Performance chasing is a common mistake among investors. It goes something like this. You buy asset A and own it for a while. Then it goes through a rough patch and begins underperforming so you sell and replace it with Asset B which has been doing really well. Unfortunately, the strength wanes and eventually Asset B starts to lag so you sell it and replace it with Asset C which has done really well over the past few quarters. Eventually, asset C tumbles and so you sell it in search of something better…
Rinse and repeat.
You are effectively buying high and selling low over and over again. Chasing what’s hot, then abandoning it after a cold streak.
It’s not a smart approach and it usually leads to sub-par returns. In most cases, you’re better off riding through the ups and downs with the original investment.
A similar phenomenon occurs with trading strategies. Their performance ebbs and flows. Because of this, many rookie traders abandon a strategy after a losing streak and jump to something else. They do so in hopes that the next strategy will be better. But, inevitably, their new shiny strategy encounters a losing streak of its own, prompting them to pivot to something else again. Maybe this time they’ll nail the right strategy!
Rinse and repeat.
The sequence of strategies may vary, but the result is usually the same. Some go from swing trading stock to covered calls to bull put spreads. Others move from iron condors to long calls to day trading futures.
If you’re stuck on the merry-go-round, consider this your nudge to get off of it.
To be clear, experimenting with many different strategies during your learning phase is encouraged. That’s how you learn what works for your personality and risk tolerance. But don’t fall into the trap of thinking your success is simply a function of not yet having found the right strategy, of not having ridden the merry-go-round long enough. At a certain point, you’ve probably experimented enough and instead need to start mastering and fine-tuning, and systematizing the strategy to improve consistency.
All systems – even the best ones – experience losing streaks. They are inevitable. But if you have a good system (one with proper position sizing, risk management, and positive expectancy) then with patience , profits will come.
I think in many cases, traders lack the patience to stick with it until profitable conditions return. This is partly a matter of the market cycle. As we rotate from a bull market to a bear market and back again to a new bull, certain strategies fall in and out of favor. When that happens you ultimately have two choices.
A) Jump from one system to another, hoping you have the right one on at the right time.
B) Stick with a system that works over time, be patient during drawdowns, and guarantee you’re there when better conditions return.
I find B more to my liking.
This quarter’s Trading Justice Newsletter just dropped and it explores the CBOE PutWrite Index. The Index tracks a naked put system. It doesn’t make money every month and has seen drawdowns along the way. But anyone who stuck with it has grown their account over time.
In this week’s video, I discuss the strategy Merry-Go-Round in greater detail.
Video Notes
Performance Chasing
Stocks: Historical return 8% to 10%
Investment Return: 10%
Investor Return: 5%
Why did investors not even get the asset’s return?
Answer: They didn’t buy & hold from Jan 1st 2000 to Jan 1st 2023.
The Behavior Gap
Investors are prone to buying high & selling low.
Over the past 3 years: Gold has done best
I’m gonna buy gold.
Next year. Look back
Bonds were best-performing asset over past 3 years.
Buy bonds.
Options Strategies
Their performance is cyclical as well.
Bullish period: Aggressively bullish strategies do best. Then they do bad when market neutralizes or goes bearish.
Market is cyclical – that means certain strategies outperform at different times.
- Try to rotate strategies and be in the right strategy at the right time.
- Build a good system that works over time and don’t abandon ship when things get tough because recovery will come.
- Iron Condors
- Covered Call
- Naked Puts
- Bull Puts
- Swing Trading
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