and supporting evidence, but the market is not paying attention.
Just be patient if no one is interested and the narrative is missing.
Ask yourself daily if you would enter the same trade for each trade in your portfolio, given the information you currently have and the current pricing.
Why do you have the investment if the response is no?
Take care and stay hard!
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