How can you judge short term trading skill?

[Lucky C]

Over the past year I've had a surprisingly good streak of short term trading using fun money (1-2% of my net worth). Now I'm wondering if that has been luck or do I now have real skill as a trader that warrants putting more in (maybe 10% of NW)?

My strategy is largely reliant on my own thoughts so it can't be judged based on backtesting. Instead I have to judge my own performance. Here is my record of recent trades employing the same sort of strategy. Note that the first one is the only losing one, but not as much thought went into it as more recent trades, and it is from over a year ago whereas the others are form the past 8 months; I'm still including it to be fair.

Gain/Loss, Calendar Days Held:
-11.9%, 90
22.1%, 87
4.8%, 7
2.9%, 6
5.6%, 21
5.2%, 3
9.1%, 15
2.7%, 210
6.5%, 266
3.0%, 268
21.1%, 9

These are all the transactions done employing my current short term trading strategy; no current open positions. Please believe me that I'm not trying to humble-brag here. After years of learning from most people that this type of winning streak should not be possible, I'm just trying to figure out if I have skill or just dumb luck!

Any way you slice it, these results are tempting me to pursue it more. Average gain of 6.5% over an average holding period of 89 days equates to 29% CAGR. Or if I had made these trades sequentially with no overlap, I would gain 91.8% over 982 calendar days = 27% CAGR if my math is correct. So clearly I am gaining confidence in short-term trading, but this is in direct opposition to my plan of sticking to safe reasonable long-term investments.

So how likely is it that this is repeatable? If we say that 10 of 11 of the trades are beating the market and compare that to a random coin toss, there is only 0.5% chance that you would get the same side 10 of 11 coin flips. If we only look at the past year (10/10 wins), the probability drops to 0.1% that it would occur by random chance (perhaps lower odds that it would beat the market by such a large amount on average?). I'm sure there are much more sophisticated ways of determining how much better I'm doing than comparing to a coin toss?

I also need to consider the pros and cons of expanding my short term trading.
Pros:
- This may be explained by most investors relying on passive investing or algorithms = more opportunity to trade using your brain (the rational part, not the emotional part) on the time scale of weeks to months?
- Diversification away from passive investing; outperformance in sideways/volatile/crashing markets
- My (statistically significant?) winning streak
- There is a clear trend of improvement over the years of my losing money quickly in early years, to a combo of losing/winning, to now winning consistently this year
- Employs my unique skills(?) that other investors lack(?)
- I wouldn't risk any amount I couldn't afford to lose, keeping enough in safe long term investments for < 3% SWR
- I enjoy it

Cons:
- This may be sampling bias / hot hand fallacy; I wouldn't be exploring this if I wasn't doing so well!
- The winning streak is only 10 trades, over less than a year, so it's not enough to make a big judgment yet
- It's not supposed to be possible to consistently make these short term gains according to most people, and even if it is possible it's unlikely I'm in the top 0.X% of traders who can do this
- It may overly rely on patterns of the past year that may not repeat in the future
- There is a limit to the number of bets I would find worth making throughout the year, so I won't be able to diversify over more bets and instead would have to risk more dollars per bet. However, this is in line with what I have read about successful investors - placing a few large bets with conviction.
- The stress of feeling the need to watch the market all the time
- I don't really need to beat the market to achieve my goals, just need to avoid major losses in first few years of FIRE
- If I trade too much, taxes will become significant (but not a problem right now)

So... how do you judge short term trading skill?

[Bankai]

I'm wondering if that has been luck or do I now have real skill as a trader that warrants putting more in (maybe 10% of NW)?

Insufficient sample size. In my first year of active investing, my CAGR was 49% (my capital back then was only a few £k). I never got close to this kind of performance again (meaning it was most likely luck).

Having said that, you can certainly start scaling up, although gradually - I would not jump from 1% to 10% overnight, but you can start increasing your exposure over time while your strategy works. The reverse is also true, taking money off the market when your bets start going the wrong way.

My strategy is largely reliant on my own thoughts so it can't be judged based on backtesting.

Do you have a written trading plan? Strategy reliant on thoughts might be difficult to evaluate. If, however, you have it down on a paper, including your selection criteria, entry & exit criteria, position sizing, stop-loss policy, increasing/decreasing exposure etc. it's much easier to make more objective decisions and later evaluate trades.

Any way you slice it, these results are tempting me to pursue it more.

Nothing wrong with that. One of the gravest mistakes an active investor can make is to consider himself a genius after a winning streak and become reckless (ignoring own rules, betting more money than he can afford to lose etc.). From what you've written, fortunately, you're far from that. You can certainly increase your exposure, gradually, as you get used to operating at each new level (say, from 2% - 4%, then to 8% etc.). If you feel comfortable with your current exposure, and you're doing well (ie. making money), then it's time to scale up, slowly.

So how likely is it that this is repeatable?

I think this is a wrong way of looking at this. Your goal is to make money, not to have a win streak of successful trades. If only half of your trades were profitable, but on average you'd make 3x as much profit on each winning trade, as your loss on each losing trade, you'd still be making a lot of money. You can even make money with less than 50% of your trades being profitable. The problem with win streaks is that you might start believing you're a genius which can lead to very painful mistakes. If your strategy is sound, you will make money in the long term, but the outcome of each individual trade is 'random' therefore there ought to be losing ones - they WILL happen, and there will be many of them. It's best to accept that asap.

