People often look for easy money in the markets. They are in for the reward without wanting to tolerate the pain. When I think systematically in quite efficient markets, the more gain you want the more pain you need to put up. Strategies with excessive returns need something that people are less willing to do. In my systematic world, for 20% annual average return a trader needs to expect around 20% drawdowns in equity, for 50% annual average return the drawdowns may be around 50% in equity that most definitely can’t tolerate. It may look good on paper when you can see the recovery, but in real life you don’t know how long the recovery might take and if the account will make a comeback at all.
Even big funds with PhD experts can’t go the pain route because they would lose clients who don’t have the mental training. So, managers in big funds need to target volatility, cut winners and double down on losers to avoid career risk. It’s okay for them to do poorly when everyone else is doing poorly, for example in bear markets. But they can’t afford to lose money in a bull market, therefore big funds try their best to do just close to a benchmark to keep their AUM.
In my own trading, I obviously manage risk and protect the downside, but I also need to do the hard thing, tolerate equity drawdowns that are hard for many, and trust my system by faithfully following it. Good strategies must be hard or they would get faded away by big money. Another hard thing is to take small losses and hold on to winners while they wiggle around giving back some profits before heading higher again. Shorts are good diversifiers in a portfolio, but they are psychologically hard to do for most market participants. Trading needs to be hard, otherwise it wouldn’t be rewarding. But the hardest part is the mental side and having the discipline to stick to what you are doing.
The US stock market got under selling pressure this week. However, it’s only been 5% down from the top. That is actually nothing, just a pullback. A trader needs to be ready for a pullback, correction and a crash at all times. The market can do whatever whenever. I started taking off short-term long risk couple of weeks ago and put on some shorts, when the underlying market breadth got weaker and rising prices were losing momentum. I’m still holding my long-term longs until they’re in uptrend. They need their own wiggle room for pullbacks to stay in the trend. Of course, my total return is taking some hit when markets make a sudden move in the opposite direction, but I roll with the punches and keep doing my thing. I don’t monitor my short-term performance but pay attention to the process. Each trading day when I follow my rules is a good day. A bad day is when not following the rules even if it ends in profit. Process over outcome. Next 100 trades. No pain, no gain.
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