Anybody can Make Money in a Bull Market

We hear that a lot. And, it may be true. Or, just an example of AVAILABILITY BIAS. In any event, let's explore what the possibilities are.

First, we need to define "make money". Seems simple. Here are some possibilities:

  • More money in the account at the end of the year;
  • Matching benchmarks such as the S&P 500;
  • Beating the benchmarks

Consider that a passive investor could put $200k into the SPY and likely reap the rewards of about 9.5% by the end of this 2018. That would both deliver more money in the account and match the benchmark.

As active investors, we cannot consider that "making money". We are putting time, energy and resources into our investing and there must be some payoff for doing that. Otherwise, playing golf is looking good.

Frankly, we need to beat the benchmarks by some significant percentage. Thus, our 10alpha program which has the aspiration of beating the S&P by 10%.

Zero Sum Game

There is debate whether the stock market is a ZERO-SUM GAME. It is more a debate about the time-frame than the concept. Taking a position today and exiting tomorrow, you might agree that it is likely your win is someone else's loss.

Taking a position today and waiting 20 years to close it, you may find it more difficult to imagine the system to be that closed.

On balance, over the short term, the market is a closed system. There is some money coming in and some money going out but for some relatively short period, those adjustments are trivial on $21.3 trillion (just the US market). Over the course of a year, if inflation or GDP growth or some other factor you might use to inflate the value of the market is 2%, the growth in value of the market isn't material given the size.

It follows than anyone gaining on a transaction must be offset by someone losing. The loser may or may not be the counter-party to the transaction. It could be somebody with options. Or futures. Or one sector losing to another on a rotation. The point is that the market creates nothing so must stay in equilibrium somehow over the short term.

I would submit, then, that anybody can win or lose money in a bull market may be more accurate.

About Risk

You'll hear, "I'll reduce my risk by using a spread" or, "I'll improve my odds by buying a put under it". I read one person's post where he said, "I like to put 'decorations' on my trades. I'll do a bull put spread and add an out of the money call just to get some better pricing". What?

Really needs to read our position on the probability of winning with multiple constraints. If you don't study probability and statistics, you are the sucker at the poker table.

Wikipedia defines RISK as the possibility of losing something of value or the intentional interaction with UNCERTAINTY. You simply cannot change the outcome in the market as you have absolutely no control over it.

It is not similar to wearing a seat belt to reduce the risk of injury. That action can actually alter the outcome. It is not like wearing a helmet when biking, rollerblading, skate boarding, etc. To the extent your language aligns these two very different concepts it will influence your decision making in negative ways.

Investing is similar to the insurance industry. A given investment may increase or lose value, something over which you have no control. However, you can take actions to mitigate the impacts should you be on the wrong side of a trade.

As a self-aware investor, you have to recognize the trap of irrational self-talk. Your internal conversations need to stick with reality. The more often you talk to yourself about mitigating risk, reducing risk, etc., the more you may begin to believe it to be possible.

Just semantics? Perhaps.

Yet those slight differences change your MENTAL MODEL of the situation, and therefore your decision-making, in ways difficult to measure. This is internally reinforced by the FRAMING EFFECT: having a 50% chance of winning is more seductive to us than having a 50% chance of losing.

More importantly, we tend toward risk-averse behavior in a positive frame (protect the gain) and risk-seeking behavior in a negative frame (recover from the loss). These natural biases are diametrically opposed to what our actions should be.

To the extent events play out in your favor, the investor will build a certain CONFIRMATION BIAS around that choice. We tend to remember positively those things that align with our actions and beliefs regardless of whether they are correct.

Additionally, the GAMBLER'S FALLACY will work against you. Gambler's tend to think that if an outcome happens more or less often than is customary then the opposite outcome increases in probability. Said out loud, it is easy to see the issue. Said internally? Not so much.

About Probability

Which leads us to probability. You will hear investors talk about their probability of winning on a given trade as though there were some table of probabilities or some universal law of probability in the market. Sadly, not true.

More importantly, there is no accurate way to calculate the probability of a given outcome for any equity type, trade type, company, industry, sector or the market at large. Anyone who posits differently, and there are many, are simply wrong.

To be wrong on this simple, fundamental truth will lead to irrational decision making.

All is not lost, however. We can do some work to establish relative probabilities. This enables us to compare investment tactics in a way that will improve investment performance. This is done by choosing higher relative probability trades, hedging (not the risk but the outcome) and establishing policies that limit our exposure (mitigate the impact) to the inherent (and immutable) risk of investing.

The final point on probability: it is only real to the extent that you take the same action a statistically significant number of times.

We don't do that with our investments. We take one shot at a given position. Or, as we teach in our TAP© training, perhaps 3 or 4 times as we create our final position as the aggregate of a few smaller positions. As such, debating whether a probability is 30% or 50% is academic at best while comparing probabilities that will lead to 10alpha performance.

For example, in flipping a coin, you have an equal probability of heads or tails. You cannot change that.

What you can change is the impact on you of the inevitable outcome. With the coin flip, the choices are limited: choose not to play or choose a loss level you are comfortable with and play until you hit that level.

But what you cannot do is change the odds, improve your chances or in any other way alter reality.

Winning Procedure

Step 1:

Choose the right companies and sectors given the state of the market. We have a PROPRIETARY PROCESS for doing this well which we teach in our TAP training.

Step 2:

Evaluate trade types that make sense considering probable outcomes. There are proven techniques for this which we teach. Additionally, our Performance Coach Software takes much of the grunt work out of the effort.

Step 3:

Establish standard operating procedure boundaries on investment size and maximum permissible loss. And stick to those SOP policies.

Step 4:

Make the trades that meet your trading plan. Wandering into the latest CNBC fad will not be in your best interest.