Measuring Performance
We measure, compare and contrast when it comes to a lot of things but one thing that I find amusing in a way is that the same rigor is not applied when it comes to understanding and shifting between good and ordinary trading systems.
Whether we wish to buy a Laptop or a Mobile or even a Car, we try to compare between the options present and select the one best suited for our requirements. But when it comes to strategies, too many are happy with something that works regardless of the fact that one may actually have made more money by just buying and sitting tight.
Too many traders / investors out in the real world care more for the thrill of trading than for actual returns. As one broker said in a interview and I quote ““Every month, your trading ‘fund’ gets replenished by your salary,”. When you aren’t there for the money, it doesn’t matter whether you outperform or under-perform as long as you get the thrill of trading.
But then again, there are many serious traders / investors out there trying to find ways to consistently beat market retursn without having to assume risks higher than what the markets showcase.
The primary belief that is needed to invest in the markets is the belief that the Index (country) shall continue to grow and stocks shall perform leading to returns that are better than what is available elsewhere (Fixed Deposit for instance). This is especially true for Buy & Hope investors since they need a market that is going up over a long duration of time rather than try and replicate the performance of Nikkei 🙂
Buy & Hold is the easiest way to take part in the market. Choosing stocks is not as easy as that though since a lot of parameters have to be looked into before buying today’s blue-chip lest it turn out to be tomorrow’s bust chip. A easier way is to instead buy funds / ETF’s that track the Index.
With most Indices being well managed (read that as including performers and dropping under performers / dud companies), the risk of loosing on the long term is significantly low. The biggest advantage in such a strategy is that you need not track the markets on a daily basis or even weekly and still be able to perform inline with the market (both on the upside and the downside).
While the strategy looks great in rising / bullish markets, when the markets get into extended periods of bearishness / range territory, one would not outperform the savings account interest let alone other benchmarks.
To overcome that deficiency, one needs to have an active trading strategy (active doesn’t have to mean intra-day trading or even end of day trading. Even a weekly / monthly trading strategy can be a active strategy).
There are various statistical ways to verify as to how good or bad the system is, but to me the simplest way to measure how good a system is (especially one that is used for trading the Index) is to see whether it has performed Buy & Hope returns. After all, there has to be something for the amount of time and effort we make and if we cannot even beat B&H, we may well just Buy, sit tight and hope that we shall eventually come out as a winner.
The benchmark idea is widely prevalent in the Mutual Fund industry as every fund is bench-marked against a Index which it hopes to outperform on the medium to long term. Without such a performance, a Do-it-Yourself passive investor will easily make more without having to pay anyone to manage his funds.
So, the next time you find some incredible strategy on the Internet, take a step back and check whether the incredible returns beat market returns or does it fall apart on a deeper investigation.
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[…] how one way to Analyze how good a system is, is by comparing the returns to Buy & Hold returns (Measuring Performance). Its hence nice to see similar thoughts echoed by the Oracle of Omaha in his 2013 Annual Report […]