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The reality of variance

I took the opportunity recently to sit down and analyse the various up and down swings that have been experienced during the four years that the Trial Spy service has been publicly available.

It provided some very interesting insights into the investment journey.

I decided to title the article ‘Perspective’, because variance is a normal and unavoidable part of any investment cycle, including with betting, but one’s perspective and how they handle the mental side of it ultimately determines how good an investor they will become.

Firstly, if you would like to brush up on your knowledge of variance and the importance of sound bankroll management, please read part one of this series here:

Variance and the importance of sound bankroll management

Now that we’re all on the same page, let’s get into the analysis.

Firstly, a quick recap of the annual results for the Trial Spy service since inception in February 2013:

Great profits every year, excellent POT% and ROI%, all smooth sailing right? Wrong.

Over the course of four years, there have been 15 losing months out of 45 betting months, or roughly four losing months per year.

See the monthly table below:

30 winning months out of 45, which is exactly 2 winning months out of every 3, or 8 winning months per year.

For some, with a very short term mindset, a couple of losing months in a row can be difficult to endure, regardless of how small in units the losing periods may be.

But what about if we take a slightly longer term mindset?

As a first step, I looked at all swings up or down of over 20 units over any given period over the past 4 years, since February 2013:

From this you can see that overall, there have been seven negative swings (downturns / troughs / drawdown periods) of over twenty units in the past four years.

That’s approximately one every six months, or two every year.

The average length of time for these downturns was 35 days.

The final point to note of course is that the positive swings in profit on almost every occasion are substantially higher than the negative swings.

Now hopefully a lot of you will be saying 20 units, who cares? We are making big profits, and our starting betting bank is 100 units, so who is bothered by a 20 unit drawdown?

So let’s up it a little and look at swings over 30 units:

From this you can see that overall, there have been only two negative swings (downturns / troughs / drawdown periods) of over 30 units in the past four years. That’s approximately one every 2 years.

However both of them were nearly 60 unit downswings, and lasted 45 and 79 days respectively.

Now some of you will still be saying 30 units, who cares? We are making big profits, and our starting betting bank is 100 units, so I still am not fussed about a 30 unit drawdown!

Okay, so let’s up it again and look at swings over 60 units:

It’s never happened.

Explanation

So, hopefully for some of you the penny has dropped. But let me explain what the point of that exercise was.

Successful property and share investors like Warren Buffet focus on the long term. They buy houses, or stocks, because of their long term growth potential, and then usually ignore them over a long period, to give them the chance to grow. Property owners don’t sit there having the bank revalue their property every day, week, month or even year. Indeed there are many very successful stock investors that also avoid the temptation of checking their stock portfolios any more than once a quarter, and when they do, they hope for a downturn, as it’s an opportunity to buy more quality stock at a discount, which is the opposite of most investors.

When you subscribe to a service, you should generally have done your research. You either know and trust the analyst, or you know and trust the company offering a new analyst’s services. You set up a bank for that service, and you trust that if you follow their selections and betting advice, you will ultimately end up with a positive result.

So at what point does your belief in that original plan waive? That is actually something you should define upfront. Write down how much of a downturn you are willing to endure before giving up, and stick to it. When the inevitable downturn occurs, take that piece of paper and listen to your past, unemotional, not frustrated, intelligent investor self.

But you know what’s funny? I can’t possibly conceive how anyone could write anything other than: when the 100 unit bank is gone. Otherwise, why have a 100 unit bank? If you are going to quit a service after it makes a 50u loss, then your bank size is incorrect.

Let’s say you have a $10k bank. The point of that bank is to protect your capital, but it is capital you are prepared to invest. So you have a $10k bank, and will bet $100 per unit.

But if you plan to give up and unsubscribe or stop following a service after losing $5k, then surely your bank should only be $5k? Therefore, you should only bet $50 per unit, and let your bank last longer.

LIGHTBULB!

Of course bank management is vital, particularly when you are following multiple services, and a very important article on this topic is available:

See Article 3: How to manage your betting banks following multiple services‏

The key point of the above article is that you must have a separate bank for every service you follow, otherwise one poor performing service can wipe out your entire bank and portfolio. Secondly, it mentions that you should allocate the size of each bank to your overall confidence in the service. So some services might have a $20k bank, some a $10k bank and some a $5k bank, for example.

