Assuming, we modestly target our annual % rate of return on capital at 30%. you'd think, that's quite a tall order, considering that S&P500 index historically made some 10-15% annual increase over a long time (well that's my impression from what i've read). Technically, if you are a one directional investor, namely a Long oriented investor, then naturally, to outperform S&P500 index, will be a challenge indeed.
Thankfully, it is NOT as difficult as it appears. BUT only if one learns to be flexible. To be flexible here means, having the ability to go both Long and Short AND also to profit in a range bound market. I'm afraid, there's really no other way to outperform the S&P500 index returns, unless and until this flexi-skill is learnt ! Think about it. If you can profit only by going Long and S&P500 tanks continuously, as it did for the last 12 months, how in the world can you make a profit? No brainer, right?
Let's get back to that 30% annualized return. To achieve this 30% annual return, all that is required is to make a very modest 2.2% profits every single month for 12 months. For the geeks, here's the math... 0.022 (to the power of 12) = 0.3 or 30%
2.2% of $5K is $110. To be precise, if you went Long 700 shares of Citibank at $7 (an investment requiring $4900) and exit at $7.16, that would make a profit of ~$110 (commissions excluded here). A mere 16cents upswing, is this impossible? Of cos not, in fact, it is quite common to see Citi making a 50 cents daily move on certain days.
Now suppose, we raise the monthly target return to 4% on a $5K capital outlay, which would mean making a monthly profit of ~ $200, we would effectively get a 60% annualized return on capital. Is it difficult to profit $200 in the initial month? Not too difficult, i think. It would be, if you only knew Long stock trading strategy.
Seriously, is making $110 or $200 or even $400 each month very difficult? Absolutely NOT ! Yet, if this is so easy, then, why aren't there millionaires everywhere?
Mathematics, comes easy to you and me, mostly. We can't say that of the concept of RISK.
And RISK, I say is the ultimate reason, many of us fail to achieve that 2.2% or 4% monthly returns consistently. To crystalize this point. Let's say, I lose $200 on the first month. To make up for this loss and still achieve my original 30% annual profit target, I will need to profit ~$440 (the 1st and 2nd months target of ~$220 + that $200 losses) by the end of the 2nd month. Recall, I only had to make $110 per month, now, due to an earlier loss, I now need to make $440, or 4 times the original target, in ONE month. Now, this is tough !!!
This is the reason why we MUST MUST and I repeat MUST cut our losses short and/or trade limited risks positions. We MUST know what we will be willing to lose even before we put on a trade. Every loss will impact the ability to arrive at that final intended % rate of return !!! Hence, if we allowed our trade to lose $1K, then it would literally take 9 months of $110/month profits, just to break even. Then, the entire year would be fuck off .....
We WILL inevitably lose on certain trades. If you don't believe this fact, you need to go back to the School of Reality. Ergo, the idea is to make an overall profit from a portfolio of trades constantly. This is the ONLY way to get ahead; there's no other way, amigo.
Achieving that 2.2%, 4% or even 8% monthly profit bottomline, is not as tough as we think. It only requires alot of planning, risks management, knowledge, skills and some lady luck. We can do this, only if we stop inhibiting ourselves psychologically.
But above all, we MUST work on our ability to manage RISK successfully. This remains the key to become Millionaires or even Billionaires in a realistic time frame...
Now, you know why we had to study mathematics in school....
Thoughts are very welcome....especially, opposing ones...thanks.
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