This huge mistake causes most investors to lose

More than 80% of all retail investors lose money - don't be a statistic!!

Over the last few months many markets, including equity indices, treasuries, energy and other commodities have been in a holding pattern, either drifting horizontally or staging rallies, then reversing direction. These conditions make it hard for investors to earn decent returns, but they can be particularly frustrating for trend followers, as they invariably result in drawdowns. A few months of drawdowns often suffice for some investors to bail or declare that a strategy is failing. However, drawdowns must be expected – they invariably follow a period of positive performance and investors who are too quick to react to them do so at their detriment.

Most investors lose

Most individual investors underperform or, if they trade actively, lose money. An 11-year study conducted by the UK Financial Conduct Authority found that as many as 82 percent of all retail investors lose money. This is consistent with the figures disclosed by many retail brokers:

This strong tendency of individual traders to lose money is almost entirely due our inclination to chase after returns. If some security has done well in the recent past (like Bitcoin in 2021 for example), we want to ‘jump in,’ but shun assets (like Gold or Silver) that haven’t moved much.

Even the most celebrated “market wizards” aren’t immune to this. One of the most spectacular examples was when in the year 2000, Stanley Druckenmiller ploughed $6 billion of George Soros’ Quantum fund into tech stocks literally an hour before the Nasdaq peaked and sustained a 50% loss over the next six weeks. I detailed this fascinating story and Druckenmiller’s own account of it in my October 2020 article, “How Stanley Druckenmiller Missed Market Top by an Hour and Lost Half His Fund.”

In the 2008 Journal of Pension Benefits, N. Scott Pritchard documented that from 1988 through 2007, while the S&P 500 returned 11.81% annually, the average investor achieved a return of only 4.48% [1]. In his commentary to Benjamin Graham’s “Intelligent Investor,” Jason Zweig suggested that investors achieve these results “simply by buying high and selling low.” Or as one blogger illustrated it succinctly enough:

Professionals are not much better

Professional asset managers are equally susceptible to this error and most of them also underperform. In his 2010 report “Untangling Skill and Luck,” Legg Mason’s Michael Mauboussin cites a study by finance professors Amit Goyal and Simil Wahal, who studied how well 3,400 plan sponsors (retirement plans, endowments, foundations) performed at hiring and firing investment managers over a 10-year period.

They found that plan sponsors hired investment managers after they had generated superior returns, only to see post-hiring returns revert to zero. They fired investment managers for a variety of reasons (poor performance topped the list), only to see the managers they fired deliver statistically significant excess returns. The key reason investors did worse than the average fund: they put the money in when markets/funds were doing well and pulled the money out when they were doing poorly.

Understand the process and the strategy!

It is not difficult to divine how and why asset allocators reach decisions that result in underperformance. An asset (or an investment product) at peak performance looks attractive with even a good looking set of statistics to show. By contrast, a decline in performance will make the statistics look much less attractive. But the key thing that statistics may not convey is the quality of the product: is it based on a valid investment strategy and is the investment process credible, well thought-out, and robust? 

As Mauboussin concludes, “in evaluating an analyst or portfolio manager, it is much less important to see how she has done recently than it is to assess the process by which she did her job… And make no mistake about it: the reason to emphasize process is that a good process provides the best chance for agreeable long-term outcomes.”

In other words, a qualitative analysis of an investment process might hold the key to improving investor performance: namely, basing their decisions on a deep understanding of an investment strategy and the management process in pursuit of that strategy.

That understanding could avert the fear which induces investors to part with good investment after a period of drawdowns. It could also make them a better judge of when to sell a stellar looking investment. Investing involves periodically sailing through rough weather. In such circumstances, “keep calm and carry on,” is often the best approach.

Markets move in trends

There’s a wide variety of valid investment strategies to consider. My own strong belief, which is supported by a vast body of empirical evidence is that market trends are far and away the most powerful drivers of investment performance and trend following is the most reliable way to turn your investing into a life-long success! Of course, this is easier said than done, but it beats losing and being a statistic. To be a successful trend follower you need a high quality strategy, iron discipline and patience. While I can help with the first part, the discipline and patience must be added at home.

We’re headed for rough waters

We are headed for rough waters. Inflation will almost certainly flare up again, stock markets might collapse, or alternatively go vertical, commodity prices - including energy, silver and gold - will probably go into a decade-long “supercycle,” and old valuation metrics might prove of little help. I believe investors’ focus should be on preserving as much purchasing power as possible over the coming crisis, and the best way to do this is through exposure to commodity prices.

Exposure to commodity prices also happens to be the best possible hedge against inflation:

We’ll be happy to help

For all who are looking to diversify from traditional asset classes, check out our TrendCompass reports (at link), which could help you navigate trends in commodities like crude oil, gold, silver and copper - as well as equity indices, bonds and FX pairs. In over 20 years, we have not missed a single LSPE (large scale price event) and I believe many lie ahead.

In addition to our ‘standard’ reports, we’ve put together lower priced offerings for individual traders. Supplying your own discipline and patience is obligatory.

Alex Krainer – @NakedHedgie is the creator of I-System Trend Following and publisher of daily TrendCompass reports. For US investors, we propose an inflation/recession resilient portfolio covering a basket of 30+ financial and commodities markets; in 2022, we significantly outperformed the S&P 500 as well as the 60/40 death trap investment model. For more information, you can drop me a comment or an email to xela.reniark@gmail.com

Notes:

[1] Pritchard, N. Scott. “The Tyranny of Choice – Why 401(k) Plans Are Failing and The Cure to Save Them.” Journal of Pension Benefits, Volume 16, Number 1 – Aspen Publishers, Autumn 2008.