Is that even possible, yes. Can I do it, yes.
The Stock Market. The Market of Stocks
Beating the stock market is probably the main goal for every DIY investor. I mean if I was not obsessed with beating the market I would just delegate the investing task to the professionals and get whatever returns they can manage to get annually. By beating the stock market I mean generating alpha, have higher returns than the market. If the JSE All Share Index return 14% in the year, return more than 14%.
Foundation of beating the market
The first and major component is having a strategy that has a proven edge. Edge is described as the probability of one thing happening over another, in this case you need to have more profit than losses. However, your win rate does not mean much, it is the size of your wins/losses that matter, the trick is in asymmetric risk-to-reward. Your wins must dwarf your losses by a broad margin.
I use Trend Following, this approach is known to have a low win rate, a 40% win rate is common. But the trend that can last for a while, if you sit on your hands, returns in the north of 100% are common as well. An ideal risk-to-reward for me is 1:3, this require a 34% win rate to be profitable. Recent data, from the #R10KStockTrading challenge, shows that there is a 50% win rate and 1:3.2 risk-to-reward. Not bad, but I would like the ratio to be 1:5, and if possible maintain that 50% win rate.
The second, and equally important, component is discipline. Once you have a strategy all you have to do is follow it. It might be tempting to ditch the strategy when other market participants are making money and you do not. But, understand the kind market where your strategy has an edge, and if you are not in that kind of a market, learn to sit out. Cash is a position. An alternative to this is having multiple strategies; then you just have to switch to the strategy that suite the market in play.
With Trend Following you will never run out of market to trade, there is always a trending market somewhere. This is also great for diversification. Depending on your broker, you might have to have multiple trading accounts if your current broker does not offer a variety of markets.
To keep this argument within the confines of a single market e.g. JSE; if one sector is down, you trade/invest in a sector that is on an uptrend. This is the take home message for this Blog, you may stop reading at this point.
The Market of Stocks
Ah, you are still here. Great. Imagine you are in a supermarket to pick up groceries, there are lot of products you can buy. You can choose the products you need, and the products you like, but you will not buy the whole shop. The supermarket is the stock market and the products are the individual stocks listed in the market. Some of the products will sell better than others, whereas others will just sit there and become stale *Nutritional Holdings*. Your job as the buyer is to buy the best products in the shop and pay zero attention to the stale products. Your strategy should point you to the best products, and you need few best product to whip a tasty meal.
The ability to chose the best from the rest give you a chance to out perform the market. The JSE Top40 is based on market capitalisation, not on performance. Although these giants have seen great days and rewarded shareholders handsomely, they are now dragging the index down as their share prices are falling. It is better to ditch some of these stocks and find other stocks that are in an uptrend, these have a chance to do better than the Top40. If they do, just like that, you have out performed the market! Of the 300+ JSE stocks, you need about ten stocks to generate alpha. You need few large positions that will swing for the fence. The diversification argument always pop up at this point; have you ever bought too little of a great performer and wished you had bought more? Yeah that is the downside of diworsifying. If you have too many small positions your portfolio start to look like the general market, now you have a chance to under-perform.
With the exception of value investors, who live in their own fantasy world that they understand. Market participants tend to have an (emotional) attachments to certain names; if Sibanye did well in their portfolio in the past, they will want to hold onto it forever, even in its worst time. Even if Sibanye declare a fat dividend, if there are cracks in the chart, leave! There are many other stocks that can reward you again. Take your profits and go fund another position, compound your returns.
Tax, eish. This is above my pay grade. Let us use a business as an example. You will not stop generating a profit for your business because you want to reduce your tax liability. If you do not sell poor performing stocks, or even good stocks (it is okay to sell a good position if there is something better to buy), due to tax reasons, I hope in the long run it is worth it. But ke like I said, tax is not my forte. I love compounding my returns and pay the taxman what is due to him, as long as the value of my portfolio is growing. Yes, compound interest, but dude, you are not compounding negative returns either.
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The resources sector seem to be exhausted, a couple of great names are now trading below their 200 day moving average. There are exception, Exxaro, South32 and Glencore are still above this level and recently clocked 52 week highs. The other stocks will recover, eventually. In the mean time find a sector that is on an uptrend and ride the bucking bronco.
Happy trading/investing.
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