The Markets reward poor process

Someone smarter than me (I can’t remember who it was) made the distinction that we can distinguish games of pure luck and those that require some skill by whether or not you can lose on purpose. For instance, if you were betting on the flip of a coin, you can’t lose on purpose. Poker, on the other hand, has aspects of skill and luck, and I can certainly lose on purpose, at least over a longer time horizon (I might get lucky once or twice).

Investing, than, is an interesting animal. I can buy a bunch of stocks that I think will go down (trying to lose) and be wrong and lose money (just ask all the short-sellers out there). Options trading, on the other hand, makes it much easier to lose on purpose, at least if you are doing it right. Remember, this is a good thing, in that it suggests that there is some skill involved and therefore a real edge to be had.

Buying naked calls for instance, is one of those scenarios where you could get lucky and make some really good returns, at least for a while (especially in a bull market). The problem here is that this can lull one into a false sense of skill. And that is when leverage usually begins to be deployed and ultimately things go badly.

Unfortunately, the more luck that is involved, the more poor process can be rewarded. Buying stocks because “they always go up” is poor process. Buying whatever is going up the most is likely poor process (but not always).

If you want to be around in this game for a while and keep your money for the long term, it is important to have a good process. You should have an algorithm, even if you are not an algorithmic trader. That simply means that you have a series of steps that you take, or list of instructions that you follow when buying or selling in the markets. That does not guarantee good results, far from it. But if it truly is a good process, then over the long term you should be successful… with a little luck.

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