Trading is often presented as this enormously complex activity that requires great quantitative skills – this is not true. However, you do have to develop an intuitive feel for what some numbers mean. You will need to understand how to position size correctly, where to place your stop, and how to calculate your returns. But all of these are simple calculations and require no more than being able to add, subtract, divide, and multiply.
What is important is that you be able to recognise when something is not quite right either in the calculation you have generated or when numbers that are presented to you don’t quite make sense. Consider the example below which is from Motely Fool and which dropped into my spam folder.
Frazis Capital specialises in “explosive” growth shares, predominantly on the US markets. While it almost doubled clients’ money in 2020, the 12 months to October 2022 saw it lose more than 61%.
Before reading on ask yourself if would you invest with this fund manager and consider your reasons why – mine is given below. But first, we need to look at the numbers presented in the quote.
The fund doubled its investment in one year and then in the next lost 61%. So if we were to ask what the average return for these two years is we would generate the following calculation (100%-61%)/2 = 19.5%pa. You might be fooled into thinking that this is world beating performance and this averaging of returns is a tactic fund managers use all the time.
However, we need to think about how this works with real money. Let’s assume we invested $100,000 at the beginning of year one. This doubles so at the end of the first year we have $200,000. In the second year, we lose 61% so our $200,000 becomes $78,000 – we are down $22,000 on our initial investment. Not what you would initially expect when compared to our simple percentage return calculation.
This outlines the true nature of using real money but it doesn’t answer the question of whether you would invest with this manager. Knowing the real returns would certainly guide your answer but the true answer is given in the quote and is linked to the way we looked at the real returns. My answer would be that I wouldn’t invest with this manager because based on what we have seen they have no concept of risk control and you could put forward the idea that the initial returns were simply the function of investing in a bull market and then not knowing what to do once this market came to an end.