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I just took part in an online trading challenge sponsored by the National Post and Eriksson:

The contest ran from 23 October until yesterday and I finished 11th out of about 5,800 entrants with a total return of 32.13% on an initial grubstake of $1 million. The winner had an unbelievable return of 79.5% in 38 days. I actually spent about 4 days in first place, but I sat on the sidelines for most of the last 2 weeks and got rolled over by the frontrunners. There were prizes for the top 15 finishers, and I won a RIM Blackberry pager, which I find very ironic given that I shorted RIM on 5 separate occasions and made $48,000 of my profit at RIM's expense (I also shorted it in real life during this period).

If you've followed my recent posts (and former posts as Semper and TWA38), you know I'm primarily a bearish value guy who tries to have a long-term perspective, so what the devil was I doing in a trading contest? Well, I was trying to practice some new tricks with a rigorous accountant to keep me in check.

For the record, my definition of investment, as borrowed from Ben Graham, is that which provides adequate return on capital and safety of principle (e.g. margin of safety). My definition of speculation is something that provides above average return on capital coupled with favorable odds. In other words, there's no guarantee that you won't lose money, but rational speculation occurs when the risk/reward spectrum is nevertheless tilted in your favor. Buying lottery tickets isn't speculation, it's gambling, because the odds are against you from the beginning. The time horizons can also be much different: investment = years to decades, speculation = weeks to months, trading = minutes to days.

A few things I learned:

1) You don't have to be right all the time to make money. I made money on 45 trades and I lost money on 30 trades, so I was only right 60% of the time. Admittedly, that's more than half, but it's a lot closer to coin-flipping than it is to perfection. You don't have to be right all the time provided you…

2) Cut your losses short. It's so easy to say, but so hard to do. It's certainly easier to take a small loss with virtual money, so in some respects this was good training. The contest didn't allow stop-loss orders, so I had to monitor positions a couple times a day and bail out if it was moving against me. In many cases, I bailed out at a loss only to have it turn around and move back my way, but you can't count on that happening. I only had 7 losses that exceeded $10,000 (1% of my original capital, or 5% of the maximum position size of $200,000), and in all cases these were situations that moved rapidly against me before I could take corrective action. With strict stop-loss orders in place, my major losses could have been reduced to 0. In contrast, I had 21 positions where I gained more than $10,000, bringing on the next rule…

3) Let your winners run. When you enter a profitable position, don't turn tail and run with piddly profits. Protect your profits with a stop-loss (or mental stop-loss in my case), and try to turn your profitable trades into killer trades. One of my problems during the competition was that I had to go on 4 separate cross-country business trips where I couldn't monitor my positions, so I shut them all down right before I left. I was doing very well on several of these, but lost out on opportunities to do outstanding (like shorting Brocade [BRCD] at $261 and riding it down to $241, but missing the rest of the ride down to $150).

4) Hedge your bets by going both short and long. Obviously to make money in the last month I had to have been playing the short side, but at any one time I was about equally short and long. Because my short positions turned over faster, I had about two short positions for every long. I made 33.9% on my short positions and lost 1.9% on my long positions, but if the market hadn't melted down like it did, the longs would have kept me from losing my arse. If you can't/won't go short, then you shouldn't try to speculate, because you'll have one hand tied behind your back relative to your competition.

5) Margin cuts both ways. We were allowed to use margin, and everybody who finished in the top 20 was certainly well extended on margin at various points during the competition. But the early leader, a trader named Sylvestre from Quebec who was up something like 45% the first week (!), disappeared from the rankings overnight when the Naz began its first free-fall (e.g., he lost more than 30% on a single day the Naz might have gone down by 5%). My rule was “never be more than 100% long, or 100% short.” When I used margin, it was always to hold about 75% short positions offset by 75% long positions. If I had been 150% long or short on margin, the big market-wide moves would have wiped me out in short order.

6) Bet big, or don't bet at all. I was risking from 10 to 20% of my capital on any given trade. If I was uncomfortable risking that much, it was a pretty good sub-conscious signal that the trade was too risky. I think diversification is fine for investing, and for speculating with real money, but if you're mentally unwilling to risk 20% of your capital on a trade, you probably don't need to risk 2% either.

