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Successful Speculation Is About Not Making Mistakes

|Includes: SPDR S&P 500 Trust ETF (SPY)

Summary

Buy-and-hold's argument in market-timing is flawed.

Avoiding mistakes through market timing can reward huge.

2 first-order mistakes everyone needs to avoid.

Misleading Propaganda From Buy And Hold Camp

I'm a market timer. I believe that market timing outperforms buy-and-hold. However, the buy-and-hold camp disagrees with me. They claim the following:

  1. It is not tax efficient.
  2. You cannot time it correctly. Once you get out, you don't get in correctly.
  3. Buy and hold at least guarantees you the same performance as the market itself.

They even come out with this graph, claiming market timing is doomed to failure. They say that most of the gains happens in a short period of time, and if you miss them, you'll fail. The graph below shows what happens if you "missed" the best 25 days of the S&P500. The red line is the S&P500. The blue line is the "incorrect" timing that you missed the best 25 days. This demonstrates that buy-and-hold trumps market timing. Really?

I Just Want to Avoid Mistakes

To be fair, the above picture is just half the story. Why not let's do the opposite thing: how would I perform if I escaped 25 worst days in S&P500? In other words, I do not want to time for "the best gain". All I want is to avoid the worst falls. How would I perform? The following graph tells you the story. The red line is the S&P500, while the green line is the "lucky timer" who happens to avoid all the worst 25 days. See the difference?

What If I Miss Both?

What would happen if I missed both? I don't get the best 25 days nor do I suffer the worst 25 days. The result is interesting -- I'm still better off than buy-and-hold.

Here's a table for easy comparison from 1950 to 2018:

Strategy Buy-And-Hold Missed_Best_25 Avoided_Worst_25 Missed_Both
Total Gain 171X 40X 1080X 253X
Annual Gain 7.7% 5.5% 10.6% 8.4%
Max DD 55% 80% 45% 53%

By looking at the table, it becomes clear that avoiding mistakes is more important then finding the right buy point. Even if we missed all the 25 best days, we can still outperform buy-and-hold if we manage to avoid the 25 worst days. 

Avoiding Mistakes Is The Key

Like all things in life, the long-term success comes not only from steady progress, but also more from making less mistakes than from pulling spectacular stunts. How does this translate to speculation? It is simple, just don't make the following 2 first-order mistakes:

  1. Stay on the wrong side of the market. You essentially are fighting the trend.
  2. Taking too much risk by wrong position size.

If you have the above 2 figured out, you'll enjoy a long lasting success of speculation.

Disclosure: I am/we are long SPY.