You Don’t Want to Win ‘em All

Across my exploration of residual income streams, I superficially examined various automated trading strategies. The goal was to figure out a way to automate as much of the research and trade execution as possible using algorithms and AI. While I put that on the back burner in favor of ideas more aligned with my experience, I did pick up one nugget that stuck with me.

Forget, “you can’t win ‘em all.”

Embrace, “you don’t want to win ‘em all.”

This was reinforced by many years of sales training that emphasized the importance of getting comfortable with rejection. When played right, you are more likely to catch a win after stacking a few losses. The losses indicate activity, and activity drives results.

Investing and entrepreneurship are risky endeavors. The reality of loss is omnipresent, and it doesn’t always show up in a complete wipeout. Often, it takes the form of opportunity cost, whereby you’re locked into a mediocre investment when a banger lands in your inbox.

As a result, the least successful investors always swing for the fences. They fear both reputational and business ruin, so, counterintuitively, they wait for only the best deals and pour an outsized share of their portfolio into them.

Here’s the thing, though. As an active investor – someone who makes a living from their investments – it’s critical to be active in the market… no matter if you’re winning or losing.

There will be losses.

The key is to manage the downside.

Problems arise when you hold on beyond the point of rationality. Everything is rosy when we underwrite deals. You wouldn’t do the deal if it wasn’t good. However, our mindset needs to shift from optimistic to skeptical once we take ownership. We need to discover that a deal is a loser long before the market and take action to unload it while the “gettins’ good.”

Day traders manage this by assessing each trade in terms of a unit of risk. This way, they’re not attached to money. Each unit of risk represents a certain dollar amount. The goal is to stack the right mix of positive- and negative-risk units so that the net over a given period meets their return goal.

For example, assume we’re investing $100,000 and want a 20% annual return. Over that period, we may treat each risk unit as $1,000 (1% of the portfolio). To achieve a 20% annual return, we would need to earn a net 20 risk units over the year. That could come in the form of 50 negative and 70 positive units, or 1 negative and 21 positive units.

Opportunity is the primary differentiator between the high-volume and low-volume scenarios above. When you are exceptionally active in the market, you see opportunities that would never present themselves otherwise. The high-volume trading strategy is more likely to overproduce than the low-volume strategy because there’s just more opportunity to win. Therefore, it’s inherently less risky.

Opaque, illiquid markets, like small businesses and real estate, don’t lend well to this kind of strategy, though. This example is unique to highly transparent and liquid markets, such as public equities and crypto. Still, there’s value in the abstraction.

To use a well-worn baseball analogy, you can’t hit a home run if you never swing. Most of the deals will be singles and doubles. You’ll strike out every so often. And a handful will be home runs. It’s important to remember that even the best hitters don’t consistently break above 30% hitting percentage. The key is to manage the downside wisely.