Luck vs. Skill – Part 1 of 2

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I think it could be very likely that we underestimate the role of Luck or even just simple Market Beta, whereby Markets over the long term tend to go up; so as long as we hold a large enough basket of half-decent Quality Stocks, then it is almost impossible not to make money if we are swimming with the powerful flow of the river.
 
I’ve been fixated by this subject for some time now and we even discussed it in the Podcast TPI 36 which you can hear here:
 
https://soundcloud.com/user-479955511/conkers3-wheeliedealer-36-market-bounce-winners-tm17-uls-hfd-gaw-purp-arw-reci-hsp-ai
 
It’s been obvious to me for a long time that Luck, both Good and Bad, has quite an impact on the performance of my Portfolio and I suspect many Investors (and Traders) might not fully appreciate, or even bother considering, what kind of influence Luck has.

I’m in no doubt that most of us like to think that the Returns from our Portfolios are largely down to our own sheer genius, talent, skill, and endeavours, but the rather inconvenient truth could well be that Luck plays a much more significant part than we would care to admit. Perhaps that is why we think so little about it.
 
Of course, if our Portfolios lose money, then that is Bad Luck !!
 
Something like over 90% of Leveraged Traders lose money, yet if a Survey is done, then over 70% of them will say they make money. Clearly these two propositions cannot both be true. But because we are all Geniuses, few of us are able to admit that in truth, we are by no means perfect, and we make avoidable and silly errors with scary frequency.
 
However, it might well be worth thinking about because if Luck really does make a difference to our Returns, then maybe there are behaviours that we can adopt that might minimise the Bad Luck which can drag down our Portfolios and, in tandem, bring along considerable mental angst; and we can maximise the Good Luck so that when it shines upon us, we can make out like Banditos .….(I’m not referring to the Corn-based Snack of the same name).
 
Or is that Doritos? Whatever, that is not the point…
 
I like those Tangy Cheese ones though……….. hmmmmm……….
 
Where was I? Right, something that I keep thinking about (apart from Corn-based Snacks and Potato Crisps, obviously), is that whenever something happens to my Portfolio, both Good and Bad, I should ask the question:
 
“Was that down to Luck or Skill? And what could I have done differently?”
 
I think if we can adopt this kind of habit, then it might help to analyse what we are doing and to focus on the whole Luck vs. Skill issue and to help optimize our Portfolio Returns. Clearly if the event is a negative one, then we need to amend the question along the lines of:
 
“Was that down to Bad Luck, or could I have done something differently in advance, to eliminate the hit or reduce its impact?”
 
Anyway, in Part 2 of this Blog I intend to look at habits we can adopt to reduce Luck, but first off, I will run through some practical real-world examples of where Luck has definitely played a part.
 
Examples of where Luck has played its part
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• A Profit Warning or Bear Attack can come totally unexpected and out of the blue. I got caught badly by this a few years ago where I had a crazy number of Profit Warnings from my Portfolio; to the point where I dreaded looking at my ADVFN App on my Fone early in the morning, when I woke up. When this kind of thing happens, and it can occur with scary ease, then it is a nightmare if you have a big position in the particular Stock. Good Luck in such a circumstance would be if you had sold the Stock a few days before or perhaps TopChopped your Position. Sometimes in with such events, Luck can help us.

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• The News of a C19 Vaccine just a few weeks ago, had an enormous impact on the Markets to the upside, and it gave a big boost to most Portfolios, providing they were nicely Long on Stocks. This was of course quite possible at some point in time, but pretty much nobody expected it on the day it hit (Monday 9th November 2020), when in fact the focus had been on the result of the US Presidential Election when Trump got kicked out. As it happens, the Bad Luck hit me personally because I had a big Short Position to Hedge my Long Portfolio and I was fortunate to realise the magnitude and significance of what was happening and I ejected the Shorts quite promptly and this meant my Portfolio was soon 100% Long and exposed to the positive upward momentum that persisted afterwards.

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• Buying just before a Takeover bid – ok, it takes skill to pick Stocks that become Takeover victims, but sometimes we just get really lucky and not long after we buy, they jump up 50% or something on a bid. That is sweet when it happens, but usually I find you need to wait a bit longer. No doubt, when someone does get a quick bid, they will be quite happy that a Halo of Godlike Genius hovers around them as they bask in the glory of their good fortune…..

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• High P/E Ratios – there is without doubt a general trend at the moment (and it has been the case for some years now) that P/E Ratios (read, valuations) have been unusually high across the Markets and Growth Stocks and US Tech in particular are on some nose-watering crazy Ratings that may cause trouble in future. However, whilst these high P/E Ratings persist, this has perhaps artificially boosted our Portfolios where we are exposed to such Stocks, and in all honesty, we might have been a bit lucky. If the Markets re-rate to more ‘normal’ levels, then it could knock a lot of % off of our Portfolios.

