Monday, January 25, 2010


I'm sure everyone has heard the old phrase "if it sounds too good to be true, it is".

I've had traders inform me repeatedly that it would be ill advised to buy and hold even during a secular bull market because occasionally during bull markets we get a severe correction like `08. The hypothesis was that one could exit if they were a trader and allocate capital somewhere else during the correction and continue making money while the bull corrected. Ultimately making a lot more money by trading the bull than just holding.

Now first off let me say I will always prefer not to ride a D-wave down if at all possible, so to some extent I will trade the bull sparingly, but the reality is that 95% (I'm probably being generous here) will not make more money by trying to avoid drawn downs with a trading approach.

Let me explain. First off one is making a huge assumption that they are going to be able to make any lasting gains by trading during a bear market or even during a correction. I dare say very few bears made any lasting money during the crash and the few that did are now in the process of giving it all back.

Next let's take a look at what you are actually competing against if you think you can outperform a simple buy and hold strategy. Let's say you bought silver at roughly $5 in `03 when it started to become apparent a secular bull market in commodities was beginning and just held on through all ups and downs. Even after the recent correction you would still be up 240% as of last Friday.

Now how many traders can say they are up 240% in 7 years? Like I said it's probably 5% or less.

Realistically what's involved in trying to produce a 240% gain in 7 years? You have to compound almost 20% annually to do those kind of numbers. Do you know how many people can manage 20% annually over any significant period? I can tell you it's not a very large number. And if this year unfolds like I expect that 240% gain may turn into a 500% gain. One would have to produce an annual gain of almost 30% to match those kind of returns.

Now I know someone will come on and proceed to tell me how they did 200% last year alone or 50% last month or some other ridiculous number. I say ridiculous not because I don't believe they did it, but because the only way one does those kind of numbers is by taking huge risk or heavy leverage. And heavy risk always means bankruptcy in the end. So I know that the person who's bragging about trading his way to fabulous gains isn't going to be around long. I'm only interested in looking at traders who are intelligent enough to recognize the real limitations in this business. Idiots taking 20 to 1 risk or even 3 to 1 risk are of no concern to me as they aren't long for this world. They certainly aren't going to survive 10 years.

The cold hard reality is that the only, and let me stress only, way for a trader to make lasting money is by strictly controlling risk. That means a trader absolutely must keep position size small if they want to have any chance at all of having more money 10 years from now than they do today. That simple fact alone makes it very very hard to even average 20% annually much less 30%.

So all in all, the chances of a trader out performing a simple buy and hold strategy during a secular bull market, even if the long term investor must occasionally hold through a wicked correction, are almost nil.

So perhaps one might want to think twice before buying into the BS peddled by gambl ... I mean traders, spouting get rich stories.

It's not what you know, it's what you think you know that just ain't so, that gets you in trouble.