There’s a spectrum on every investing. On one end, the big Wall Street funds have huge supercomputers and trade ultra-high frequency thousands of times a day. On the other end, you are buying a good stock and holding it forever. And in between, there’s a whole bunch of different ways of doing it.
As individuals, we can’t do this high-frequency thing; you can’t compete. We can do the long term buy and hold forever, but the trouble is that we don’t typically have access to the research, management team, or the company. We can’t interview the CEO or can’t form those high convictions, deeply researched positions that maybe someone like Warren Buffett can. We can delude ourselves that we can and say “Oh yeah, I did research. I Googled it.” But, the truth is, we don’t know.
Back to the question of what trading is, it’s actively buying and selling stocks, crypto, and commodities. It’s using rules to get you in and out of the market, hopefully with a profit over time. There are different ways of trading. You can do fundamental research, which is understanding the company and understanding the marketplace and the competition. That’s pretty hard for an individual to do and even if you do it, it’s hard to know if you’re any good at it because you can’t test it in the past. You can only do it now and then, in 10 years, say, “Hey, did I make any money in the last ten years?” It’s like, you’re not willing to leave that to chance.
But technical trading, which I do, is where you have rules based on the price movement of the thing you’re trading. You see the stock market charts, the little candlestick bars, and the price goes up and down, and you can put indicators and moving averages and that sort of thing on there. That’s what I’m talking about. And the good reason is that as an individual, you can do it and learn it.
But what most people do is they get their chart and draw some indicators, and they look at it and go, “Okay, well, I think this is going to happen. So I buy.” And that doesn’t work either because what we think will happen is all driven by our emotions. I want to take it one step further and suggest that you need a system, a set of rules. And if you trade by a set of rules, you have some exact conditions that get you in and exact conditions that get you out. And the cool thing then is that you can take those rules and test them on past data.
I took one of my sets of rules the other day, and I tested it on all stocks that have ever been listed in the United States between 1950 and today. I did a backtest, wherein I put those rules into the software and took all of that data every day, every stock, found all the buys and sells, assembled the portfolio and showed me how that portfolio would perform over time.
The question is, if I gave you a strategy and you backtested it, and that strategy lost money for the last 70 years, would you think that’s a good strategy? Would you follow that going forward? Of course not. That would be dumb. But if I gave you a strategy and could show you that it worked over the last 70 years consistently, the trend of that strategy was up the whole time. It had some dips and whatever, but generally, it made money. Would you think that might be a good strategy? Yes.
Most people follow rules that never worked in the past and so they’re never going to work in the future and then they wonder why they lose money. But if I test it the right way on the historical data, and it did work, there’s a much better chance that you will make money in the future.