Return and Risk in Trading – What we actually want from our investing vs what we think we want
Over the past week, I have had the opportunity to do a road show around the country and meet a large number of fellow traders and investors. One thing that stood out, is that investors are looking for better risk adjusted returns. Effectively, how to get an optimal return, with a more limited amount of risk in trading.
Yet at the same time, many get excited about the prospect of the “home run trade” ie the goal of making big money, quickly. With such a lofty objective comes of course risk.
80 years ago, Babe Ruth broke the record for most home runs in a season. That same year, he also broke the record for highest batting average. Sounds pretty good so far, right?
There is a third record he broke that year that most people don’t know about: In 1923, Babe Ruth struck out more times than any other player in Major League Baseball – in other words also had the highest fail rate in the competition.
However, for the more mainstream among us, what strategies offer us a decent risk adjusted return?
We arrive back at our old friend, Covered Calls. Over time, the strategy has been shown to outperform straight equities, through the study conducted by Sydney University (outperformance of as much as 7.25% pa) and also shown in the chart below, where the blue line is the buy write index, the green, the ASX 200.
More, as a strategy it is not one that can soak up hours of your time and can happily run along in the background.
To give you a couple of examples from my own trading in the past couple of weeks:
FMG purchased at $4.68 sold $5.00 March Calls for 18.5c Stock break Even ($4.49)
DLTR Purchased for $39.96, sold $40.00 March calls for 1.45 closed – net profit of $1.38/share or 3.4%
Exchange Traded Fund TBT – Purchased at $68.59, sold $69.00 March calls for a nett $1.43 a share (2.1%) having recently bought them back. I am now waiting to re-sell again for a “double dip” of premium.
As I write, I am looking at a V shaped bounce in the market – yesterday’s shock horror seems to have been quickly forgotten as gaps get re-filled and life goes on. Certainly yesterday, China spooked the show. However, this is normal – markets don’t simply go bottom left to top right on the chart.
Perhaps the pullback we have seen, is a second chance buying opportunity? With the banking sector roaring ahead, materials have absorbed the lion’s share of the pullback and may present better value than the “stretched” banking sector.
So, what happens next? Well really that is down to you.
Apply our 4 Rules and you will likely be in a better place than doing nothing.
This then brings us back to where we started – Risk! What we want vs what we don’t want and the reality behind this is a simple one.
The biggest risk you can take is doing nothing and watching the world go by, hoping that your fortunes change.
Click here and see what we are doing right now, and how we can help you, in terms of applying a strategy that balances risk and return in a way that is working.