Investor Questions: Returns That Are Too Good To Be True – 8 Reasons Why

investors-questions-too-good-to-true

Every once in a while, an investor will send me an email or post to the forum discussing their “aha” moment. That moment when they realize they could indeed become a very successful do-it-yourself investor. They are always surprised by the types of returns they are making, because they know that investing is like a grave yard filled with investors who have lost large quantities of hard-earned cash through trying a wide variety of methods. Whether on their own, through a financial planner, broker or even a robo-advisor they have not done well.  They have tried mutual funds, ETFs, stock picking, books, magazines, podcasts, call-ins, call-outs, text trades, newsletters, day-trading, swing-trading, shorting, buying, dividend investing, forex, e-minis, bitcoins, bonds and much more. In short, just about every method you can think of, they have tried. In the end the vast majority of retail investors feel like they are entering the largest casino in the world where the odds of “winning” are stacked in favor of the house. Investors make some money in one stock and then lose it in another. In the end few become better investors. Most lose capital and the majority never return.

On the members’ forum an investor, Nitromicro wrote this post wondering if the returns he is getting are too good to be true. Here is his post:

“So I’ve been managing my own wealth since the 90s, learning as I go. I’ve made mistakes that cost 100s of thousands (investing in start ups, dot com stocks, various can’t miss stock picks). These lessons have been hard earned, but I’ve learned from them.

I have read all the standard investment books (Benjamin Graham, etc) and I switched to pure dividend investing after the 2008 crash. It’s worked out well for me. I did a little options trading (because pure dividend investing is soooooo boring).
I wasn’t very successful (I sold put options near earnings announcements, just before dividends, etc).

Then I came upon this site. I was always a big reader (about investing), I’ve read everything on this site. I only trade a limited selection of large cap dividend paying SP500 / TSX stocks. I sell put and covered call options (not around earnings), but I do the Bollinger bands trades and the Supercharge buy/writes among others. I roll out and down sometimes, try never to lose money, etc.

Here is my big question: I’ve been comparing my portfolio delta changes to the SP500 and the TSX. When I look back over the past twelve months (since I started spreadsheeting it daily), I have beaten both the SP500 and the TSX in terms of growth/return EVERY single month for the past twelve months.

I see Amy, who can pay for a beautiful wedding for her daughter all thanks to trading (a little riskier mind you).

HOW IS THIS POSSIBLE? This is simply too good be true. Teddi, your performance is incredible, following your trades and only doing the ones I fell comfortable with has worked out tremendously well. This is amazing. Can alpha really be achieved using your methods? Tell me I’m not dreaming.

I keep thinking I must be making a mistake somewhere.”  Nitromicro – Mar 31 2017 5:57 PM

For members, you can read his post through this link.

Some Answers

This article is open to all investors because I think it hits upon what I consider to be key elements of successful investing.

There are many reasons for the types of returns Nitromicro is seeing. There is of course the bull market itself which, although it had spent a lot of time sideways over the past 12 months, has still maintained an uptrend, albiet a small one. As well the largest pullback seen to date was just prior to the Presidential Election and it was not large enough to impact a lot of the stocks I trade in.

But there are other keys. Here are some of the reasons why Nitromicro is not dreaming or making a mistake somewhere.

Reason 1: Capital Preservation Is Number One – Profit Is Number Two

When I trade I focus on preserving my capital first. It has to be the main focus of any investing plan and every trade I enter is built on protecting capital first and earning a profit second. It is the number one rule of my strategies.

I will not risk my capital in a manner which increases risk, just in the hope of making a profit. Those trades I do not enter. Profit is important, but preserving my capital is more important. Any capital lost has to be recovered and that means time and more capital must be risked to recover lost capital. This is time lost when my capital should be growing. Instead if I spend most of my time recovering from losses, then my capital cannot grow.

As a sidenote, this is why investment gurus are wrong to advise young investors that they can afford more risk. This is absolutely the wrong advice. Young investors have a huge advantage that older investors do not – time. Time will compound even the smallest portfolio if losses are not taken. Earning even just 5% consistently each year and having that money compound is better than earning 12% one year and losing 10% the next.

Reason 2: Stay Away From Speculative Stocks

Almost as important as reason 1 is staying clear of most speculative stocks. Nitromicro indicates that he trades those stocks he is comfortable with. This is immensely important. Trading stocks that you “think” you would own, only to decide when it pulls back that you would rather “not” own it, is a huge disadvantage. It means that options that you have sold or a trade you have entered, ends up with losses rather than gains since bailing out of a failing trade, “rarely” happens at the beginning. It almost always happens when the stock is so low that the pain of loss is unbearable to the investor and he folds the trade, often losing large quantities of his capital.

Instead if it is a stock that you would indeed own, there are no fast rules that say you must “own” that stock today or even tomorrow or even 6 months from now. Investing in stocks is very risky. Options on the other hand, are designed to help control that risk. A declining stock can allow an investor to keep compounding his profit as long as he understand that at some point, he may be assigned shares. In many ways using options to control risk of stock ownership can mean getting into a stock “eventually” at a huge discount from where it is currently trading. But if an investor trades in a stock that makes them “uncomfortable” as it plunges, then they should not have traded in the stock from the very start. Staying away from speculative stocks is a prime reason I have been so successful.

