Don’t get your hopes up by annualizing returns

So I got a good email from someone who said, “Hey, I’m having a really good year. You know, I’m up 50% and that’s annualizing a 100% so what should I do about it?” And I’m not sure that there’s anything to do about it. Congratulations for being where you are right now, I would shy away from annualizing numbers for a whole bunch of reasons. One is annualizing is a way of forecasting and forecasting means the future. And we don’t know what the future is. We only have today. So I try to stay grounded in the moment of now not to live in the future and walk around like, “wow, I’m up a 100%.” And then if I can do that year over year, and now I start to have expectations.

And then what happens if those expectations don’t get met? They say expectations have built in disappointments. And so you can put yourself in a tough spot. If you’re up 50% right now you want to just focusing on managing risk and not getting ahead of yourself. Of course, look, congratulations again. I’m not trying to pee on anyone’s parade, but I will say that you going to be careful when you start to anticipate the annualization becoming predictive, because it’s not. If you’re up 50%, there’s a strong chance you could keep going, but there’s an equally probable situation where you finish the year up 40%, up 50% up 60%. Because every time you put on a trade the thing about trading is people think, “well, this is my model. This is what the odds, this is what the expected value is.”

But the truth is is that it all changes every day, every trade things change. So you’re kind of dealing with guesstimate. All you have is your behavior and you are being disciplined, but where that all ends up at the end of the year is very difficult to predict just based on where you’ve already been. So yes, things are trending higher. And again, congratulations, it’s not about trying to discount how well you’ve done. It’s just that trying to infer how things are going to go going forward is very, very difficult to determine based upon how well you’ve done so far.

Case in point look at if you follow American baseball, the New York Yankees got out to a great start. And they’ve basically collapsed since the All Star break. And earlier in the year, they were comparing this team to the 1998 Yankees and all these different things. And if we could only do this and that, blah, blah, blah, and now it’s like they’re playing – even though they’re in first place by a small margin, they’re playing more like a Wild Card team. They just collapsed. So even it happens in other walks of life is what I’m trying to tell you is that you cannot infer how well something’s going to go and then use it to predict how the rest of the year’s going to go. And in the case of the Yankees, it’s a complete 180 degree turn. So likewise with your trading, absolutely celebrate your success for sure, but just keep in mind that it’s very easy to start losing money. So what I would do is stick to your discipline, make sure you know what you can lose on any one part particular trade…and honor your stops…

…don’t negotiate with them and stay focused on the now all you can do is manage risk in the ever evolving moment of right now, it’s very difficult to start getting ahead of yourself and thinking that you’re going to be managing risk or trading bigger. You don’t want that type of risk to get into your system to be like, “Hey man, I’m onto something…” because in the short run, you don’t know if it’s skill or luck. You’ll take both. So will I, but if you don’t have 10 or 20 years of trading experience, you don’t have a lot to go on and you might be getting a little bit ahead of yourself. If you start to think like, well, I’ve been doing this now 18 months, I’m up 50% again, by all means, enjoy it and keep doing what you’re doing, but don’t forget your “job #1” is to place superior defense. If you start trading larger, start taking flyers, start thinking that you’re onto something. Start shooting from the hip trading from your gut. You know, this is when you start to open yourself up to giving back some of those gains. And so think about it ahead of time. You’re up 50%. Your behavior changes. You finish the year up 30%, you still up, but what happens to your mindset at that point?

So stick to your rules and keep doing what you’re doing. Of course, focus on entering your stops and playing superior defense. Worst thing you could do is start changing your behavior and get more aggressive because you want to get to that annualized number more sooner than later, just focus on your process. That’s all you can do.

This is a computer generated transcript.

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