Why Time is The Most Overlooked Trading Tool: By Justin Paolini

“Compound interest. Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.Compound interest is the most powerful force in the universe.” – Albert Einstein

Trading is not easy, and it is certainly not the only way to compound your way to wealth. Traders who constantly follow the pot of gold at the end of the rainbow eventually blow up. The main reasons for this are:

  • trading too frequently (looking for action instead of sizing up probabilities)
  • risking too much on each trade (greed, instead of properly respecting market risk)
  • pressure (whether self induced or deriving from others, instead of maintaining a relaxed and positive attitude)
  • lack of discipline (especially when faced with a drawdown, not sticking to your method and instead going astray)
  • etc.

Once again we need to talk about the adverse effects of chasing profits or focusing on the money. Have you ever realized that all trading (and investing for that matter), as well as going after high-paying jobs, is just an attempt at beating time?

Time Rewards Discipline and Consistency

Whenever you attempt to pick the strongest trend, or pyramid into a winning position, or maximize any given investment opportunity, in reality you’re just trying to beat time. Einstein had already realized that time is the most valuable asset in your investment arsenal, if you allow it to work for you.

Let’s suppose you’ve got an asset allocation that allows you to compound at 5% per year. For the common retail trader, looking for 50% gains per year, 5% seems like a waste of time. However, if the retail trader studies/tests/performs simulations, and is only able to deploy his model after 4-5 years of hard work, the “dumb” conservative investor already has a head start of around $4000 (or 40% on the initial account balance of $10000).

Why? Because the trader’s capital is sitting in his account “waiting” to be employed, and as such in real terms is losing value due to inflation. If we conservatively hypothesize that inflation is 2% per year, then 10000 nominal dollars become $8860 after 5 years of sitting in a bank account. And that’s before any maintenance fees from the bank.

In the meantime, 5% per year has given our conservative investor a 27.6% return over the same time period ($12762). So the real opportunity cost for the trader has thus far been $12762 – $8860.

The lesson here is that you need time to work FOR you, and not AGAINST you. A funny example is the career length of professional soccer players. The very few fortunate and talented individuals who make the major league do receive healthy compensation for kicking a ball, but their career also has a short duration: 8 years on average (as reported bybusinessofsoccer.com). A professional football player in the USA has even less time than that: 3.3 years on average (as reported by statista.com).

Going back to trading, the less time you give yourself/the more pressure you’re under, the worse your overall results will be. Remember that the best investors in the world have become milionaires by compounding at an average rate of 20% per year. Some did better, for a shorter amount of time (Jim Rogers, Stanley Druckenmiller), and some did a bit worse but for a much longer amount of time (Warren Buffett).

Source: Excess Returns: A comparative study of the methods of the world’s greatest investors 

Here is what your account growth would look like if you were able to compound at an average rate of 20% per year: the chart starts going parabolic.

As a trader, we are trying to beat inflation (2-3% per year on average), beat a passive allocation to the S&P 500 (a quite volatile 9.8% long term average annual performance) so ideally we’re trying to make 13-15% on average, each year, with much lower volatility than the S&P500.

This is a very difficult thing to do. Consider the average annual returns of the best trend-following CTAs in the world:

  • Abraham Trading: 19.2% p.a.
  • EMC  Capital Management: 21.81% p.a.
  • Mulvaney Capital Management 15.19% p.a.
  • Dunn Capital: 12.68% p.a.
  • Drury Capital 12.60% p.a.

And yet all of these managers are extremely successful traders. What makes you think you can do better?

The Time Constraint

Given enough time, everyone could enjoy a wealthy lifestyle. However, time is a very limited (precious) commodity. So what we do with our time, and how we spend our time, is very important if you want to accomplish anything in your lifetime (so perhaps it’s time to rethink the amount of time spent scrolling through Facebook timelines, Twitter feeds, Whatsapp chats, or even streaming news outlets).

Most people actually run out of time, and then spend hours frantically attempting to make up the lost time (which is one reason people seek outsized gains in the markets, with no consideration whatosever for the risk of doing so).  Instead, by starting early and giving yourself 30-40 years of time, you can compound even small percentage returns each year into something satisfying.

Risk Control and Time

One of the major impediments to consistent compounding is the drawdown effect.

We need to keep drawdowns as contained as possible! In 2008, many investors lost 50% (or more) of their portfolio value. Depending on the average recovery speed, it can take a long time to recover.

One guest trader that came to speak in our System Development workshop made a performance of 170% over a 3 year period (which comes out to a geometric mean return of just over 39% per year). However, he also sustained a drawdown of over 70% in the same period.

It’s much easier on the psyche to work with more conservative gains, and more conservative drawdowns. Consistency really is the key in this game.

Over to You

Are you driving yourself crazy, trying to obtain unrealistic performance metrics whilst overlooking the simple yet effective principle of compounding over time? How big is your opportunity cost at this point in time?

The key point is this: don’t look for the Holy Grail. Come into the System Development Workshop, allow us to help you build a consistent trading model with simple yet robust rules so you can start grinding out some profits in a conservative yet consistent manner.

Then, let time do the heavy lifting for you!

About the Author

Justin is a Forex trader and Coach. He is co-owner of www.fxrenew.com, a provider of Forex signals from ex-bank and hedge fund traders (get a free trial), or get FREE access to the Advanced Forex Course for Smart Traders. If you like his writing you can subscribe to the newsletter for free.

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