I use to tutor for the math portion of the SAT.  During my tutoring sessions I would spend a lot of time going over the tips and tricks of how to solve mathematical mind puzzles.  One day I read a simple fact that changed how I tutored for the test.  I read that the last question of the test had only about 7% of correct answer responses given of the people that bubbled in an answer.  At first I thought, that makes sense--the questions get progressively harder as the test goes on, so naturally there would be few correct responses given for the last question.  But, the wrinkle was, that the question had 5 answer choices.  Therefore, by just pure random chance, 20% of the bubbled in choices should have been correct.  So, how could only 7% of the responses given be correct?  Here’s how...if you read the question, the chance of getting the correct answer goes down--not up.  The question (or stem) sends you down the wrong path.  When I realized this, I immediately began telling students that if you were not consistently getting the last 2 questions correct on the practice tests--then the strategy should be to NOT read the question, but just pick your answer choice randomly (a, b, c...), and just bubble it in as soon as you get your test.  Reading the question directed you to the wrong answer.

So, what does this have to do with the stock market?  Well, over the last 10-15 years of my trading, I have found a tremendous number of people consistently lose money in the stock market.  As a matter of fact, there are rumors (that I can’t substantiate, but that I believe are true) that several brokerage houses had isolated some accounts that had high stock turnover rates and the brokerage house actually took the other side of the trades instead of executing the trades in the open market.  Thus, if the person bought 100 shares of apple-the brokerage would short 100 shares of apple (and carry the risk) and not send the trades to the open market because the brokerages found that these people/accounts had an extremely high chance of going to zero.  Therefore, the brokerage would get all of the individuals trading losses (which was anticipated by the brokerage) rather than placing the trade in the open market and only collecting the commissions for the trades placed.  Some brokerages (perhaps) made money on the consistency of some people’s poor trading.  The conclusion from this...trading must be hard.  It must be incredibly difficult to make money in the financial markets.  As a matter of fact, I bet that for most of you reading this, if/when you tell your family about your trading endeavors people look at you as a wreckless gambler (because “you will surely lose everything”) rather than let’s say, a “sophisticated” real estate “investor.”  It is widely accepted that trading the financial markets has a very small chance of success. In light of this, I thought...is trading really that hard?

To look at this--I had a friend of mine do an interesting test.  He looked at the S&P 500 from 11/96 to 11/07.  Here is what was tested.  On day one, pick a random number between 1 and 10--buy the S&P 500 on that day.  Next, pick a random number between 1 and 10--exit the S&P 500 that many days later.  Repeat the buying and selling for 10 years.  Then, run the same test 1000 times.  With these parameters, I figured that making these trades was random.  I wanted to test what the success or failure rate would be if someone just picked trades out of a bag.  Over 90%  (of the 1000 samples) of the outcomes made money.  And the remaining 10% were close to profitable.  Wow.  I could just pick randomly and make money or not lose money 90% of the time?  The example given above, is completely random trading--and we are having a hard time making this trading “strategy” lose money.  The test is in cash for some strings of time, the test is going in and out of the S&P 500 quickly over some strings of time; and, it is hard to lose money!  Keep in mind, that this makes sense because the S&P 500 has about a 0.04% edge on any given day over the last 20 years.  Let’s take this a step further, the well publicized “Dogs of the Dow” strategy has made approximately 17%/year over the last 20 years.  If you look on the TradingMarkets.com website there are multiple systems that perform double and triple digit annual returns over the past 15-20 years.  Heck, look all over the web and in books--there are strategies all over the place that make money.  What is the conclusion from all of this...it is hard to NOT make money in the market.  Just like it was hard for only 7% of the people to get the correct answer on the last question of the SAT when there were five answer choices.

How could this be?  Perhaps, the construct of “the market” is always steering you to the wrong answer.  As a matter of fact, by “reading and studying” “the market” most people do worse than average.  Amongst a sea of winning strategies and combinations--we, as humans, amazingly find with remarkable accuracy the wrong combination of buys and sells as several brokerage houses have found (which is why they took the opposite trades).  One of my longest winning streaks when I started trading came from talking to my “trading buddy,” ask what he was buying or selling and then (without telling him) take the opposite side of the trade--and the same thing with the exit, of course.  It was incredible how my trading profits improved.  Amazing.

How do we take this information to improve our results?  I believe that the true answer is consistency in your trading plan.  You can’t deviate every time something doesn’t go your way that is what causes extremely terrible performance.  People often switch trading plans, styles, stops, and position sizing at the worst possible time.  Only to find out if they had just continued doing what they were doing--their account would be performing well.  I don’t know why it works this way--I guess it is the “collective consciousness” of the market.  We are all in some way--feeling the same way at the same time.  One of my friends always says that if you want to change what you are doing--you should write the idea down, and then in 2 months look at your idea again and see if you still want to change to your new idea. This way you prevent yourself from altering your trading plan in the same way that everyone else would want to at the same time. Not surprisingly, of the many times that my friend wanted to change his trading plan--he actually only ended up changing his plan one (1) time.  It is truly human instinct to keep looking at “greener pasteurs” and think, if only I was breakout trading right now, or, trend trading, or, counter-trend trading, or buy and holding, or selling options, or big-cap trading, or ....fill in the blank---that your performance would be better.  So what do we, as humans, want to do--we want to switch, and that switch is always at the wrong time.  In the end, we end up doing worse than random.  It is not that hard to make money in the markets with a well-thought out plan.  The hard part is sticking to that plan.  The edge I am passing on is to be consistent, it will, perhaps make a bigger difference to your account outcome over the next 10 years than studying and tweaking the stochastics of the 10 period RSI.  

Stick to your plan,

Steven