Roulette Table

My car broke down over the weekend. As I lost feeling in my toes and smoke billowed out from underneath my hood, I immediately assumed that the problem had something to do with the repairs performed nearly a month ago by individuals who will remain nameless. Not surprisingly I felt a bit of righteous indignation and let out a few expletives – some of which still hang frozen in the air over I-80. Once help arrived and upon further review, it appears that my anger may have been misplaced. The jury is still out on what happened to my car, but in all likelihood I rushed to judgment.

My car mishap got me to thinking about investing. It is not unusual for investors to attribute investment success or failure to the wrong things. Perhaps the most egregious error is when an investor confuses a winning trade with skill when it may have been luck. In this scenario, much like a gambler on a winning streak at the roulette table an investor will continue to make trades that will eventually lead to ruin because he does not recognize the lack of an edge. Conversely, an investor may have a winning strategy, but exogenous factors such as forced withdrawals or government intervention may lead to a loss. In this scenario, it is important the investor not abandon his strategy and remain patient.

This discussion naturally leads to the following questions: 1) how can an investor distinguish between luck and skill and 2) how can an investor identify what works and what doesn’t? For individuals, it is helpful to maintain a trade journal where the reasons for entering a trade are noted beforehand and then reviewed after the position is closed. This provides helpful feedback. Here at CLS, we are able to perform attribution analysis on our funds. This practice provides helpful insights into what is and isn’t working. As we continue to run analytics on the funds, we will use the feedback to identify and reinforce what works best while avoiding jumping to conclusions like I did with my car problems.

Comments provided by guest writer Matt Chadwell, CLS  Investment Research Analyst