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• Many C19 wonder Stocks were ‘saved’ by the Virus – lots of pretty ropey AIM Listed Biotech and Pharma Development and Testing Stocks had been doing nothing for years and years excect for burning copious amounts of Cash, but suddenly, C19 came along and gave them a huge opportunity to perhaps make some Revenues. This resulted in a big buying frenzy with loads of them getting driven up to pretty elevated levels that might be difficult to justify with future Earnings once time plays out. Of course, in time since the Vaccine announcements started to appear, many of these Stocks have dropped back. The Holders of these got a bit Lucky when the Virus hit; and a bit less Lucky when the Shares tanked on the Vaccine news.

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• Good Luck can help what is a very High-Risk Portfolio – many people have Portfolios which are risky in the sense that in the good times they can shoot up and make big returns, but in the bad times, they get massacred. Personally, this is not for me (partly because I am Risk-averse and tend to go for Investments where my certainty of success is very high, and the other reason is that I gear-up my Stocks using a ‘mirror’ Spreadbet Portfolio so having Risk that is too high simply does not work) and it can mean a Portfolio that one year can return 60%, but in the next year it can lose 80%. Usually it is because people hold too few Stocks and do not diversify across Sectors/Styles/Geographies/Sizes etc. much, and often they hold Junky AIM Stocks that are inherently very Extreme Risk. Of course, the trouble here is that when people running a Portfolio like this have a good year, it is easy to think it is down to their Skill, but more likely it is actually simply Good Luck. The test is time – if it is Skill, then you will be able to do it year after year and demonstrate endurance.

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• Luck can really help or hinder when you are showing some Indecision. I had an example of this where I was holding Trifast TRI and sat on a huge Profit, but I was being really indecisive about whether or not to sell. I think I topsliced a few times and finally I sold the whole lot, and really I was lucky because not long after TRI put out a nasty Profit Warning and then the Shares went into meltdown. That was definitely Luck and not Skill. Sometimes I am thinking of Topslicing or Selling but I hesitate for a bit (I NEVER rush any trading decisions) and procrastinate on the trade, but suddenly a Takeover Bid happens or a good Trading Update comes out and catches me by surprise – but in a good way. In such an example I would have got lucky because I could have sold and not had the Exposure when the good news came out.

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• The FTSE100 collapsed to about 4900 back in April 2020 and of course many people were utterly terrified and lots of panic and fear reeked in the Markets. However, the reality is that we got lucky with the FTSE100 only dropping to 4900 – why couldn’t it have gone to 4000? Or perhaps 3500? Or even 3000 or lower? The simple reality is that we got lucky. I am sure many people would have given up if we had dropped much more. The Rally since then has been tremendous and loads of Traders and Investors are now well in profit for the year – but it would be foolish to think this is down to our Skill alone. The truth is that we got Lucky.

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• Back at the tail end of 1999 at the height of the DotCom Boom, I bought loads of Unit Trusts right at the top. This was when I started Investing and I had utterly no idea what I was doing. Of course, the Markets then duly collapsed and they bottomed out as late as 2003 (I suspect my Portfolio was down at least 50% but I was too scared to look at it !!), after which a huge Rally started up to the 2008/9 Peak and the Credit Scrunch. Again, I got Lucky. This was not because I am an incredible Investor or anything, but unlike many other People, I did absolutely nothing because I simply had no idea what to do. So I sat on my Unit Trusts and waited. Then many years later, I sold them all for a good Profit and in the meantime I learnt a lot about Investing and tried to boost my Skill element !!!

 
That’s outlined plenty of examples of where Luck (both Good and Bad) can influence how our Portfolios perform. I am sure if you start thinking carefully about both things that have happened to your Portfolio in the past, and if you pay more attention to the role of Luck going forwards, you will start to appreciate that Luck does make quite a difference.
 
It is important to realise that Skill is truly enduring and if you are still in this game in 5 years time, and especially if your Returns are improving and you are feeling more confident and capable, then you can be pretty sure that you have a handle on the Luck aspects and you are acting with behaviours that maximise the Skill elements.
 
One of the worst things that can happen is Beginner’s Luck. I am not suggesting that the kind of battering I suffered in my first few years of Investing is good for anyone (quite honestly, how I stayed in the game and didn’t just sell everything in despair is a mystery), but certainly a year where you lose maybe 15%, helps to focus your mind and motivate you to work hard in terms of learning the skills needed to make money. If you have a cracking few first years of Trading/Investing, it is easy to get over-confident and way, way too cocky. When that happens, the Market will take you down mercilessly and the kind of kicking we got back in March/April 2020 will have shaken many Newbies to the core.
 
It is definitely better to fail a bit in the first few years and to learn to treat the Markets with respect and to understand that you cannot rely on Luck to make money over time. You have to put in the effort and the hours, and to work in a methodical way with a clear Strategy and the necessary underlying tactical behaviours to make it work.
 
It is better to Fail and Learn, than to Succeed yet be Clueless.
 
‘Til next time,
 
cheers, WD.