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Monday, 7 January 2019

YEAR IN REVIEW : IMPORTANT TRADING LESSONS LEARNT IN 2018

2018 was both a great and humbling year for us. It marked the first year that the Fund is fully operational, and consequently the documenting of its performance via this very blog. It is a result from four solid years of planning, painstaking research, unsuccessful experimentation, and various other failures.
 

 Keep the pain inside. Source.

Through this blog, we have also encountered (actual) people who (actually) enjoy reading about our journey. We have received a lot of encouragement over this project, even from random strangers on the Internet. We are grateful for the support and look forward to publishing more meaningful content for our readers this year.

Our modus operandi is simple : if we run the Fund well, and conduct excellent trades, we will have something good to write about. We are real believers in giving away information and lessons for free. We do hope that our writing helps you in some way in your own investment journey, whether as a value investor or a contra trader. Whatever you want to be, take charge of your finances. Be bold and take risks, because YOLO.

Obviously last year was a challenging one for the markets. There was a lot of volatility and as a result, investment performance was undoubtedly impacted; it doesn't matter if you're a hotshot multibillion dollar protfolio fund manager or small fry like us.

Our own returns, while good, have been very lumpy. This was a consequence of experimenting with different tactical approaches. We explored many, many strategies with mixed results. But only by doing this - and by incurring the occasional five-figure losses - can we fine-tune our philosophy.

To be a proper fund manager that can consistently outperform the broader market, we needed a competitive advantage. We had to find what we're best at and filter out our worst impulses; indeed, we do partake in emotion-driven trading and suffer from indiscipline when it comes to setting our thresholds.

We are not rockstars; this has been a slow and steady and sometimes painful process. But we are passionate about trading, which has been a major part of our lives.

We don't mind waking up in the middle of the night to check gold prices. Ask us about the history of Bursa Malaysia and we will bore you for hours with dull facts. We have no choice but to become morning people as our biological clock is attuned to market hours.

To us, figuring out the markets is the most interesting puzzle in the world.

What we aim to look like by the end of 2019. Source.



MAJOR LESSONS LEARNT LAST YEAR - IN NO PARTICULAR ORDER

 
1) We are Traders, and That's OK 

We have used the words 'trading' and 'investing' interchangeably in the past. This is because we do not care for the distinction; both practices are intended to chase profits. One is supposedly long term and the other short, but in essence they are both wagers on a positive future outcome.

Of course, value investing (and the dividend yield approach) is seen as more respectable compared to trading. Rightly or wrongly, traders are viewed as scalpers, vultures, short termists, and other undesirable terms.

But tell you what: George Soros was a short term trader (among other things). Warren Buffett is a long term value investor. They both became billionaires in their own approaches. Our point is: there is really no right or wrong. We value diversity of thought, not absolutism.

Without short term traders, there would be no liquidity in the market. And without liquidity, stock markets would be even more volatile than they already are. Even major funds like the EPF engage in opportunistic short term trading. We are all out there to try and deliver the best results, no matter the approach.

When we started the Fund, we admittedly were somewhat confused about this distinction. We have aspirations of being a long term value investor, but that's not really part of our skillset. Like everyone else, we do enjoy the benefits of short term trading and large gains, but we did not see ourselves primarily as traders.

Now it is very clear : we are traders, because that's what we are best at. This means that the Fund's mandate should only be to capture short term opportunities. Our track record speaks for itself. 

So choose an approach that works for you. It's your money; be responsible for it.


2) Being 100% in Cash is Almost Always the Right Move (In a Volatile Market)

The wealth funds that manage billions of ringgit of your money are big fish in a small pond. It's a double edged sword; the EPFs and PNBs of this world own enough shares to support the entire stock market, but this essentially means that their overall performance is directly correlated with the FBM KLCI. The market goes down, they go down (Editor's Note : we mean their ability to deliver fat dividends).

Just like us, sometimes they end up making stupid decisions. But they have to stay invested, because of their mandate, and because their stakes are so big they have no choice. In worst case scenarios, you'll encounter something like Tabung Haji's ridiculous markdowns on their disastrous stock investments.

