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Archive for July 14th, 2008

Good lesson in sticking with a trade from this one.  On July 8th, I recommended taking positions in XLE, XOP and/or XES.  On July 9th, I took those position but was quickly shaken out of them.  But what I realize is that I was trading with too tight a stop.  So while I didn’t do too badly, I could have been doing a lot better if I had just ridden out the drawdown.  Actually, what probably would have made more sense would have been half position on the 8th, half-position on the 9th.   Anyway, let’s take a look at how they done since that post:

  • XLE: 0.54%
  • XES: 3.22%
  • XOP: 1.79%

So not bad returns.  Here was the real problem – I didn’t really define for myself when I would be out of the trades.  No plan, no trade.

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Nick Gogerty over at designing better futures (via Worldbeta) has an excellent post on the importance of not losing money.  Here’s the chart and the money quote:

Hardlyworking

The acceleration point for losses requiring greater gains is around a 13% loss.  Think of it as inverting the power of compounding returns.  Currently the S&P is 26% below it highs.  To get back to the previous high point for domestic investors the S&P 500 needs to gain a little over 35%. The long term +80 year historical average return for equities is around 7-8%, so back to break even then in around 4 years.  Based on historical average return would be 2012-2013.The ex dividend annual return for the S&P for a dollar based investor since 1998 has been roughly .3%.  When one factors in an inflation estimate of 2.5% per year, one ends up with an effective loss of purchasing power of 25% over the last decade.  Welcome to the lost decade.

His point is well taken – that when you consider being down 20%, it will not be a 20% gain that takes you back to parity.  Once you cross the 13% rubicon, you’re into needing a huge amount to recover.   This is why I am interested in different approaches to investing – consider that some people who invested in the Nasdaq during the dot.com boom are still underwater.

But what really got me was when he laid it out in terms of time given an average equity return – 4 years to get back the gains.  Now, obviously the S&P has had returns greater than 7% in any given year, but we’re talking average returns which might well be what we are in store for over the next decade (as readers know, I’m not a predictor of future returns).  Nick’s blog has some other great posts and thus will go into the blogroll.

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