Some great feedback on a post that mentioned ‘rain’ the other day:
Michael – The emailer who ridiculed the idea of betting on “rain” or “no rain”? I’d be happy to take those trades if I knew that a correct bet paid off 2-to-1, or 3-to-1, and an incorrect bet paid off 1-to-1! That’s what critics don’t ever seem to get about trend-following. Its not about being “right” or “wrong” – its about the expectation of the payoff when you win. I try to explain it this way to friends and colleagues (who never seem to get it either). Granted this is a generalized method that doesn’t include trading costs, etc, but I think it makes the point. I’m going to make 10 trades. Before each trade, I’ll identify a place on the chart where I will exit the trade for a loss of 1-percent of my total portfolio value if I’m wrong. Let’s suppose I make 7 bad trades out of 10. A little math: 7 x (-1%) = a loss of 7% to my portfolio. If I make even a tiny gain on each of the other 3 trades, let’s say 5% ( 3 x +5% = gain of 15%), then I’ve just made 8% (gain of 15% minus loss of 7%) after 10 trades, even though I was wrong a majority of the time. Simple enough. What’s the hard part? The hard part is admitting you were wrong on the 7 trades, and exiting when you said you would. In my opinion (and experience), a person can use whatever entry/exit method he/she wants – 55-day breakouts, MACD, stochastics, the moon moving into the house of Aquarius… You want to pick a bottom or a top because of a certain jiggle on the chart? Go ahead – as long as you’re only going to lose a fraction of your portfolio if you’re wrong. Once you embrace the idea of not getting hung up on predicting a market’s behavior, you are suddenly “freed from tyranny.” You no longer stay up until 4am analyzing charts and looking for the “holy grail” indicator. You no longer hem and haw over whether to buy or sell a promising stock, only to watch it go up (or down) a little each day until you feel like you’ve “missed the move” and have even more regret. It becomes easier to shut it all off at the end of the day. In short, you have a life. And best of all, you gain confidence, and over time, make money.