Some Perspective on Performance

Wed, Oct 7, 2009 | Jared Woodard

Meta, Monthly Review

Investors are notorious for chasing performance. If a mutual fund or advisor or trading strategy has done well recently, chances are much greater that traders will commit money to that strategy or product, often independently of the long term performance, general suitability, or distinguishing features of the strategy or product.  I’ve seen the same behavior among the audience for our paid newsletters: after a winning month, new subscribers are more likely to rush in, and if we have a flat or down month, interest from new readers drops. This is exactly the kind of backwards thinking that dooms most investors to underperform even basic market benchmarks: most investors would literally be better off allocating every cent to a plain vanilla index fund, rather than jumping around from one strategy to the next like insects in the lighting section of a hardware store. I get frustrated on behalf of smaller and newer traders in particular, because while they tend to have low risk tolerance and tend to face higher transaction costs – i.e., they’re the group who can least afford to chase performance – they’re also the most likely to do exactly that. You don’t see smart, profitable institutions switching from following commodity trends to selling volatility to trading fixed income every time one of those asset classes has a nice run.

This behavior is particularly bizarre given the features of our strategy: we manage to be uncorrelated to the market indexes, show consistent outperformance versus not only buy-and-hold but also compared to similar hedge funds and market-neutral strategies, and offer an educational experience that subscribers have told me is unlike anything else they’ve found. Despite all of those advantages, the response from new readers in a given month seems almost entirely dependent on the headline performance numbers from the prior month.

When I say that the retail investor tendency to chase good performance is backwards, I mean it literally. The time to invest in a new strategy, product or advisor is not when it’s just had a string of great returns. Quite the opposite: the best time to begin is often after a sizable loss. Unlike stocks (and, in this environment, every other asset under the sun), trading strategies cannot acquire momentum. If anything, strategies and advisors are more likely to oscillate around some average, which means that for any proven strategy with a comprehensible edge, a “buy on the dips” attitude is often a much more rational approach (note that I’m talking about the decision to “buy into” a strategy after it’s suffered a momentary setback, not about buying any particular asset directly). If a strategy you’re following generally has winning months 90% of the time and suddenly experiences a losing month or two, unless market conditions have changed so dramatically that the strategy is no longer effective, or unless outcomes are independent from month to month (like a coin toss), then the odds are in favor of a subsequent return to good performance.

Our core base of subscribers – many of whom have been around for years now – have seen the benefits of consistency, and it’s that kind of long-term thinking that I want to encourage. Since the inception of this newsletter, I’ve posted reviews each month of the performance versus several major benchmarks, along with analysis of the individual published trades and a few other features. From now on, I will discuss the performance of the newsletter on a quarterly, rather than monthly basis, after March, June, September, and December options expirations. This should allow me to give a more comprehensive summary and to take a broader view of market action in relation to our strategy. I will continue to update the Performance page and the individual trade list on a monthly basis. But smart, consistent traders don’t need a constant intravenous drip of profit & loss data; those who do need it are more likely to abuse the drug.

More reading: on the investor tendency to chase the “hot hand”; Tversky et al. famously showed that the hot hand phenomenon in sports is a myth, although there are rejoinders.


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  1. Thursday links: trending and thinking Abnormal Returns Says:

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    [...] Woodard at Condor Options recently had a piece up expressing his frustrations with investors who to their own detriment flit [...]

  3. The song remains the same | Financial engineering resource center Says:

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    [...] reasons underlying this mean-reversion effect was written by Jared Woodward of Condor Options here http://www.condoroptions.com/index.php/meta/some-perspective-on-performance/ . Thus there are actually two sides to this coin–1) you can ride a strategy equity curve as [...]

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Jared Woodard specializes in trading volatility as an asset class. With over a decade of experience trading options and other volatility products ... Read More

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