For many investors, return on capital becomes more important than the return of capital. Wait, did you catch the difference there?
The wording is subtle yet there is a powerful difference between return on capital and return of capital. The first is the return on the money you invest. For example, if you made $8 on $100 of invested money you would have an 8% return on capital.
The latter is the ability to get at least your $100 back at the end of the day and not lose any money. And I'm here to tell you that if you trade smaller positions you have a better chance of making money!
Success is measured by how much you keep
Back in 2009, the best money managers and investors weren't those who earned the highest return in 2008, but rather those who lost less than everyone else. Being a "smart" investor meant having money left after the s**t hits the fan, and the same is going to be true in the coming years.
Looking back at my trading journal, what was so successful for me was that I had small positions and a lot of put protection.
Moreover, I stayed mostly in cash and waited for the best opportunities to come out before I put money at risk.
Living, and surviving, the markets in 2008 taught me to focus my attention on the return of capital.
And as we have mentioned in the past, it's actually the trader that invests less and keeps more in cash that can generate more income long term vs. the guy who blindly allocates 50% of his account to each trade.
From $20/share to bankrupt in just 5 days
Above my office computer is a picture of the front page newspaper from the October 1929 crash. It is there to remind me of what can happen overnight and the systematic risk factor that is prevalent in all markets.
Lehman Brothers is also a classic example and still recent enough to remember the pain of a market crash.
Keep in mind that it took just five days for Lehman to go from a $5 stock and still worth millions of dollars to bankruptcy. And even nine months before the crash Lehman was a $60 stock. Always remember how quickly things can turn!
The Option Alpha Handbook is a great resource to discover more Performance Metrics & Return Calculations.
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