by Chris Tate
Punter: I went to this really great seminar on the weekend
CT: Really….what did you learn?
Punter: We stood on chairs, danced, hugged the person next to us and I even broke a board karate style.
CT: Interesting, so this was sort of a motivational, awaken the giant within, think big grow rich, lose weight and improve your hairline type of seminar?
Punter: No, it was about trading.
CT: Really?
Punter: Yep and I learned this great strategy, I can’t tell you about because it’s a secret and brokers don’t want you to know because it’s a passport to instant wealth. They even showed us a picture of a tropical island.
CT: Really
Punter: Yep, they said that they had extensively back tested their system on the S&P ASX 200 and the results were stunning.
CT: Okidoki, remedial clear thinking for beginners. An index is comprised of a variety of shares, in this case 200 of them.
Punter: Yep……..with ya so far
CT: The shares that make up the index today are not the same as the shares that made up the index last month, last year or 10 years ago. The shares within an index get turned over.
Punter: Yeah but he said just buy the shares that make up the index and hang on to them.
CT: Ok…here is a list of the shares in the ASX 200, find me Westmex, Ariadne, or Qintex
Punter: Are we talking about trading or a history lesson.
CT: We are talking about trading. You have been sucked in by what’s known survivor bias. When you look at the chart you are seeing a sample which reflects stocks that are in existence today. So if you are back-testing a system for the validity of entry signals then your system is fatally flawed because you are only testing it on stocks that are still in existence.
With an index what you see is not what you get or more appropriately what you would have got. Today is not the same as yesterday.
Punter: Yeah but he said that in the past two years the return from his system was 100% and then they had a set back and were down 50%. And if you make 100% every second year you can afford a setback or two.
CT: So how much would you have made if you had invested at the beginning of the first year.
Punter: Simple, they gave us the average return for the past two years. They said based on their figures they made 25% pa on average.
CT: Really?
Punter: Yeah…. look its simple…100%-50% = 50% return divided by two years = 25% per annum.
CT: But how much would you have made if you had given them $10,000.
Punter: Easy 10,000 x 25% = $12,500 at the end of year one and $12,500 x 25% = $15,625. So if you let it compound you make a fortune quite quickly, the bloke at the front even showed us a picture of a Porsche to demonstrate how much they make.
CT: Your certain about the amount you make?…….you don’t want to phone a friend or something?
Punter: Course I’m certain.
CT: Okidoki, the correct answer is 0
Punter: Pardon? That cant be right, how else could they show us a picture of a large boat?
CT: Work it through, you start year one with $10,000 and you make 100% for that year. How much do you have at the end of year one?
Punter: $20,000
CT: Okay you start year two with $20,000 and you lose 50% how much do you have at the end of year two?
Punter: $10,000
CT: How much have you made?
Punter: 0
CT Correct……so how much did this seminar cost you?
Punter: Yeah but he said that in the rare event that we made a loss we just risked twice as much on the next trade because we were due for a win.
CT: Who was this bloke…..a football coach?
Punter: Don’t think so, but he did run on stage to the tune Eye of the Tiger.
CT: Here toss this 50 cent piece, I’m going to get a cuppa
Punter: What do you want me to do?
CT: Nothing, just count the number of times heads comes up in a row.
Punter: When are we gunna talk about trading?
CT: Don’t worry when I get back
Punter: I’ve been tossing this damned coin for ages what the hell have you been doing.
CT: Don’t panic, how many times did heads come up in a row?
Punter: 8
CT: So what did this bloke tell you to do when you made a loss?
Punter: Double the size of the bet because each loss brought you closer to a win.
CT: Let’s assume that you lost and $10,000 on your first trade how much would you have to bet on your next trade?
Punter: 20k
CT: If you were wrong 8 times in a row how much would you have to bet by the time you got the 8<sup>th</sup> trade to get your original 10k back.
Punter: Easy. 10k 20k 40k 80k 160k 360k 740k 1.480mil
CT: So this seminar cost you money
Punter: Apparently so
Punter: I went to this really great seminar on the weekend
CT: Really….what did you learn?
