Friday, August 13, 2010

Expectations When Stock Trading

Over the years of trading, training, and coaching I have had the pleasure (mostly) of meeting and working with quite a large number of traders and I am always interested in what results they expect in their own trading. Sadly, most have not even come close to realizing their own expectations. It seems to me that those results suggest one of three things: either their expectations are unrealistically high or their trading is not as good as they think it is or will be or, a combination of both.

I remember when I first began and read a trading book (that shall remain nameless) where the author illustrated a description of strategies with an example of an actual trade or two. The trades were always winners and often in the examples the trades were relatively short term, from a few days to a few weeks. Many achieved very nice percentage returns over the short periods and the author then went on to annualize the results. He would take a trade that had made 30% in a month and then annualize the percentage to suggest that a trader could make 360% a year (12 months x 30%) using that strategy. Annualizing a result like that can be both deceptive and dangerous. Of course those kinds of returns are possible but it is the extremely rare trader who has achieved such great results over the period of a year or more. The simple fact is that almost no one does. The truth is that it is the relatively rare trader who beats the S&P in any given year let alone year in and year out.

Recently I had a discussion with a relative novice trader who has been undergoing long term mentoring with a fellow employed by a brokerage as a paid mentor for the brokerage clients. The trader with whom I was speaking had lost several trades in a row and was somewhat discouraged because the young fellow doing the mentoring claimed that he was making between 200% and 300% a year in his own account. I wondered aloud why the mentor was still working for someone else if he was doing so well. Whatever the truth, the mentor's claim gave rise to very high expectations on the part of the trader with whom I spoke.

Not only do traders often have exaggerated expectations of how well they will do, but they also often have completely unrealistic expectations of how fast they will do it. I often see this type of unrealistic impatient expectation in the subscription services I edit. In $10 Trader, for example, I have closed 15 consecutive winning trades since last October following the close of an exact breakeven trade. Since April 8th of 2009, I have closed 20 out of 23 trades as winners. In spite of those numbers I am often amazed to see subscribers quit after only two or three days or a week of their free trial. I can only conclude that things are not fast enough for them in their learning experience. If they are going to trade with real money it seems that results rather than a lot of action might be more important. If it is action we want, we can find it in any casino in the nation.

I don't mean to suggest for a moment that it is realistic to expect more than 85% winners. In fact, it isn't. Money can be made with a much lower percentage of winners if appropriate cut loss measures, money management, and reward to risk parameters are employed.

The stock market is not the lottery. It takes time and it takes work to become a good trader. However it seems to me that when a trader has unrealistic expectations concerning the time required to trade, the return to be achieved, or the speed in which reasonable success can be expected, or any combination of those unrealistic expectations he is likely to become prematurely disheartened.

If we stop for a moment and consider how much of a return we get from a savings account or from a CD we may have a greater understanding of what a decent or good return is in the stock market. In my latest book, "Smart Investors Money Machine," for example, I discuss a number of strategies to produce income. Among them are covered calls that often return 1.5% to 2.5% a month and MLPs that pay healthy quarterly distributions, some greater than 8% or 9% a year. One might consider an MLP that is optionable, get the quarterly distributions and also sell covered calls. Even if that trader only averaged 1% every other month on the covered calls and also got an 8% distribution over the course of the year he might achieve a 14% or 15% annual return. Certainly that is a much higher return than a CD might offer, but, of course, there is added risk in that the unit price of the MLP will almost certainly fluctuate and could go down over the course of a year. In fact, the company could go out of business (as with any stock) so there is always risk to be considered.

At times I have made as much as 35% or more in a month on a single credit spread, but the fact is that credit spreads may and do lose so it is unfair to say I am making 35% a month on my credit spreads. Some do, many don't. For me they are fine to trade because I don't expect them all to win. In point of fact, I know that some inevitably will lose and when I open one I never know whether that particular one will be a winner or a loser. Through years of trading the markets have taught me that my initial expectations were significantly overly optimistic. Does that mean I quit trading? Definitely not. I now understand and accept that some trades win and some lose and as I wrote in a recent article, a few do really, really well. That is what I expect. I expect to study, to read, to continue to learn, to win some, to lose some, and every so often to achieve a big gain or two. That is what experience (mine and observing others) has taught me. Almost certainly, at least with rare exception, the trader who jumps in expecting to make a quick killing succeeds only in killing his own trading account.

by Bill Kraft, Editor
Copyright 2010, Makin' Hay, Inc.
All Rights Reserved

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Harold said...

I've been reading your articles for about a year and enjoying them. But this one is the best Ive read. I agree completely and have faced and felt all the emotions you talked about. Keep up the good work.

Bill Kraft, said...

Thanks, Harold. I'm glad you've been enjoying the articles.
Bill Kraft

diesel said...