Objectively speaking, we think this is a senseless portfolio.

As an individual retail investor, your advantage lies in your nimbleness. You can actually get out of the market and remain in cash. Are you a dividend chasing investor? You can still get out and wait to buy your favorite shares at a discount (Editor's Note : to us, averaging down is simply throwing good money after bad, and it's totally unknown if your future dividend yields can actually offset this reckless behaviour).

Our mindset is that of someone preparing for a market crash scenario; the volatility we have seen in the markets so far tends to be a precursor to much darker things to come. During a crash, your favorite dividend-rich stocks will not save your portfolio; their long term value may be assured, but you may be underwater longer than you can hold your breath.

If you're young (20s to mid-30s), you probably haven't lived through a real bear market as an investor. If you're older, and have lived through a real economics slowdown driven bear market (97-98), you're either totally scared or have become wise enough to know when to take your profits.

We always pick safety over complacency. And being in cash has saved us many times in recent months from the worst of the market turmoil. Ready cash is a potent weapon; keep some to buy into the market when everybody else is panicking.


3) The Simpler the Strategy & Mandate, the Higher Probability of Profits

Just like you, we think we know everything there is to know about buying stocks. We have made tons of money by using Strategies A, B, and C. Therefore we are experts in all three, and immediate success awaits.

We used to think this way, and we were completely wrong. There is a better way which can deliver even better returns.

Let's say you're especially good at three strategies. For example, let's say:

A = technical trading
B = trading volatile stocks during earnings season
C = trading KLCI component stocks (big caps).

The best way to optimise your performance and trading profits is not to keep pursuing all three strategies. You actually need to find the one strategy you're best at, and keep at it. Even if it means losing out on potential profits from the other strategy.

Still doesn't make sense? Then compare it to a surgeon with a specialisation, or a lawyer who only practices in one segment of his field. Our point : in trading, don't be a jack of all trades and don't be too smart for your own good, because eventually the losses will catch up with you.

We value clarity of thought above other things. By concentrating on one thing, we're able to steadily hone our competitive advantage, or that all-important 'edge'. Our mind is not muddled by three different approaches at the same time. If you have three things you think you're good at but you can't figure out which one it is you're best at, then you might be in a bit of trouble there.

We're not saying it's bad to be good at different things. But for trading, concentrate on one thing at a time. Learn to compartmentalise and prioritise your work.

What we have learnt was that the easier it is to explain our competitive advantage - to other people, and especially to ourselves - the easier it is for us to find the best trading opportunities.

Make it worth the pain. Source.


4) Psychology & Intuition Matters

Speaking of competitive advantages, one of ours is that we're adept at analysing 'fearful' market phases.

There have been countless times where we have gone into a stock or warrant and made good profits because of the temporary, artificial mispricing. Understanding this segment of market psychology is the foundation for our trading activity. Without it, we would be toast.

But at the same time, we have developed a better understanding of trading intuition. To us, it's not about choosing between being a 'gut trader' (purely intuition) and a 'systematic trader' (purely systems or signals-based).

Obviously doing our homework on the stock is just as vital. But intuition helps us make that trading decision just a little bit faster, and in certain situations, this can make all the difference.

We firmly believe that intuition can be developed from repeat experience. You've seen the same situations before; you may not recall exactly what but as a collective whole, you understand that this trade has important similarities to a previously profitable trade.


5) Detach Feelings or Emotion from Trades Quickly

A lot of people, when they're just starting out, tend to take trading losses very personally. It can lead to indecision, regret, and feelings of stupidity. It's basically the failure to detach the self from the trade.

Our advice: if you really want to be a trader, never take losses personally and emotionally. Some people take a day to get over it, some can move on after 10 minutes of crying your eyes out, and some can move on after not trading for an entire week. Do what works for you; even more importantly, don't rush back into trading until you're regained that clarity of thought.

This is important because every trade must be analysed critically and unemotionally. We don't rush out to get new spouses right after a divorce (Editor's Note: those who do probably have no place in the trading biz).

So for your own sake, do learn how to overcome painful trading losses. They will inevitably happen, but don't let them kill you. Let them make you stronger.


