Trading and Investing Success Equation

Many traders and investors fail because they are either in a hurry to become rich or underestimate the amount of work needed to achieve their goals. Others fall victims of get rich quick schemes. Success comes by working hard and being patient.

Trading and investing success equation

Probability of success = 40% (hard work) + 50% (patience) + 10% (noise)

A successful trader told me about a version of this equation in early 90s. I have modified slightly the equation over the years to better reflect the realities of the markets as they evolve. What does this equation tell us?

The equation tells us that the probability of success is a function of hard work, patience (including discipline) and noise, which some people call good or bad luck. Hard work has 40% impact, patience and discipline have 50% contribution and noise has weight of 10%. Note that over the years I have not changed the noise contribution, I think about 10% reflects reality.

We are talking about probabilities here: if someone works very hard, she is very patient and luck is on her side success is almost the certain event.

More importantly, note that if someone is not patient, even good luck is not enough for the probability of success to get better than fair coin toss.

In fact, extreme patience and discipline (hint: trend-following) and some good luck due to circumstances (market dynamics) were enough in the past for the success of CTAs. These traders used relatively simple systematic strategies that required patience to follow. Due to influx of dumb money and presence of higher serial correlation in market returns along with a downtrend in bond yields, CTAs made exceptional returns. But now their luck has run out due to shortage of dumb money and mean-reversion/algo dominance. This means that for CTAs to increase their probability of success, they must put some serious work in developing new strategies.

Most intraday and short-term traders fail because by virtue of selection of timeframe they are often not patient traders and usually luck is not on their side. In addition, developing strategies for those timeframes is a difficult task.

Factor investing and asset allocation schemes have led to crowded trades and they do not offer an edge. Probability of success is nearly the same as coin toss. For hedge funds to succeed they need to search for idiosyncratic alpha.

HFT traders have put a lot of hard work in developing algos and they are executing them patiently. This has allowed them to accumulate significant profits on the back of impatient traders and relaxed “do nothing” passive managers.

Many traders and investors fall victims of “gurus” and scams that promise quick profits. Some of those who make the promises enjoy large follower counts in social media while those who emphasize the need for patience, for example in following systems, or necessity of hard work, are being avoided. This is partly because people see the market as a gamble. Winning in markets means being more intelligent and working harder than other participants. Money don’t come out of thin air. Usually no one is willing to lose, especially the market makers. Crypto traders got that bitter lesson earlier last year.

It boils down to this

The harder you work and the more patient you are the higher the chances of success especially if luck is on your side.

  • Most of those who believe in get rich quick schemes eventually lose everything
  • Patience may not be enough if luck is not on your side in absence of hard work
  • Hard word is not enough even if luck is on your side. Patience is needed too.

Finally, a heuristic to act as a filter regarding probability of scam based on promised return levels:

Promised return (annual) Probability of scam
> 30% 50%
> 50% 75%
> 75% 99%

Especially irritating are some “gurus” who at the end of each year select securities in hindsight, compound the returns without any regard to risk, money management and capitalization constraints and announce huge returns to a large group of clueless followers who search for ways of getting rich quick. There are some of those in Twitter but unfortunately, or maybe naturally, they enjoy a very large follower count. This is an indication that people are not aware of their deception.


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