6
Mar
2016

Owning my mistakes

“It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much money you lose when you are wrong.” – G Soros

So over the last 12 months I have been doing a bit of CFD trading. You know, the advert with the Lady Gaga lookalike who shows her “too chic” knickers.  Then the CFD trader bloke decides to buy some “too chic” shares and makes lots of money when lots of teenage girls also buy the “too chic” underwear brand and company sales accelerate.  Yes that’s me.  I’m that guy.

Except I’m not.  The advert is wrong on so many levels.  No one I know sits around daytime TV trying to do that. Because the product gives you 10x leverage (for equities) this amount of leverage is actually unhelpful, because the random fluctuation means that you can lose money even on a good idea.  In fact, I’ve spoken to a former hedge fund manager who said that he tried, but found that it was too hard to make money trading CFDs.  I’ve never met anyone who has done it successfully.  Even Sean Quinn, once the richest man in Ireland lost hundreds of millions buying a CFD in Anglo Irish Bank’s shares.  A stunning statistic is that 80% of day traders lose money and quit within a couple of years. See this study.  So with those warnings ringing in my ears, I thought I would give it a go.

So with those warnings ringing in my ears, I thought I would give it a go.  For fun.

And these are the shares I bought over the year (NB I wasn’t shorting anything, I decided that was too hard).  The graph shows the share price performance from 5th April 2015 to when I closed my positions.

What I bought

RELX graph 1

So that’s why I’m not running a hedge fund.  My mistakes are obvious.  Most of the companies I bought went down over the year. You’ll notice that Reed (RELX) is the best performing stock +8%.  And Standard Chartered Bank (STAN) is the worst performing down 50%.  But weirdly I still made money.

The reason is that choosing what to buy is probably only 10% of the skill.  The other 90% which is much harder, is choosing when to buy, how much, how long to run with your winners and how soon to cut your losers.  And it is funny that vast majority of the financial services is to do with the 10% “what to buy”.  And there is virtually no help on the other 90%.

Looking at the graph shows how inept I was.  I managed to lose money in Reed and Royal Mail, which increased in value over the year. This is because, despite them being good investments, they first went down and I cut my losses too soon. And I actually made more money, buying Standard Chartered, Indivior and De La Rue  which all performed poorly, but I managed to buy at the right time.  Buying a falling share with 10x leverage is risky, commonly called “catching a falling knife”.  But I seemed to be able to do this (albeit I also lost some money on STAN trying to repeat the trick).  The important thing is that I did it in a disciplined way, and made sure I had zero “risk of ruin”.  The trade off is that you have to take the small loses.  Sometimes the things that everyone thinks are risky (rock climbing, parachute jumping) are not risky if you make sure you are well prepared.  And commuting to work on a motorbike, that is risky.

How I made money

INDV graph 1

So I found it an interesting exercise.  Particularly the distribution of gains and losses.  I made most of my money in my two best trades, and I lost most of my money in my two worst trades.  All the other stuff in the middle, I just about broke even.  The trick was that (perhaps by luck, rather than skill) I made 3.5x more money on the winning trades, than I lost on the two losing trades. I don’t think professional fund managers would like to release this sort of information on how they do, because it is too humiliating for them.  You could see their mistakes.

Is this gambling?  Maybe.  I sit opposite a guy who is into sports betting, and he never bets on his own football team,because it is too easy to become “emotional”.  And I would like to think that my approach is similar. I actively dislike the previous management of Standard Chartered, but I’m still prepared to make money in the bank’s shares if I think it is the wrong price.

I actively dislike the previous management of Standard Chartered, but I’m still prepared to make money in the bank’s shares if I think it is the wrong price.

For what it is worth, I think marketing CFDs to retail investors will be banned eventually.  The product is highly questionable when such a high proportion of people lose money.  It seems to me that a lot of financial services is about helping people to (legitimately) avoid paying tax, in this case stamp duty tax.  But the tax you save, is completely eaten away by the money you lose to the financial services industry offering these derivative products where you have to be really self disciplined.  

I wonder too about the social usefulness of providing people so much leverage just to trade with each other.  Really financial services should be about providing equity to growing businesses like my friends at Tandem Bank and Mondo.  The latter just raised £1m in 96 seconds on a crowdfunding website.  These are risky investments.  But it seems like a socially useful way of losing money.  Probably most of these challenger banks will barely break even, or be loss making.  There is a high probability of failure.  But one or two could go on to be really successful.  Maybe.  So if you make sure you keep your potential losses manageable, there might be some outsized gains.  

Anyway, I’ve closed out all my positions and am off skiing.  An activity with different risks and rewards.

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