The Case for Active Trading

For most investors, there’s nothing wrong with passive investing.  Most of the time, it works just fine: minimizes expenses, avoids “underperformance” and saves taxes.  And, it’s becoming increasingly popular.  JPMorgan estimates that fundamental discretionary traders account for only 10% of daily trading volume.

But, we all remember 2007-2009, when a little market timing would have come in real handy.  Of course, that period was followed by a pretty strong meltup which erased all those nasty losses (and, then some) if one was able to avoid (or, better yet, capitalize on) the volatility during 2015-2016.

Whether active trading is right for you depends on more than market conditions.  What are your cash flow needs?  How much volatility can you stomach?  How aggressive or risk averse are you?  What tax bracket are you in?  And, most importantly, what are the alternatives?

There’s no doubt that active trading is hard.  And, it’s getting harder.  Both fundamentals and technicals seem out of touch with reality half the time.  The rest of the time, they suggest diametrically opposed outcomes.

Recently, a client congratulated me on some decent calls in oil over the past year.  This happened at about the same time that Andy Hall — such a successful oil trader that his nickname was “God” — announced he was closing his fund after sustaining large losses in 2016 and 2017.

How could someone that experienced and savvy do so poorly?  Maybe it was time to go back and see exactly how we had done.  Note: I haven’t tracked performance in anything other than equities, and I’m months behind on tallying that.

Sure, it works in practice.  But, will it work in theory?

I started making active calls in oil (West Texas Intermediate or WTI, symbol CL) futures on October 14, 2014 when CL was 82.27 and falling.  I expected it to continue falling to at least 74 or 64, a target that was lowered many times over the following 16 months (along with many bounces involving higher target prices.)

Had we simply shorted it there and covered yesterday, we’d be sitting on a nice gain of 39.6%.  That would easily rank us in the top 10% of all energy-related hedge funds in terms of performance over the past three years.If we had used the 200-day moving average to signal long/short trades, our return would have improved to about 79% — doubling our outcome with minimal additional effort.

If we used both the 200-day (red) and 20-day (white) moving averages to guide us, the return would have been even better: about 1,772%.Last, utilizing basic Fibonacci patterns, trend lines, moving averages, chart patterns, and (the secret sauce) considering the effect that oil prices have on algorithms, we posted the following buy and sell signals over the past three years.  The buy signals are marked with yellow arrows and the sell signals with red.The net effect was significantly better than either of the moving average approaches and insanely better than the “set and forget” approach.

Again, the point isn’t that active trading will always be more effective than passive or some derivation thereof.  And, I’m certainly not claiming to have found a foolproof way to earn 22,000% over the next three years.

Rather, the point is that active trading can be much more rewarding than passive investing — when incorporating the proper signals.

What are the proper signals?

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