Stocks & Commodities V. 27:5 (98,97): At The Close by L.A. Little

At The Close by L.A. Little

The Measure Of A Trader

What makes a successful trader?

IN 1973, Burton Malkiel published a book titled A Random Walk Down Wall Street, where he argued that asset prices typically exhibit signs of random walk behavior and that we cannot consistently outperform market averages.

Independent of the questions raised by this and subsequent works, the idea that should concern you is that it is impossible to consistently outperform the market averages. If that is true, then why are we all wasting our time? Further, is that really true?

HOW DO YOU MEASURE SUCCESS?

If you want to measure your success as a trader, there are three critical components. The first is that you must consistently outperform the average of the indexes that you trade. This is very close to what Malkiel said was impossible to do. A little later, I’ll deal with why this is quite possible.

The second component is that not only do you have to outperform the average of the indexes that you trade but your overall returns must be positive. It doesn’t mean anything if you were to outperform the average of the indexes when the indexes lost 40% and you only lost 25%. Losing 25% of your money is a failure, no matter how you look at it. In fact, the way you consistently outperform the indexes over a long period of time is that you don’t ride the market up and then back down, losing most or all the gains you made over the years. The real key to making money is keeping it!

The final component is that your gains have to outpace inflation. Now, we can argue what to use as an accurate measure of the real rate of inflation, but that’s an argument for another time. Your returns need to outpace the consumer price index (Cpi), if not some tougher measure. If the returns are not greater than the rate of inflation for the period being measured, then you are not really getting anywhere; instead, you are losing ground.