Thursday, May 8, 2014

Knifes, Cold Streaks, and Investment Process

I took a knife skills class recently in which the instructor taught us how to use 8 inch cooking knives to break down vegetables to cook.  This guy could dice carrots with his eyes closed. How do you do this without cutting off your fingers?  


Every single time you start to cook, you hone your knife first.  Every time.  There is no mental dialogue of "Well, maybe the knife is still pretty sharp because I didn't use it that much last time."  No.  You hone your knife EVERY time.  You hold the knife the same way, the right way, every time.  You have your other hand in a certain posture so you are less likely to cut off a finger.  The instructor often had to cut up 60 lbs. of onions in minutes.  Process.

I was involved in this conversation recently:

Trader: "Well, when you're hot, you're hot, when you're not, you're not."
Me: "What do you mean?"

I was thinking he meant the fact that I went from up 9% this year to down 9% over the course of two months, after being up 51% last year, without using leverage.

Trader: "You sold XYZ stock yesterday and now it's up 8% today.  Everyone gets cold streaks."

This is a man who doesn't understand investing at its most fundamental level.  I sold XYZ stock because it hit my stop-loss discipline the day before.  Then, the stock beat earnings and happened to go up the following day.

Did I make a mistake?

No, absolutely not, because I followed my discipline.

I DO NOT GET HOT.  And I don't get cold either.
I follow my process, my discipline.

What is discipline?    Discipline is breaking down your rifle and cleaning it perfectly EVERY DAY, not just the day you expect to see combat.

Discipline is not: "Well, I always sell when my stock is down 20% from my entry point except when I think it still has good fundamentals."  Process is not: "I am on a hot streak because the stock went up more than expected, even though I bought ahead of earnings and it could have gone either way."  Discipline is realizing when you have made money for the wrong reason.

My investment style may go in and out of favor.  EVERY style goes in and out of favor; no style works in all market environments.  But I know, having done this for almost 20 years, and ten of those years with an actual process and discipline, that my method works. (For me.)

The seminal insight in Schwager's "The Market Wizards", one of the best investment books ever written, is that process and discipline matter more than anything.  He interviews a dozen different traders with a dozen different styles and they have only one common element: disciplined process.  The famous "Turtles" were completely that!  The traders that did the best were the ones that were able to blindly follow the discipline, regardless of their emotions.

I often see people on twitter, like a certain famous short-seller, tweet his winning trades.  It goes something like this: "I shorted TSLA at 200 and now I'm covering at 185."  Sometimes they double down, sometimes they don't. No process.  Just randomness.

When people see me about trying to get hired as a hedge fund analyst, especially new MBAs, they always tell me about their investment successes.  "I bought ABC widget Co. at $8 and it went to $16!"  Or "In my PA, my return was 28% last year."  Fine.  Now tell me your process.  That is all I really care about.  I want to know your discipline.  I want to know how you will be able to repeat your performance.  More important, I want to know what you are going to do when you are wrong, when the stock goes against you.

Process is everything.  When I first started at Merrill Lynch, years ago, we used to do HUGE mailings.  We would mail out 5000 letters to invite people to seminars.  I would enlist the help of   admin staff and even college interns.  We folded, stuffed, and labeled 5000 envelopes and took them to the post office.  You know what?  Even in a mindless task, there is always a better, smarter way to complete it.  I could tell a lot about the people just by how they stuffed envelopes.  The smart people were always looking for a more efficient, uniform way to do it.

I went to the Ira Sohn conference recently; I go to a lot of these conferences.  Most people mistakenly think that the value of the conference is the investment ideas.  They can't wait to find out the symbol of whatever Mr. Bigshot Hedgefunder is pitching.  There are armies of people at these events liveblogging and tweeting the stocks pitched, which of course, move right away.

They are missing the whole point.  The reason I go is to learn how these super investors think. Do you really think you are getting their freshest, best idea?  In fact, most of the time, I leave the conference without a single actionable idea.  But what I see is process.  Discipline.  How much work these people do.  How they do it.  How they pitch a stock.  What they look at.  Bill Ackman is a perfect example of this, with his detailed slideshows.  Process.

And when the market gets volatile, the ONLY thing you have is your process.

I don't want to cut off my finger because my knife isn't sharp. When someone is shooting at me, I do not appreciate when my rifle jams because it's dirty.  And I sure as hell am not on a hot streak just because my investment style is in favor at the moment.

Here's a mantra I will share with you:

I do not get hot.  And I don't get cold either.  I FOLLOW MY PROCESS.


  1. This is a great topic. I'm glad you brought it up. Because, for me, it's tough to be so mechanical. I believe markets have cycles. That doesn't mean I believe they are cyclical necessarily, only that certain strategies come in and out of favor.

    It's difficult to back test the political environment your in. More and more, that's what I see as the overriding factor. The more the institutions at the mouth of the river are dependent upon the prevailing political winds the less I pay attention to the "fundamentals" - be it valuation, or technical.

    And, the more I experience things in the market. I believe that's a natural occurrence with one's age.

    So, I have a hard time staying mechanical.

    Here's a woman that started as retail. Now is running her own fund.

    I'm going to share a link. And, the title will certainly put you off. But, check it out.

    I've begun watching this program daily. Mainly because I've learned so much about options from these guys. But, I'm sharing this because here is someone who most certainly has a process.

    Dude in the beret........yeah, I know.....Started thinkorswim. The other guy, was in the pits next to him. There are longer videos of the 3rd, and most recent interview available - but you'll have to register at their site. When I think of all the guys plying their trade and charging people for their "views" and these guys give it away.....I think they're sincere, but, then again, they have an economy of scale most don't.

    Anyway. As you'll see.......She's basically "always" looking for the "other" leg of the strangle. She starts out, way, way out of the money..........and "enhances" the puts she sells by selling "closer" calls.

    In her most recent interview, which was in Feb....she says she trades 40K times a year. She gives no secrets away to her process there............mind you. Still though. Sosnoff, and Batista don't say it......but, it's palpable they think she's Neiderhofferin it.

    Just thought you might enjoy.

    Here's part 1

  2. Have you stopped publishing/writing for good? Pity, if so. Hope all's well.