Conventional trading wisdom states that traders should set an annual performance target. (E.g. I want to make 20% per year). The thinking goes:
- Setting an annual target is good for your trading psychology. If you hit your target early in the year, you can slow down and take the best trades instead of taking all the trades. This reduces your risk later in the year.
- You can slow down your trading and focus on other things such as improving your skills and knowledge once you hit your annual target. Improving these skills is good for long term performance.
- Traders should set realistic expectations. If you set insanely high expectations, you’ll be too aggressive with your trades and push trades that weren’t good setups in the first place. You increase your risk, which means you could blow up your account.
I disagree. Traders and investors should not set a predetermined annual performance target.
You should set an annual performance GUIDELINE
There’s a difference between an annual performance TARGET and an annual performance GUIDELINE. A target implies that you HAVE TO hit X% year after year.
I use a performance guideline. I.e. I want to achieve an AVERAGE annual return of 30% per year over a span of 10 years.
Get my book!
This soothes my trading psychology because I’m not stressed out if I have a poor year. The simple reality is that no trader or investor can make money year after year after year. People who claim consistently high annual returns usually end up being Bernie Madoff (i.e. a ponzi scheme). There are going to be good years and there are going to be bad years. I’m happy as long as my investment performance is stellar over the long run.
Setting an annual performance target causes unecessary stress.
It doesn’t matter if your annual target is realistic (e.g. 20%) or unrealistic (e.g. 60%). Having an annual target will cause unnecessary stress because no one can consistently hit their target year after year. An annual target can actually be deterimental to your trading.
Let’s assume that it’s almost year-end and that you’re still very far from reaching your target. With the annual target in mind, you will probably take more trades, many of which will have lower probabilities of success. This is because you’re desperate to hit that target. The irony here is that the harder you push your trades, the more likely you are to lose money.
Reaching your target too early in the year can be dangerous too
Some traders like to be more conservative after they’ve reached their annual performance targets. This is actually detrimental to one’s long term trading performance.
Discretionary traders and investors have winning streaks for a reason. Your gains are supposed to more than make up for your losses. If you are more conservative on your trades after you’ve reached your annual performance target, you will essentially be limiting your gains. This is where the saying “let your profits run” comes from. It doesn’t mean that you have to be a trend follower. It means that you should continue to trade the same way even after you’ve reached your annual target.
You should always be improving
You don’t have to start improving your trading skills and knowledge after you’ve reached your annual target. You should be improving your skills so all time time, even before you’ve reached your target.
- Traders learn on the job. There is only so much that books can teach you. You will learn how to place better entry/exit trades and how to improve your risk management WHILE you are trading!
- Do not rest on your laurels. You shouldn’t be “taking it easy” if you consistently hit your annual guideline year after year. You should increase your annual performance guideline!
Just stick to your trading strategy and trade as normal
My trading strategy is constant regardless of whether I’m making or losing money this year. That’s because I know that I can achieve my performance guideline over the long run. I accept the fact that I will underperform in some years. Losing money is just a part of the process.
Traders need to accept that no one’s strategy is perfect. A guideline gives me the mental flexibility to be ok with losses. I don’t let my short term wins and losses impact my trading strategy. A long term performance guideline allows me to ignore the short term ups and downs so that I can focus on long term outperformance.
What’s a realistic long term performance guideline
Beginners should set an average annual performance guideline of 10-15%. The stock market yields an average of 7% over the long run. If your guideline is too low (e.g. 9%), you’re basically underperforming a no-brainer buy-and-hold strategy after taxes. Remember, traders face higher taxes than long term investors.
Slowly increase your performance guideline after you gain more experience and improve your trading/risk management skills.