Don’t pretend to be a professional investor – just think like one

Australians love to manage their own investments and wealth. Around a quarter of Australia’s $3.5  trillion superannuation savings is held in self-managed superannuation funds (SMSF), 35% of  Australian adults directly owns shares on the ASX, and $9.8 trillion is held in privately-owned real  estate, as of the September quarter 2023. 

There’s a broad interest in hands-on investing, however I am concerned about enthusiastic amateurs  thinking they have to play with the pros in order to be successful investors. There’s a growing market  out there for day-trading platforms and strategies for making millions from the home computer, and  the target market is people with a lot of enthusiasm but not much background in the financial  markets. 

If the ‘invest like a pro’ scenario was real, it would make globally traded markets the only facet of  modern life in which the total amateur can get on the field with the best-equipped, best-educated  and most successful people in their fields, and somehow beat them. 

If you made me play against Messi and Ronaldo, I would not fare well. If I had to face Pat Cummins  with the new ball, I doubt I would last more than one delivery. 

And yet people who are schoolteachers, plumbers and doctors are jumping on trading platforms,  being shown how to trade in derivatives and leveraged instruments, and they wonder why it doesn't  work out so well. I am reminded of the 90/90/90 rule: that 90 percent of first-time investors lose 90  percent of their investment in the first 90 days. 

I’m not saying ‘don't be an investor’. I’m saying, use the thinking and the rationale of the professionals,  but don’t compete with them. You can learn technique and tactics from watching Conor McGregor in  the UFC, but you wouldn't want to be in the octagon with him. 

Here’s a few insights from a professional if you’re a self-directed investor who wants to make more  than you lose:

Specialise: professional traders don’t freelance into areas they don't understand. At  banks and fund managers there are teams for bonds, equities, currencies, and commodities  and they use futures and other derivatives to hedge their positions. Traders stick to their lanes  because that’s where they have the competitive advantage. Lesson: become an expert in a  small niche and build-out from there. You don't have to know everything all at once.

Sharpe: proprietary traders must routinely ‘make Sharpe’, or they lose their seat. The  Sharpe ratio is – simplistically put – the ratio of returns to risk. For instance, the average  Sharpe over the last 100 years for the S&P 500 is 0.3, meaning for every 10% volatility you  endure in the S&P500, it ekes out a 3% return on average. If you want a job trading equities  on Wall Street you have to generate a Sharpe of at least 1.5 – or five-times the S&P 500 Sharpe  – and that is just the starting point. It is not uncommon for proprietary traders to have Sharpes  of 3+. Lesson: the Sharpe Ratio achieved consistently by the professionals will usually be  unrealistically high for the amateur, so set your own target Sharpe somewhere between  market average and the professionals.

Adjusting for volatility: even within the bounds of the long-run Sharpe Ratio,  professionals track current volatility to adjust their exposure to a market or index. Let’s say I  set my own benchmark for volatility at 10% in a certain market. If the measure of volatility  doubles, I halve my exposure in that index. And so forth. Lesson: Understand measures of  volatility and allocate your investments accordingly. When you see sudden gains in a market,  you’re watching volatility and volatility comes with downside risk. 

Be Active with Passive investments: if you’re a self-directed investor you don't have  to operate in the confines of ‘active’ or ‘passive’. You can enjoy the best of both worlds by  becoming an active investor with passive investments such as Exchange Traded Funds (ETFs).  ETFs track a market index such as S&P500 or ASX200 as well as many industrial sector indices.  This approach – which is also pursued by a lot of professionals – gives you the combined  wisdom of professionally-traded markets, alongside your own targets and data. Lesson: you  can have the control of being ‘active’ and the safety in using ‘passive’ investments. Don’t  worry about labels – worry about your own target KPIs, and reading the data.

Personal investing: the secret of the trading world is that most of us put our wealth  where amateurs put it, which is with fund managers, real estate or cash. Professionals focus  so hard on managing clients’ capital that trying to thread personal account investing into the  day is just distracting. So, we don't do it unless it is in the fund that we manage. Lesson: there’s  nothing wrong with being a really good doctor, plumber or business owner, and allowing a  professional to be really good at managing your investments.

Ego: the markets don't care about your ego, the car you drive or the quality of your  wine cellar. Active trading in the global markets is driven by ‘quants’ – quantitative analysts – who track data in very large amounts, and who look for correlations between different  markets, and the proxies for those relationships. Then we war-game our ideas with parallel  simulations to see if we’re correct, and most of the time we’re wrong and we don't put-on the  positions. In other words, we’re wrong and we know we’re wrong – the data doesn’t lie.  Lesson: put your ego on hold when you trade. Don’t fall in love with stocks and don’t think  that because you made money on a couple of trades, that you're smarter than the market. 

Finally, knowing why you’re investing is crucial to how you approach the markets. If you like the  challenge and you get a buzz out it, that’s a different scenario to running an SMSF that must invest to  provide retirement income to the members. There’s something for everybody in the investment game  – but you don't have to jump in the ring with the professionals to find what you’re looking for. 

Toby Carrodus is an Australian professional trader who has worked in London, Frankfurt, Sydney and Los  Angeles for some of the world’s largest hedge funds and asset managers, including PIMCO and Winton Capital.

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