The importance of reflection in trading and investing

A good investor/trader can average 15-20% per year based on natural talent or hard work alone. But what separates the good investors/traders from the great ones?

Great investors and traders constantly reflect on their past investments, trades, and strategies. They’re also constantly reflecting on others‘ strategies.

Only through nonstop reflection can you continuously improve your trading strategy. Traders who don’t spend enough time on reflection will repeat the same mistakes over and over, while traders who do reflect can achieve 30%+ returns per annum. Here’s an example of traders who don’t reflect.
A lot of Bitcoin traders felt like geniuses. They made a lot of money by drawing trendlines, moving averages, technical patterns, etc on cryptocurrency charts. They think they’re making money because their strategy is working.
In reality, their profits have nothing to do with their strategies! They were making money because they were simply buying crypto during a bubble! They need to compare what’s more profitable:

  1. Their trading in and out of Bitcoin, vs…
  2. Their buying and holding Bitcoin.

If trading in and out of Bitcoin is less profitable than buying and holding Bitcoin, then their strategy is not helping at all! That’s the power of reflection.

If you can’t beat buy and hold, then you’re doing something wrong. You need to reflect.

Now that Bitcoin is in a bear market, most of these traders are losing money even though they’re using standard technical analysis.

How I came to understand the power of reflection

I’ve been trading the S&P’s ETF’s since Day 1. I used to be a more short term trader until one day it hit me. “I’m busting my ass here, but I’m not generating exceptional returns!”
I did a simple calculation.

  1. What I’m doing right now, vs….
  2. Buying and holding the 3x leveraged S&P etf (UPRO).

You can calculate a theoretical UPRO because UPRO matches the S&P very well on a day-to-day basis. UPRO returned an average of 17% from 1950 to present! In other words, buying and holding UPRO results in a return that beats the majority of full time traders!

This quick reflection is how I got started on the Medium-Long Term Model. 15% per annum today is a bad year for me.

How you should reflect

The first question you need to ask yourself is

Am I beating my benchmark (e.g. the S&P 500 is the benchmark for most stock traders)?

If you’re consistently underperforming the benchmark, then you’re doing something wrong. For example, the majority of hedge funds underperform the S&P 500. Clearly they’re doing something wrong. Investors pay fund managers hefty fees so that they can underperform? What a load of BS.
The second question depends on how you answered the first question.

  1. I’m consistently underperforming.
  2. I’m outperforming by a little bit.
  3. I’m outperforming by a lot.

If you’re underperforming…
Then what you’re doing is wrong. Plain and simple. And it’s usually not a small mistake that you can fix via a small tweak to your trading strategy. It’s usually a big mistake, which signals that your strategy does not work in the market that you’re trading.
The solution is simple: go and see who is making money! Part of the reason I switched from short term to medium-long term trading is because I know that Jeremy Grantham is one of the best S&P 500 investors. He employs a medium-long term approach that combines fundamental signals and technical signals. So I read through all of his past newsletters to understand his strategy. There is no shame in copying others if you are unsuccessful.
If you’re outperforming by a little bit…
Then what you’re doing isn’t wrong, but there is room for improvement. This usually means that you’re strategy doesn’t work under specific market conditions. How can you edit your strategy so that it performs better during those market conditions? For example, your strategy might work better during a market that’s trending strongly. How can you improve the strategy so that it works better during a choppy market?
Or perhaps it’s better to combine someone else’s strategy with yours. For example, I know a currency trader who used to trade forex solely based on price action. She was doing ok, but not phenomenal. One of her friends was a good technical trader who used Gartley patterns. She combined Gartley patterns with her reading of price action, and today she is a very successful currency trader.
If you’re outperforming by a lot…
Congrats. But be careful. There is always room for improvement. Success can turn into failure if you’re not careful.
Be careful if you’re outperforming by a lot. Perhaps it’s only a temporary streak that’s caused by the current market stage. For example, I know a commodities trader who’s portfolio is up more than 300% this year! He feels like a genius. But I know that his average return is barely 20% per year. His strategy works best when a market swings sideways, and that’s exactly what commodities have been doing this year. He barely breaks even when the market trends strongly. So if he were to reflect, he’d start to improve his trading skills when the market trends strongly.

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