I could not have said it any better. I have a friend who I have been trying to help, but he expects to just go out and get the BIG HITS without putting in the time and work it takes to be a "Trader". He thinks the small profits are not worth his time. They add up over the long haul, they are income generators. He has worn his trading account down trying to get the BIG HITS.

Anonymous said...

Hi Bill great blog , you really got into the meat with this one.
Very valuable info thanks .
It seems a little alarming about
being relitively rare that a trader would beat the S&P in any giving year, but very good to know.
From 2000 to 2003 the S&P lost 43%How do down years factor into things if your able to short the market.


Anonymous said...

Hi Bill,

I’ve worked at trading for 19 years and have developed some excellent screens/trading approach. I don’t claim to be able to equal your prowess, but would be interested in hearing from you if you find a 310% return (YTD, annualized) interesting.


Anonymous said...

This is amazing to me, i.e., that your expectations should be so low.

I should think that you would still be searching for a better way to trade?

SUJIT said...

Hello Bill,

Read your blogs with interest. I agree that the claims and counter claims (yours included) is simply mind boggling. It is always the one that got away ...

I always see that in your "vital statistics", you too write things like "Achieve returns with us like 16.48% return in 5 days!". Instead of "in 5 days", how about a numer against "in a year"?

Again, let's match this claim "52 Wins in 52 Weeks" (really? - wow!) against this observation "I wondered aloud why the mentor was still working for someone else if he was doing so well." You get my drift, right?

My personal trading history shows that I make a disproportinately high winning trades than the losing ones. BUT that ONE well aimed shot, the one that pierces the heart, brings all winning trades to a nught. So claims like "x out of y winning trades", though sounds wonderful, has little meaning for traders like me.
For a truer picture, a calculation based on actual completed trades, over a tax year, would make real sense.

I agree completely with you that this is DEFINITELY a long term game not for the faint hearted nor for the greedy fidgety people witbout conviction. This is not a game where you roll the dice. And lady luck has no part in the long run.

I have bettered myself as a trader by teaching myself to be patient in letting trades come to me rather than me going out for them. In my greenhorn days, I used to shoot anything that moves, the idiot that I was. I had read Buffet's famous quote where he said that he was like an elephant hunter sitting patiently by the water holed, but had not bought into it - to my own misery.

It is in the more mature years that I realize that not only is his quote 100% correct, that its corollary, that you don't have to necessarily make thousands of trades (like the "merchant banks" on wall street) to make money. It is the few but selected trades, that meet your investment criteria, that really puts one in the gree zone consistently.


Bill Kraft, said...

Thanks, diesel. I have a lot of empathy with your efforts to help your friend. Unfortunately a lot of would be traders just don't get it until they have had some graduate level classes in the school of hard knocks.
Bill Kraft

Bill Kraft, said...

Thanks, Morris. In general novice traders often make only bullish trades and in down markets they can expect to get hurt pretty badly.
Bill Kraft

Bill Kraft, said...

Paul, that sounds like some wonderful trading though I urge extreme caution in projecting overall returns by annualizing. You've clearly been doing the work that's needed to achieve great success. Keep up the good work.
Bill Kraft

Bill Kraft, said...

Dear Anonymous, did I say those were my expectations? They are not, but I have traded for my living for a long time. I'm talking about relatively inexperienced traders; ones who have made fewer than 1000 trades. Where do you fall?
Bill Kraft

Bill Kraft, said...

Sujit, your comments are excellent. I should note that I am not the trader claiming 52 wins in 52 weeks. That particular service is run by the publisher of MarketFN. I edit only the Option Trader, Trend Trader, and $10 Trader. I did write in the column that I have not had a losing trade in the $10 Trader since last October. That's 17 straight closed winning trades. In Trend Trader it's been 20 winners out of the last 23. I also agree that most of the money is made in just a few trades and that has been the case in my own trades as well. I do make a lot of trades in my own account, however, because one can never know ahead of time which one will be the winner. Even Mr. Buffet has taken some very large positions that did not turn out so well. His recent retreat from Moody's is an example of an elephant that didn't fall to his rifle.

Oh, by the way, Sujit. I don't work for anyone but me.
Bill Kraft

Anonymous said...


Isn't the truth that if you didn't have this column and the other service conduits you sell to the readers you email to, you would starve to death? Not totally trying to be mean, but let's have some honesty here.


Bill Kraft, said...

No, Mike, your statement/accusation is absolutely false. I make the great bulk of my living trading. I email to no one. I do edit 3 subscription services and share in the very modest returns on those. If they went away tomorrow it would have absolutely no effect on my life. I resent your accusations and want to tell you that your impressions are completely false. Only a fool would make such accusations without knowing about which he spoke.
Bill Kraft