Cons:
- This may be sampling bias / hot hand fallacy; I wouldn't be exploring this if I wasn't doing so well!
- The winning streak is only 10 trades, over less than a year, so it's not enough to make a big judgment yet
- It's not supposed to be possible to consistently make these short term gains according to most people, and even if it is possible it's unlikely I'm in the top 0.X% of traders who can do this
- It may overly rely on patterns of the past year that may not repeat in the future
- There is a limit to the number of bets I would find worth making throughout the year, so I won't be able to diversify over more bets and instead would have to risk more dollars per bet. However, this is in line with what I have read about successful investors - placing a few large bets with conviction.
- The stress of feeling the need to watch the market all the time
- I don't really need to beat the market to achieve my goals, just need to avoid major losses in first few years of FIRE
- If I trade too much, taxes will become significant (but not a problem right now)

It can certainly be a bias, however, I don't think it should stop you from exploring further (if you want to do this). As long as you are reasonable about it. Yes, the number of bets would be limited but you shouldn't have more than 5 (maybe 10 at most? but only with a big account) stocks at the time anyway to keep things manageable. You don't need to watch the market all the time - with your time horizon being weeks to months, you don't need to be glued to the screen like a day trader, although having a look few times a day is advisable. There are also stop losses to help manage the downside. Re taxes - if you're paying more taxes, that means you're making more money, right? So it's a good thing.

[Mister Imperceptible]

So how likely is it that this is repeatable?

Agreed with Bankai. Might it not be more important to ask, how would a losing streak affect my rate of compounding? What type of winning streak would I need to recover from a losing streak? How many winning streaks do I need compared to losing streaks, and what are the consequences of having a few losing streaks too many? Etc.

Although I do think taxes matter. If the point is to avoid drawdowns with short term trading I don’t know how you avoid this outside of a retirement account without becoming a buy and hold investor.

Are you buying stocks with stop losses? Are you using derivatives? One of the things I am trying to be cognizant of is the fallacy of stop-losses, as major gaps downward of stock prices in a liquidity event will not trigger the stop loss at your desired exit point.

[Peanut]

I would definitely encourage you to keep trading and try scaling up. Personally though I couldn't come to much of a judgment about skill beyond "looks promising!" And if you enjoy it, pursue it as much as you feel comfortable doing. Controlling your own money as much as possible is more satisfying than not.

"So how likely is it that this is repeatable?"

For me, that would not be an important question. Along the lines of what Bankai said, consider a trader who invested 10k, had 9/10 losing trades, but was still up 4k at the end of it versus another trader who had 10/10 winning trades and was up 3k. Who is the better trader? I also think scale can change the way one trades and thinks about trading. Traders who are turning 5k into 10k, 50k into 75k, or 500k into 600k are likely approaching the same thing quite differently. Developing your own approach, which is to say rules to trade by, as well as altering them along the way, is helpful.

As for taxes, trading in a Roth IRA should be tax free? May be worth looking into.

[Mister Imperceptible]

consider a trader who invested 10k, had 9/10 losing trades, but was still up 4k at the end of it versus another trader who had 10/10 winning trades and was up 3k. Who is the better trader?

And what if the trader with the expected .100 batting average but a high slugging percentage goes 10 at-bats without a home run? (Just for the sake of argument)

[arcyallen]

Let's look at the big picture for a minute. The movement of the market in the short term (say, a year) is based much more on your fellow investors sentiment than actual value. Half your investments were held for less than six months. I'd never, ever sincerely put much credit in anything that made or lost money over the course of a year like that (although it's tempting). Even Warren Buffet will tell you he has no idea where the market will be in a year.

Short term trading is literally trying to bet what other people will do, not based on how valuable certain stocks are. If you can consistently predict your fellow man's short-term actions, you are more than a hero! The only path I see that lines up with this is taking advantage of short term situations (people overreacting) and locking in that current high or low (usually lows), knowing that the market will -eventually- revert back to it's intrinsic value.

Good for you, btw, to be self aware like this. Most people just pat themselves on the back and chalk it up to luck. Then open a margin account

[Lucky C]

Thank you for the responses! It's helping me think this through. One weakness of this brief record of mine is that there are some overlapping periods of correlated assets, so even though the 10 trades took place on different days, some would have benefitted from the same underlying market moves. I shouldn't consider myself much better than the trader who makes easy gains in this bull market by trading FAANGs 10 times, even though I feel like what I'm doing is smarter than that.

For now I will set a hard limit of 1% of my NW per trade and a max of 3 such positions at a time. Then I can have some fun without having to worry or keep track of too much. Even if they don't do well this year, they will still provide a bit of diversification, as well as learning opportunities.

[Jason]

If you are actually trading and not gambling, I look at it as any skill that needs to be developed. Good traders don't stop when they lose. I would argue you can't become a good trader until you lose and can use losing as a pedagogical experience. A gambler plays the hot hand. A good poker player plays the odds. Sometimes the gambler wins and the good poker player loses. Warren Buffet plays chess while everyone else plays checkers. Trading is work.

You are also using a very conservative portion of your portfolio. If you are having success, I would incrementally increase it. As you gain confidence, you increase more.

[subgard]

I know exactly where you are, but I'm unsure of what to advise you.

Increasing frequency of trades or money allocated would result in a painful learning experience, maybe one you need to have.

The best advice I can come up with may seem a little weird. Study Eastern style meditation and mindfulness with the intent of being able to clearly separate emotional desires from intuitive judgement.

If you spend some time as a student of the market, your intuitive judgement will be 99% correct, while your emotional desires will cause you to be incorrect 80-90% of the time.

Knowing the difference between the two is extremely important for a non-mechanical system like yours.

While playing with "fun money", you were relying on intuition (the reason your trading was so successful), but your questions indicate a burgeoning emotional desire to be successful at trading (which will cause you to lose).