I recently read The Indomitable Investor by Steven Sears. It is easily one of the best books on investing I’ve ever read. The chapter on ‘Fear’ alone was worth the price of the book. The subtitle best sums it up – Why a Few Succeed in the Stock Market When Everyone Else Fails.
I don’t want to give away much of this book, as I’d rather you just go out and read it for yourself. What I will do is share some of my favorite quotes. Safe to say Steven did extensive research and interviewed tons of investors along the way, making this one an instant classic in the process.
“To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information,” Warren Buffett says. “What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.”
Exactly. I’ve always said as a trader I’d rather be lucky than good. Now we make our own luck by how hard we work, still, being smart isn’t what it’s about. I’ve traded against a lot of CFAs who might understand a balance sheet more than me, but that doesn’t mean you understand crowd psychology and are open to being wrong.
“Risky things are not in themselves risky if you understand them and control them. If you do it randomly and you are sloppy about it, it can be very risky,” says Ray Dalio. “I’m always trying to figure out my probability of knowing. Given that I’m never sure, I don’t want to have any concentrated bets.”
Dalio is one of the best investors of our generation and is the founder of the investment firm Bridgewater Associates. As an option trader, I feel close to what he is trying to say. I am comfortable with potentially losing my whole premium if a trade drastically goes against me. Sure, it hurts – but is part of the game sometimes. The issue comes when traders don’t understand leverage and are burned. I’ve seen time and time again, novice traders put all their eggs in one basket and rarely does that turn out well.
“Why do you rob banks,” someone once asked Willie Sutton, the famous bank robber. “Because that’s where the money is.” This is the same logic for most investors and is recipe for failure just as Slick Willie was arrested and locked up.
Sometimes the obvious trade isn’t the best trade. Poor Slick Willie learned this the hard way
“What’s the personality of the most successful investors? They aren’t affected by other people’s feelings. In fact, the most empathetic people I know are the worst investors,” says William Bernstein, a neurologist who manages money at Efficient Frontier Advisers.
It is good to have feelings, but when it comes to trading they can crush you. Getting attached to a trade that isn’t working is a dangerous game. You’ll find yourself picking reasons why it ‘should’ work, or as we call it around here – you’ve entered ‘hope mode’. Once you start hoping a trade will work, it is probably too late. The best traders are those that realize they made a mistake and exit the trade, with no emotional damage done. I’ve been doing this over a decade and I’m much better than I was when I started, still the stubborn part of my psyche comes out once in a while and it usually costs me.
Schiller’s dictum: “Anyone taken as an individual is tolerably sensible and reasonable – as a member of a crowd, he at once becomes a blockhead.”
This is all about crowd psychology. As individuals, we naturally feel more comfortable in a group. The only problem with this is the crowd can be wrong a lot of times. In fact, they are wrong most of the time near the extremes. Remember when housing prices would never go down again back in 2006? Or how in 1999 Internet stocks would never go down and could justify their massive P/E multiples? Or more recently, how Fiscal Cliff was going to pull down the stock market and economy in 2013?
“Unfortunately, I was so successful for so many years in that particular field that I began to believe my own success. I thought that because my method worked in markets that I knew about and had quantified, I could apply the same methods to something I didn’t know about,” said Victor Niederhoffer, famed Hedge Fund manager.
Niederhoffer was an investor with massive success over the years, but he is also better known for blowing up not one, but two funds. Once in 1997 and the other in 2007. His biggest flaw, as he notes above, was he became too confident. Success will do that to you. There’s a reason most teams don’t win the Super Bowl two years in a row. Success can make you comfortable, satisfied, or even lazy.