7) Patience is a virtue, even for traders. Even though the competition was only 29 trading days long and I was out of commission for 8 of those because of travel, I didn't trade just because I had capital available. If there was nothing compelling (and I was looking for something where I thought the odds were > 2:1 in my favor), then nothing was often the best thing to do.

8) And finally, this ought to be fun! I know it's no fun to lose money, but by the same token, it doesn't do any good to gloat when the market is going sky-high, taking all your stocks along with it. Trading requires a quick admission of guilt when the market proves wrong what seemed like a good idea at the time. Bouncing back from these losses (and learning and adjusting to the mistakes, if any) is probably impossible if you don't have a good attitude about it all. Even though it was only virtual money, punching in the sell order on losing trades (or “buy to cover” for shorts) always hurt at the time, but just like flushing the toilet, it gave me a clean bowl to work with.

Good luck all,

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Was this just individuals in this contest? Or where there investors from banks in this?
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Congratulations Todd! While most people might find this impressive, remember, your portfolio isn't being invested for 29 days, but perhaps for decades. Your probabilities of being right on a stock selection is 50/50. The more trades you execute, the greater the likelihood that your performance will gravitate towards this ratio.

Todd executed 75 transactions and was correct on only 60% of them. He benefitted from the fact that his winners provided greater returns than his losers. But this is very unlikely over any prolonged period for the average investor. It would be very interesting to see what was the median return on the portfolios for all participants.

Also, Todd, were frictional costs, such as commissions deducted from your portfolio? As well as, capital gains that would be paid out on the transactions were excluded, if this portfolio wasn't registered. While buying stocks, trading, watching the markets and studying your portfolio may be exciting, the average investor would be wise to be LTBH. Portfolios in the long-term would be best served to be in quality companies, or diversified index trust units or low-cost mutual funds, assisted with regular contributions and little concern regarding the day to day gyrations of the market! Cheers!
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It would be very interesting to see what was the median return on the portfolios for all participants.

Interesting post Todd, congratulations on your results. I'm jealous! I have long accepted the horrible truth that I am totally inept when it comes to trading. :>)

I agree with Parsad, I too think it would be interesting to see the median results in these sorts of contests. Such a number would tell us the returns that 50% of the participants exceeded and also the returns below which 50% of the participants earned. This is a much more meaningful number in situations like this than the mean which can be significantly skewed by a few strong performers.

Let us know how you do next time around ... who knows, you may have discovered a latent talent for making money!!

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<Your probabilities of being right on a stock selection is 50/50. The more trades you execute, the greater the likelihood that your performance will gravitate towards this ratio.>

..For some this is not true, I think for Todd to rank so well takes a bit of talent. To make money in these markets all it takes is to follow the rules he mentioned in his post.

..The hardest part of speculating is to follow those rules, it may seem easy thinking about it, but actually taking losses on trades without flinching takes a sense of detachment from the money.

..When I started out speculating some 10 years ago, I use to have beliefs that were rooted in inexperience of the markets. I use to think the market was pure chance and luck had more to do with making money in the short run then anything. But this is not true, systematically you can pull out a good deal of cash from the market. All it takes is a plan, and some risk management.

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While this is a great board, it is downright stingy when it comes to awarding recommendations. No other Fool board that I frequent is so miserly. (Maybe we are just being quintessentially Canadian). Up to this point you have accumulated 24. I can't remember any other message on this board receiving such an honour in the year or so I have followed it, and in that time there have been great posts from some highly knowledgeable posters. Congratulations! I hope it makes Post Of The Day. It deserves it.

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Congratulations Todd, your stock-picking abilities and quality of your analysis are well known to everybody who reads your posts on this board. As for the lesson #1 that you learned, I think you can expect better than coin-toss or 60/40 ratio IF your investments are long-term oriented. I don't believe that in real life you will make 75 trades per month (never mind your bearish, careful approach; nobody in his right mind can ever state that 75 somewhat meaningful DDs can be accomplished within one month). You were gambling, not investing. You probably had your homework done and most of the companies you were buying met some kind of entry criteria... But for your real portfolio, your real retirement money the entry criteria is probably much more strict.

Keep posting,

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Congratulations, Todd!

I find it amusing (and disappointing) that most of the others who commented on your success also told you that you were doing it wrong.

Perhaps it is just human nature to run down others, instead of learning from the best.

Do these guys criticize a home run because it came from a bad swing?

A hockey goal because it came from a rebound?

Anyway, from this corner, without reservations, well done!

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