Reason 3: Risk Capital Only With Large Cap Dividend Paying Stocks

The third reason is extends reason number 2. I trade in large cap stocks that pay dividends. This is not because I want the dividend. I usually sell options, so most often I do not earn the dividend since I am not holding shares. But the dividend, especially a dividend that grows annually, builds strength in a stock. It is true that support lines will break in any bear market or severe crisis. However it is also true that many large cap stocks will recover back to support levels at some point in the future, so I am always trading in an asset that should keep growing in value over decades. This gives me a lot of confidence in the stocks I pick and risk my capital in especially during bear markets and unexpected corrections and pullbacks.

Reason 4: Stay Focused On Small Gains

The fourth reason is that I stay focused on small gains. I trade for nothing more than small returns. I will accept a return as small as a quarter of percent if it means there have been no losses. If I can earn more than that in a trade, I consider myself lucky, but I am not willing to risk my capital longer than absolutely necessary.

I am never looking for a “10-bagger” stock.  Those are the stocks that can give back 10 times the original investment but can also literally wipe out a portfolio.

Reason 5: Close Early and Take The Profit

I close my trades early and take my profit. If I am in a trade and it goes my way but could have earned even more if I had been willing to take on more risk, I take my profit and move on. Taking profits is something most investors are incapable of doing. By selling options whether through Put Selling or covered calls, I am forcing myself to take my profit. I don’t have to question if I should wait longer. I close and secure the profit.

Closing trades early “rescues” my capital from risk. It immediately ends the risk of the trade and returns my capital to the safety of cash.

Reason 6: Setting Up Realistic Goals and Having A Plan

The goals I set are realistic goals. I have a plan from the outset on how I will manage the trade if it fails. I don’t second guess the trade. If it fails I implement the rescue. If in the end the rescue was not needed, it means the trade will still close with a profit and more important, my capital will be returned without loss.

This is why the Tomorrow’s Trade Portfolio does so well. It is based on having a plan in advance for rescuing a trade and it takes profits continually. The entire portfolio is designed around protecting capital first and earning a profit second.

For those investors who have a strong adverse to any kind of loss, using a stop-loss can be a big advantage if they refuse to “second-guess” the original stop. It is the same as Having A Plan since a stop once triggered forces a trade to occur and the trade ends either with or without a profit, but it ends and the capital is pulled from the risk of the stock market. A stop-loss can be a powerful tool if an investor picks their price point and remains focused in closing the trade at that stop-loss. Many investors who use stop-losses, often adjust them lower as stock or trade begins to fail. That is a mistake. Setting realistic goals and implementing the plan to meet those goals is essential to successful investing and capital preservation.

Reason 7: Understand Compounding Of Profits

Selling options or as Nitromicro mentioned doing the Bollinger Bands Strategy Trade are all designed for one thing. Small profits that compound quickly. My methods of investing are built around taking dozens of small profits consistently, week after week and watching the portfolio compound.

Earning $200 or $300 may not seem like much, but they quickly add up into a few thousand in a matter of weeks. Small profits taken constantly means my portfolio has more and more cash available for more and more trades. This is why it is important to understand the power of Compounding Profits.

Reason 8: Focus On The Trend and Don’t Listen to The News and Gurus

I always focus on the underlying trend of the stock market itself and the stocks I am risking my capital in. This is why each night I look at market breadth and the stock market outlook. I take profits continually in stocks that have a long history. So on one hand I consider myself a long-term investor since I follow specific stocks for decades until there is a reason to stop trading a specific stock. On the other hand I take profits week after week so I am also short-term oriented. This is because short-term I have better control on a trade than I do long-term. All I really need long-term, is for the stocks I trade to always recover from bear markets, corrections or pullbacks.

Watching the news and listening to “gurus” can often cause unneeded concern. Remember that news is all about sensationalism. The media love to drop “scary” facts so whenever the stock market is not rising, they parade out the bears with wild tales of the billions of dollars investors will be losing “shortly”. The belief in the media on down days is that this “could” be something “worse” about to start. Gurus love down days.

On up days when stock markets are surging and especially when they make new highs, the media talks about how overvalued the market is and how this type of rally just “cannot be sustained”. Negativity runs deep with the media and many “gurus”, no matter which way the stock markets move.

Don’t listen to them but instead watch the market trend and stay with the trend. When it eventually changes to down, and it will at some point, the strategies I use change so I can profit on the way down. The trend is far more important than the news or gurus.

Summary

There are of course, other reasons for Nitromicro to remain optimistic, but the most important reasons are the 8 I have listed above.

The 8 reasons above are the ones I adhere to in my investing. If Nitromicro takes a moment to review his trades, he will also see that whether he is aware of it, he too has been adhering to the same 8 reasons and because of that, his profits have remained consistently better than any of the indexes.

So to answer his question of “To Good To Be True”, it is not a matter of luck or good fortune but instead his returns are the result of focus, discipline, good stock selection and consistently taking profits while protecting capital from risk.

Thanks Nitromicro for your post. I hope others enjoyed it as much as I did.





 

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