A Quick, Easy Physics Lesson
Once upon a time, I taught physics. Among hundreds of other topics I covered, I taught students the difference between accuracy and precision. Although a lot of people use the words interchangeably, accuracy and precision are actually different things.
If you aim bullets at a target they might hit it with high precision – a tightly grouped bunch of hits – but low accuracy – your hits are far from the bulls-eye.
Precision AND accuracy are achieved when you get a tight grouping of hits on the bulls-eye.
Working Hard NOT to make Money
When you’re trading, or investing, it’s more important to be accurate than precise. If you have a big idea that’s wrong, you can analyze it to the nth degree, but it’s still not going to make money. Since the first rule of trading and investing is to avoid losing money, you’ve got to be accurate with your big ideas. If your big idea is right, you’ll have to work hard at it not to make money.
Accurate Investing – the Big Idea
A big idea that I caught onto a few years ago was the idea of peak oil. I could write pages and pages about this, but I won’t. Suffice to say that oil is a finite resource. The US has already passed its peak of production, as has the UK. Oil is being consumed faster than it’s being discovered. There are huge reserves of “alternative oil” around the world but the large-scale viability of these resources – such as Alberta’s oil sands – demanded much higher oil prices than the $20 – $30 per barrel that crude oil was trading at five years ago.
So a good “big idea” was to invest in oil stocks.
Some stocks have done better than others, but provided you caught the big idea, you were almost bound to avoid loss and make a decent return. If you did something obvious, like buying Exxon (XOM) you’d have made 100% in the last five years, or Royal Dutch Shell (RDS-B) 60%. If you did the opposite and invested in GM or Ford, who were busily building a new generation of gas-guzzlers, you’d be down 29% and 41% respectively. You see the value of getting your big ideas – your accuracy – right?
Precision Investing – making the most of a Big Idea
If you’d thought a bit deeper, you might have been able to make more money from your oil trade – this time by improving your precision and identifying a nice tight grouping of the highest profitability trades to express your big idea. You don’t need to put money into all of these – but at least you’ve identified a tight group of stocks that should deliver you the highest rewards.
For example, the oil sands that I mentioned in Alberta were marginal or unprofitable at $20 – $30 oil. A big increase in oil prices would almost certainly give a bigger boost to oil-sand company’s profits than to Exxon’s. In fact, the Canadian Oil Sands Trust (COS-UN.TO) has quadrupled in price over the last five years while Suncor (SU) has quintupled and UTS Energy (UTS.TO) has sextupled.