Why I actively trade in the stock market
July 04, 2020
Active trading has a bad reputation lately. Why not just buy an index fund and forget it? Even Warren Buffet advocates the S&P500 index for most people.
What I learned from a good investment advisor
When I was a university student in Canada in 2013 I bought a mutual fund mirroring the predominant Canadian index, hoping for the often-promised 7% average gain. When I checked 1.5 years later the gain was only 2%.
“What happened? Why are the gains so low?” I asked the investment advisor. I was still in university, and what she said stuck with me, after I’ve forgotten most of the finance class.
“You bought high in the 52 week range”, she said. The relatively stable Canadian stock market didn’t rally much because it is mostly energy and finance sectors. “There are other mutual funds with more aggressive growth, would you like to see?”
“Yes!” I said. She showed me a mutual fund that instead of the 2% gain, had posted 45% gains in the last year. “What is in that mutual fund?”
She showed me the prospectus. It had 50%+ concentration in US stocks. Furthermore the fund has benefited from the USD’s appreciation against the Canadian dollar.
I was dumbfounded. First, I was thrilled with the great wealth of information available publicly on the Internet, that I can tap into to make better investment decisions. Second, I was slighly peeved that this was not covered in the Introduction to Finance class. Instead of continuing with the passive fund, I sold and began to teach myself how to actively trade. I still buy and sell index funds opportunistically: when the stock market goes up the indexes go up; when the market is down buy something to profit from the upswing.
The goal is to actively trade stocks and options to:
- Make money when the market goes sideways, then the funds barely move
- Hedge the concentrated positions
- Generate a bit of income, preferably 15%+ annually
Why 15%? Because I need to have a threshold to place my trades, and if I can achieve 15% annual growth that means doubling the money every 5 years, instead of the 10 years with the average 7% stock market returns.
How I haven’t blown up my bank account (yet)
As a business student turned engineer I set some parameters for myself. After all, Warren Buffet said the #1 investing rule is: never lose money. To this end I:
- Trade infrequently: no day trading
- Journal every entry: what’s the rationale behind the trade? Ie. did I buy for potential capital gains, or is it mostly a dividend play? Is it a long term position or a short term one? What’s the exit and the stop loss?
- Aim to buy quality stocks on sale: use limit orders to buy S&P 500 companies around price supports, preferably around their 52 week low
- Stick to what I’ve tested out on paper trade: sell naked puts, and maybe covered calls
- Focus on tax efficiency: moved most of my money into tax advantaged or tax deferred accounts
In 2020 in 2 weeks I’ve made $10k paper trading options which is 5% of the paper trade portfolio, and since March I’ve made 20% in real money with a mutual fund tracking the Nasdaq index. I chose Nasdaq because it contains the biggest names in tech, and the work from home phenomenom benefits them.
Investing as a potential revenue stream
I am fortunate that I have an engineering job with a good salary, however no job is permanent. I am building out this skill set in my twenties to develop a revenue stream that hopefully will support my frugal lifestyle.
Next steps: learn more about
- Trading USD/CAD pair on forex
- Bonds: when to buy?
- Futures, especially how to provide downside protection when the market goes bonkers?
I love learning the fundamentals via paper trading, then applying them in real life.
Looking forward to more investing adventures.