What ways can we ‘Manage’ a Trade to make such a difference?
As per much of the text in Part 1, I am of the conclusion that how I manage a Trade has a huge impact on my Returns and might explain how I got higher Returns than my friend last year who has an extremely similar Portfolio. Here is a quick list of the factors that I think make a real difference:
If you scoot across to my ‘M3 Manifesto’ webpage then you will see a lot of stuff like the above which I use to make up my ‘Rules’.
Something I wish to add here is that although I have suggested that the above ways of managing a particular Trade might explain the differences in performance between my Portfolio and those of People I know with similar Portfolios, another very simple explanation might arise from the Power of Compounding over very small differences. What I mean by this is that say for instance I buy a Share for 500p but my mate buys it at 505p and then when we come to sell it, I sell for 600p but my mate sells at 594p - I won’t show you the boring maths but even on this simple trade, I would be 2.4% better off than my friend. Compound this over many trades and it would make a lot of sense that our Overall Portfolio Performance for the Year would vary quite a bit. Of course, in reality, there will be many occasions when she gets a better Price to buy or sell than I do - which sort of explains why the overall Performances don’t vary massively.
What are the key Psychology Factors?
Allied to the kind of Rules that I have laid out above, there are some helpful Psychology aspects that I think can have a huge impact on whether or not a Trade is successful:
An Unusual Hypothesis
All the stuff I have scribbled above leads me to a bit of a thought experiment that could actually be tested if people could be bothered (I can’t, but no doubt others have tried similar experiments in the past). If I am right that Stock Selection is of such low importance with regard to whether or not a Trade is successful and that how we manage a Trade matters more, then if we chose a basket of Stocks at random (‘Monkey with a Pin’) then in theory we could make money.
Simplistically, we could choose maybe 18 Stocks from the London Stockmarket and then use a pre-defined set of Rules, similar to mine listed above, to go about managing these 18 Stocks. This might or might not work, and I suspect that if we open it up to all Stocks available in London, then we would end up picking many of the utter cr*p AIM trash that lurks around in the WheelieBin - and if we get a couple of our Random Stocks going to zero then it is likely that the Experiment would fail.
To improve the chances of success, it would probably make sense to do some initial screening of the Universe of Stocks and try to remove the stinky Junk that could cause problems - maybe parameters like the following would help:
If you pop over to my ‘WheelieBin’ webpage then you will see a huge list there of these kind of Risk Factors that could be incorporated to whittle down the Universe of possible Stocks to include - but obviously if your parameters are too strict then the Universe will be a bit meaningless. You might find that you could even just say your Universe is the FTSE350 and pick 18 Stocks randomly from that.
All you then need is one Monkey and one Pin. Easy. Especially if you live near a Zoo.
Following the selection of the 18 Random ‘Monkey’ Stocks, you would then manage the Portfolio according to the Rules - for instance, if a Stock moved up 5% you might have a Rule that says you need to buy more - so you would add to the Position etc. As part of the approach you would need ‘Selling Rules’ as well, and once a Rule is triggered to Sell a particular Stock, you would need to borrow the Monkey from Whipsnade Zoo again and get him (or her) to pick your next Stock to buy.
I won’t go into detail here about how you tell the gender of a Monkey……
If you were to undertake such an Experiment, and of course you need to have appropriate Trading Rules and the Psychological temperament to apply them with the necessary discipline, I would bet that even with a Random selection of Stocks from the Universe of ‘Quality’ Stocks you would produce good Returns. Of course, if I am right, then to a large extent we are all wasting our time doing all this in-depth Research and Fundamental Analysis on Stocks……..
I haven’t really thought this Section of text through, but I just wanted to lob something in so that Readers are aware of it and can perhaps do their own thinking around the Contradiction I think exists.
The sort of background theme of this Blog Series is about how maybe we are fooling ourselves trying to Pick Stocks and that perhaps it is much more important to focus on how we Manage those Stocks in our Portfolios (obviously assuming we are not buying Cr*p which will almost guarantee we will lose money however well we attempt to Manage the Portfolio). Not only does this idea help to explain why my Portfolio Performance differs so much to that of my Friend with a similar Portfolio, but it also helps explain why so many People on Twitter with entirely difference Baskets of Stocks get such similar overall Results.
However, it strikes me that the Stockopedia system that uses things like ‘StockRanks’ to create Portfolios of Stocks that might perform well sort of contradicts the idea that Stock Picking is a waste of time. I am not a Stockopedia User myself, although I am very impressed by it and from what I have seen about Model Portfolios and stuff, it is clear that it does seem to work.
Obviously if this Stockopedia Stock Picking approach is then combined with the kind of Portfolio Management ‘tricks’ I have mentioned, then a highly superior Performance might be possible to attain.
Hopefully that makes the point I wanted to put over.
Some related Blogs you might find just about bearable:
Targets - all 3 parts:
The Hedging Epic:
What is your Edge?:
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