What would you say if, over the space of 1000 trading days (about 4 years), someone took their brokerage account from $100,000 to $368,756, while over the same space of time, the market drifted slightly up on average (as it’s generally accustomed to doing)?
Trading genius, right? Are you sure? Certainly a 370% gain over four years — in thousands of transactions over 1000 days — has to be due to skill, right? The more trades and the longer the time, it "stands to reason" that returns are going to approximate the mean and reside within a standard deviation — unless attributable to deliberate and sound conscious intervention, right?
This mean and standard deviation were used to produce random series of
daily changes (normally distributed), for 1000 days for each of 100
hypothetical traders (HTs). HTs don’t have any skill predicting the
market; they trade hypotheses in chat-rooms but buy and sell index
futures at random…
Of the 100 HTs trading just 1 emini at a time, the average final
balance was $98,965; loss of about 1%. None went below $10,000 equity
("bust"); the lowest point for the worst trader was $41,500. The winner
finished with $153,751; a gain of almost 54%…
There was another group of 100 traders, the HRHTs (High-rolling-hypothetical-traders). This daring crew also started with
$100,000 each, but traded five mini contracts each 1000 times (About
3.75X leverage; $250/pt, $30 vig round trip). The HRHTs average final
balance was about $95,000, but this erroneously includes those with
large negative equity at the end. Turns out 40/100 HRHTs busted
somewhere along their 1000 trades (defined as equity < $10,000. OK
they give up too easily, but if they were allowed to borrow from mom
the worst HRHT would have ended with -$189,000). However the winner of
the HRHT contest finished with $368,756!
Even without market prediction skill, leveraged trading in
updrifting market can be profitable just by chance. And the more
leverage used, the higher the possible return and risk of ruin.
I think that sometimes we neglect the first question or problem having to do with human endeavors. That is: how much of this (whatever) is simply chance? If you look at both cases, average final balance was roughly the same and not much different than where they all started from. But look at the distribution. Look at the amount of both good and bad chance that came to everyone.
It’s sometimes said that we make our own luck. I don’t know that’s true, but I do think that within the context of our lives, such as they are, we have a more-or-less random distribution of relatively good things and bad things that come along. If you have an optimistic or "I’m lucky" outlook, it can serve you well in that you’re open to the good chances that come along; but you must be careful, because your optimism might cause you to overlook important things that could derail your opportunity if not properly attended to.
On the other hand, if you have a pessimistic or "life sucks" outlook, you’re more likely to miss the good chances that come along and rather highlight, and then embrace the bad luck as affirmation that life really does suck.
This doesn’t always hold for everyone at all times, of course, and it must be understood that it’s relative to your baseline standing and context of life. Conversely, seizing and properly executing the good chance opportunities that come along positions you for bigger and bigger opportunities — amidst bigger and bigger risks, too.