People’s reactions to variance

I’ve been offering my services publicly for 4 years now, and per the above have experienced, along with my members, many drawdown periods during that time.

There are 3 reactions I see from members during what is (in their opinion) a period of substantial or sustained drawdown:

1) They cancel their subscription

Whilst there are numerous reasons a member may cancel a subscription (often having nothing to do with the service itself – e.g. moving overseas, work conditions changing etc), a drawdown period certainly is one of them. New members can be trigger happy when they first start and don’t see the immediate positive results shown on the results spreadsheets. Some members just cannot handle a big losing day, so if there is one day that is a wipe-out, they jump ship. Others cannot handle a sustained losing period. It all mounts up in their head, and even though the losing figure may not be substantial in comparison to their bank, they cannot see the light, and give up. For me the sad element is how many times I have seen a member cancel and have their subscription lapse just a day or two before the inevitable enormous winning day or period.

2) They decide to stop betting for a while until results improve

If you’ve done this before, give yourself a slap in the face, then go back and read this article again. Can you imagine how many profits you would have missed out on by doing this? It’s mathematically flawed, as you have endured the drawdown, and will now miss out on the impending upswing. Ultimately if you’ve lost faith in the service, then you must decide whether to cancel the service, or reduce your bank allocation for that service, and hence the units you invest. There are of course times this is appropriate, but if you make a decision, stick to it. Don’t just stop betting, and then go back once profits have been made. It’s a quick way to disappointment, frustration, and reduced profits.

As a side note, studies have shown that if say a managed fund makes 10% profit per year, the average mum & dad investor in the fund often makes only half of that. That’s because when they hear bad news they sell, and then when things are good again they buy back into the same or a new managed fund. Ever heard someone advise you to BUY HIGH and SELL LOW? No, but that’s what most people do with shares, and what a lot of punters do when following services as well. They either jump ship and try another service out at the wrong time, or they stop betting until results improve, costing themselves the inevitable profits.

3) They reduce their stakes

If this sounds familiar, give yourself a slap on the other cheek. Whilst better than stopping betting completely, unless you have done your research and decided to stick with that decision for the long term (because you’ve reduced your bank and allocated it to another service), then this is again a mathematically flawed decision.

It’s always darkest before the dawn…

In July 2014 we had lost 9 units. In the preceding month June, we had only won 9 units.

So over the previous 2 months we had basically broken even.

As a result of this flatlining, some members unsubscribed.

Then on 2 August 2014, we won 63 units for the day, which included a $30 winner, a $400 exacta and a $3,700 trifecta.

This also was the start of a 234 unit winning run (without a drawdown of over 20u) over the next 242 days.

Similarly in November 2014 we lost nearly 15u for the month.

Again, as a result of this, a couple of members unsubscribed…

Just before a big run of 67u profit in the next 17 days in December

Caveat

Please note my caveat on all of the above is that you must be following proven, successful, reputable and respected analysts or tips service providers for the above to be valid. It actually doesn’t apply to most services, but that comes back to your research and why you selected that particular service in the first place. Which is a topic for another day.

Conclusion

The point of this article was to put some perspective on losing runs. When it comes to this service, although they are unavoidable, they are also (comparatively) short lived, and as the analysis showed, ultimately inconsequential when taking a long term view.

The challenge is dealing with the mental side of things as they occurring. Every day placing the bets, watching the bad rides, or photo finish beats, or horses running way down the track, and later appearing injured or lame in steward’s reports. It feels like it’s all happening at once, because it is! That’s what happens during a downturn, and that’s what a drawdown period is. But if you take a look at the above, and can get out of the ‘day / week / month 20-unit swing’ mentality, and into the ‘biennial 60-unit swing’ mentality, then you will hit investor nirvana, and will reach success, happiness and profit maximisation in far quicker time.

2 COMMENTS

  1. Thanks Todd. No I did not, firstly because there is no single cost of the subscription. Subscription costs have changed over the years, and are different based on a monthly, quarterly or annual subscription. However, more importantly, the article focuses on the importance of the long term perspective, so for a simple calculation, there was a $1,870 annual cost for an average $14,534 profit per year.