‘Never underrate either the majesty of simplicity or its proven effectiveness as a long-term strategy for productive investing. Simplicity, indeed, is the master key to financial success.’
John C. Bogle, Founder of Vanguard Mutual Fund Company
Many traders would disagree with this statement. Simplicity is a refuge for novices. A real trader uses complex strategies. This is what gives them their edge.
Just look at today’s financial products: binary options, bitcoins, CFDs, collateralised debt obligations, leveraged FOREX trading. The list goes on…
The simpler ways of earlier times are a distant memory. Cutting-edge strategies and exotic products are the only way you can make it big these days.
Or so they say…
John Bogle is a pioneer. He made funds management accessible and affordable to everyday people. This was at a time when Wall Street was charging an arm and a leg for underperforming funds.
Vanguard’s strength is its simplicity. It aims to match the performance of an underlying index. There’s no discretion. The funds simply replicate the index they’re tracking.
And you know what…it works. Vanguard manages over $200 billion and is the world’s second largest fund manager. That says something about keeping it simple!
The US Navy has a name for this way of thinking. It’s called the KISS principle — keep it simple, stupid. The theory says that simple systems typically work better than complex ones.
This very same logic applies to trading. And I’ve seen it many times. Simple strategies will often trump their fancy complex cousins.
Many people think it’s clever to be complex. They make the mistake of linking simple with unintelligent. But that’s wrong. Simplicity requires clear thinking. And that can be hard.
Quant Trader uses elements of both complexity and simplicity.
The system’s architecture is unavoidably complex. It involves a lot of code and it deals with hundreds of thousands of pieces of data. There’s no getting around this.
But the strategy itself is easy to grasp. In fact, my 10 year old understands the concept. And that’s the way it should be.
Let me describe Quant Trader’s strategy in a couple of lines:
It’s all about buying what’s going up, and avoiding — or shorting — what’s going down. You then cut your losses, let profits run, and use a trailing stop.
I use a few extra techniques to improve performance. But that’s essentially how it works. I call this elegant simplicity.
So how’s the strategy stacking up?
Let’s start by looking at the All Ordinaries.
(The following charts and figures are for the close of business on last Thursday.)
The market was strong between December and February. But it’s been tough going since. The All Ordinaries is nearly 350 points below this year’s high.
Next up is Quant Trader’s performance over the same period.
This chart assumes placing a $1,000 on every long trade. And it doesn’t include dividends or costs. Shorts currently only have a small net effect. I’ll save a discussion on these for another day.
You can see that Quant Trader is clearly outpacing the All Ordinaries. The strategy of keeping it simple is doing well.
But a performance chart is only part of the story. It’s a bit like looking at a house from the outside. You need to see what’s happening inside to get the whole picture.
Quant Trader currently has 200 open long trades. These range from a gain of 135% to a loss of 31%. The average open profit is currently 9.4%.
It’s also useful to take time into consideration. The average holding period for open long trades is 147 days. This gives an annualised open profit of 23.5%.
These numbers are only for open trades. We need to include closed positions to get the full picture. The average for all open and closed long trades is 6.8%. This annualises to 17.5%.
In comparison, the All Ordinaries is up around 3.5%…or an annualised 5.6%. So by this measure Quant Trader is doing well.
Now let’s drill down further. I want to look at the distribution of open profits. This will help you understand how a trend following system like Quant Trader works.
Have a look at the table below. It separates the portfolio into four quarters.
The top quarter contains the best 50 trades. Then there are the middle tier stocks. The final quarter holds the worst performers.
The result is exactly what I would expect. The second and third quarters cover the losses and leave a small gain…while the top performers deliver most of the profits.
This is how a trend following system typically works. You make your money by letting winning stocks run. It’s simplicity in motion.
The key is to spread your trades. This increases the odds of getting a few top tier stocks.
Now think about this. Many traders like to complicate matters by locking in relatively small profits. This caps a stock’s upside potential — it can never become a big winner.
Imagine this table without the top 25%. It would drastically reduce profitability. This is what happens when you take lots of small profits.
Even good risk management won’t save this sort of strategy. The small winners will cancel out the small losses. People who trade this way often just muddle through, at best.
The first step to success is to develop understanding. From this comes confidence and expertise. It’s elegantly simple!
Until next time,
Editor, Quant Trader
Editor’s Note: This is it. In just a few hours your chance to get the lowest price you’ll ever see for the Quant Trader membership expires.
Tomorrow people will have to pay $3,499 to join.
But until midnight tonight, you can get in the door for just $2,199.
So if you want in, don’t delay. This is your final call.
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