Imagine that I claim to have a secret formula for playing a certain game. With this formula, I keep doing well in the game and am ahead of people. Would I reveal this formula?

Even if I were altruistic and want everybody to benefit from the secret formula that I’ve learnt and developed, would people still be able to use the formula if everybody’s able to learn it?

If the answer to both questions above is a “no”, then you should automatically give the middle finger to anyone who claims to have a secret formula that they would like to teach you in return for a fee. This applies to trading in any form of financial products or physical assets like gold or property.

Some caveats

  • The argument I’m going to put forth applies only to trading systems where the bulk of returns are from price movements.
  • I’m not saying that ALL these people who claim to have a secret formula are lying or that they are deliberately out to cheat you.
  • And least of all, I’m not saying that trading is a useless activity. It’s not. I’m just saying that it’s better left to the people who actually know how to trade.

Cloning a Golden Goose

If I currently have a golden goose, the last thing I would want to do is teach others how to own their own golden goose. After all, if my golden goose produces golden eggs, then teaching other people how to obtain golden geese is going to increase their amount of golden eggs available and basic economic theory tells us that golden eggs will become less valuable and therefore, less profitable.

The same is true with any trading system for any asset. Profits from trading can only be gained from any misinformation in the market. A trader identifies an asset that the market has valued wrongly, buys/sells it and profits when the mispricing gets corrected.

Assuming the trading system works, more people being able to identify mispriced assets means that mispriced assets don’t stay mispriced for long and therefore, learning how to trade using an effective system means believing that (a) few people currently know about the system and/or (b) you’re faster than others who also use the same system.

No matter what you believe, the more people know the system, the less likely it’ll be profitable for anyone.

Double whammy if guru says the system is easy to follow

From the previous section, we can conclude that even if a trading system works, it’s going to make it hard to work for long. If the trainer says the system is easy to follow, that makes it worse.

Easy-to-follow systems mean that the chance of having more people use the system if high. Once again, more competition means less mispricing and therefore, any system that purports to be easy to follow is not a good trading system to use.

However, for most people, if it’s not easy to follow, then what’s the point of paying good money to use it?

Be skeptical of people selling you formulas

The urban legend (which is possibly true) is that Coca-Cola and KFC have their secret recipes locked in a safe that few people know the combination to. The reason for that is simply because their recipes are their secret sauce and the main reason why those companies are so profitable.

Now, apply the same logic to people who sell trading courses.

Why on earth would they be selling their secret sauce if it’s so profitable? The answer to that is perhaps their sauce isn’t so secret or so profitable after all.

I found a Straits Times article profiling one of those gurus* who sell trading courses and some bits struck me as odd. When asked about his portfolio, the reply was:

I have about $300,000 to $500,000 in equities, indexes and forex. I also have invested in insurance policies that will fetch me more than a million at maturity. Besides, I own a condominium apartment in East Coast.

First, if someone’s been so successful at trading for so long, why’s the portfolio more like any regular old investor? If I was his age, my portfolio would be easily double of what he has right now.

Furthermore, the bulk of his net worth is in insurance policies and real estate. Is that a sign of no confidence in his trading system or is it proper diversification?

In short

Those get-rich-quick workshops out there are probably ALL useless of precisely the same reasons: (1) it works until it doesn’t, (2) it’s hard to make it work if everyone can do it. (3) the trainer probably can’t even make it work for him/her so it’s more profitable to teach it to you.

If you still want to learn how to trade in any asset class, you probably should ask the company a few questions:
(1) How many students have learnt this program?
(2) How long has this program been developed?
(3) Is it easy to follow?

If the answer to (1) and (2) is ‘many’ and/or the answer to (3) is ‘yes’, you shouldn’t waste your time.

Notes:
*This is also one of the reasons why Singaporeans’ financial literacy is so bad. The ST does a big disservice by profiling these people and I suspect this is what happens when the journalist has a background is communications rather than business or finance. That’s fine for the political and current affairs portion of the paper but for the money section, it’s a huge no-no.