6) The Key to Active Trading Is... to NOT Trade So Often

We get it. Trading sounds like fun, rewarding work. That's probably why you've read this far into the post. Easy money? Sure; we understand that short term trading elicits the same feelings you'd get after a big win at the casino.

Sorry to burst your bubble, but to stay alive, you must NOT be trading most of the time. Trade smart, not trade often. Even if we're doing this trading business full time, we accept the likelihood that there may not be any trading at all to be done for days, or even weeks. That means zero cash flow, and a stint driving fro Grab to make ends meet for your spouse and children.

A freelancer, needing to fine tune this business model. Source.

The real lesson is to only trade when the opportunity arises. And the next one will dispel any notion of 'fun' you may have towards trading: it takes considerable mental strength to do absolutely nothing most of the time. But there is no better filter against losses.

A simple analogy: Military strategists have now discredited carpet bombing (indiscriminate trading) as an effective method of defeating the enemy. They cause a lot of collateral damage (your small losses adding up, plus your brokerage fees), and do not meaningfully contribute to the end outcome of winning the war (making substantial, sustainable profits in the long term).

Instead, we favour precision drone strikes (Trading only when the situation allows it). The military now only attacks specific strategic targets to erode the enemy's capabilities (trade smarter, not more often). And this is done very rarely, and is backed by thorough planning and analysis (duh). The intention is to minimise collateral damage (decrease overall losses) while optimising the intended end outcome.

You win the war by conserving your resources and deploying them effectively, not via brute force. This is trading smart in a nutshell.


7) The Biggest Losses Come From a Series of Crucial Mistakes

The really big losses - and we've had several - come from a series of lapses. They tend to be a succession of serious misjudgments that snowball into into a major one.

A simple example is what tends to happen when you don't stick to your loss thresholds. Maybe you planned to exit that stock at 35 sen. It just hit 34.5? Hmm.. perhaps you should wait a bit for a rebound. By the time you're done with this thinking the stock probably would have collapsed to 30 sen, thus rewarding you with an extra 5 sen per share loss.We've gone through this scenario countless times - we're still learning.

The only way to prevent this from happening, or at least minimise its frequency, is to be self-aware of the mistakes quickly. We set very rigid, unbendable rules nowadays. Self-discipline has to be mastered; it does not come naturally for most of us, especially in a high pressure trading context.

So always write down your trading parameters and stick to them. Any breaches should be punishable by death (metaphorically). Even when you falter, always take notes to mark down your mistakes.

The next time you exited a bad trade at a huge loss, look at the catalogue of mistakes you've written down. You will find that the losses could have been minimised at every step of the way.

If you're not self-aware, you're bound to self-destruct.


8) The Biggest Gains Come From Playing It Safe & Boring


Consistent profits only happen when you execute your trading plan properly. When you have a winning trade, the temptation is always to try and maximise your gains. Even worse, you may be tempted to double down on your position, thinking that you're playing with the paper profits.

This is a fatal approach; doubling down simply means your profits can evaporate twice as fast. And if doubling down was never part of your trading plan at the beginning, you've also committed the lethal mistake of letting your greed take over your brain.

As an example, let's say you committed RM10,000 to a stock. It just gained 10% - fantastic. If getting out at 10% was part of your plan, you should exit and call it a day. Even if the stock immediately went up another 20%.

Because when this happens, we are naturally tempted to go back into the stock and chase the gains we didn't get. It's human nature to try and roll the dice. But if you're aware of this - the fact that your decision making is grounded in greed and foolishness, not logic - perhaps you will avoid doing this the next time.

Understand what parameters are for. For loss limits, we should never let them be breached. For profit targets, it's hard to exit and forego your extra gains, but trust us, it's the right thing to do. If you don't want to gamble with the losses, don't gamble with the profits. Value them for what they are; profits derived from a well-executed trade, not from rolling the dice.

IN OTHER WORDS...

Learning is a slow process. Like trading, you should never feel rushed. The process is incremental and can be painful at times. But stick to it and you may end up with some good stories to tell.




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