Punter: We stood on chairs, danced, hugged the person next to us and I even broke a board karate style.
CT: Interesting, so this was sort of a motivational, awaken the giant within, think big grow rich, lose weight and improve your hairline type of seminar?
Punter: No, it was about trading.
CT: Really?
Punter: Yep and I learned this great strategy, I can’t tell you about because it’s a secret and brokers don’t want you to know because it’s a passport to instant wealth. They even showed us a picture of a tropical island.
CT: Really
Punter: Yep, they said that they had extensively back tested their system on the S&P ASX 200 and the results were stunning.
CT: Okidoki, remedial clear thinking for beginners. An index is comprised of a variety of shares, in this case 200 of them.
Punter: Yep……..with ya so far
CT: The shares that make up the index today are not the same as the shares that made up the index last month, last year or 10 years ago. The shares within an index get turned over.
Punter: Yeah but he said just buy the shares that make up the index and hang on to them.
CT: Ok…here is a list of the shares in the ASX 200, find me Westmex, Ariadne, or Qintex
Punter: Are we talking about trading or a history lesson.
CT: We are talking about trading. You have been sucked in by what’s known survivor bias. When you look at the chart you are seeing a sample which reflects stocks that are in existence today. So if you are back-testing a system for the validity of entry signals then your system is fatally flawed because you are only testing it on stocks that are still in existence.
With an index what you see is not what you get or more appropriately what you would have got. Today is not the same as yesterday.
Punter: Yeah but he said that in the past two years the return from his system was 100% and then they had a set back and were down 50%. And if you make 100% every second year you can afford a setback or two.
CT: So how much would you have made if you had invested at the beginning of the first year.
Punter: Simple, they gave us the average return for the past two years. They said based on their figures they made 25% pa on average.
CT: Really?
Punter: Yeah…. look its simple…100%-50% = 50% return divided by two years = 25% per annum.
CT: But how much would you have made if you had given them $10,000.
Punter: Easy 10,000 x 25% = $12,500 at the end of year one and $12,500 x 25% = $15,625. So if you let it compound you make a fortune quite quickly, the bloke at the front even showed us a picture of a Porsche to demonstrate how much they make.
CT: Your certain about the amount you make?…….you don’t want to phone a friend or something?
Punter: Course I’m certain.
CT: Okidoki, the correct answer is 0
Punter: Pardon? That cant be right, how else could they show us a picture of a large boat?
CT: Work it through, you start year one with $10,000 and you make 100% for that year. How much do you have at the end of year one?
Punter: $20,000
CT: Okay you start year two with $20,000 and you lose 50% how much do you have at the end of year two?
Punter: $10,000
CT: How much have you made?
Punter: 0
CT Correct……so how much did this seminar cost you?
Punter: Yeah but he said that in the rare event that we made a loss we just risked twice as much on the next trade because we were due for a win.
CT: Who was this bloke…..a football coach?
Punter: Don’t think so, but he did run on stage to the tune Eye of the Tiger.
CT: Here toss this 50 cent piece, I’m going to get a cuppa
Punter: What do you want me to do?
CT: Nothing, just count the number of times heads comes up in a row.
Punter: When are we gunna talk about trading?
CT: Don’t worry when I get back
Punter: I’ve been tossing this damned coin for ages what the hell have you been doing.
CT: Don’t panic, how many times did heads come up in a row?
Punter: 8
CT: So what did this bloke tell you to do when you made a loss?
Punter: Double the size of the bet because each loss brought you closer to a win.
CT: Let’s assume that you lost and $10,000 on your first trade how much would you have to bet on your next trade?
Punter: 20k
CT: If you were wrong 8 times in a row how much would you have to bet by the time you got the 8<sup>th</sup> trade to get your original 10k back.
Punter: Easy. 10k 20k 40k 80k 160k 360k 740k 1.480mil
CT: So this seminar cost you money
Punter: Apparently so