A few weeks ago, I mentioned we were 50% long, 50% cash (up from 100% cash in May), and were planning on selling into any rallies. Since then, we have sold some winners outright (PWER), cut back other positions, and been stopped out completely of losers; win some, lose some. We are now approximately ~85% cash.

The reason I bring this up was to share with you two reactions I got when describing these recent trades and cash holdings. I had two separate conversations in July — one with a well known Trader, the other with a Fund Manager (known in the industry, but not a household name) — about our posture prior to yesterday’s drop.

The two responses were polar opposites, 180 degree apart.

The trader respected the discipline of honoring stop losses. Good traders know that opportunistic speculation is a process. Ignore any one single outcome, focus on the methodology that can consistently avoid catastrophic losses, manage risk, preserve capital. A good process can be replicated, a random spin of the wheel cannot.

The fund manager, who was having a decent year being long high vol names (at least before Wednesday), was having none of it. “Stops are for losers” is a quote I shall long remember (and email him after he blows up). Apparently, real men have the courage of their convictions.

These two conversations were in my mind when I stumbled across a post at the Less Wrong blog; its a site dedicated to “refining the art of human rationality.” One of the things we humans do is come up with short cuts and heuristics — experience-based techniques that help in problem solving, but often contain unwarranted assumptions.

The post Five-minute rationality techniques mentioned a quote we are all familiar with: “It takes a big man to admit he’s wrong.”

Stop to consider that quote for just a minute, and you will realize how silly it is. If we are honest with ourselves, we will have to admit that all of us are wrong about something every single day. The daily details of life are filled with our own errors: What will happen today, the best route to take to work, anticipating a colleagues reaction to something, the weather, etc.

Investors are just as wrong just as often, including errors on the really big things: An assumption we made about a major issue, a small but crucial fact we misremember, a forecast we made 6 months ago — just some of many things we believed that were all wrong. Consensus for earnings, econokkmic reports, how the markets behave. Expectations are rarely made, consensus is frequently off. We are habitually, regularly, predictably wrong about nearly everything.

Rather than fight our foibles, people should admit to themselves that this error stream is real. Why not repair the errors of our ways as soon as we discover them?

I have noticed over the years the difficulty some investors have in cutting losses, admitting an error, and moving on. Way back in 2005, I wrote a piece advising people that they should Expect to Be Wrong (originally published 04/05/05). In it, I noted that “I am rather frequently — and on occasion, quite spectacularly — wrong.” However, if we expect to be wrong, then there should be little or no ego tied up in admitting the error, honoring the stop loss, then selling out the loser — and preserving capital.

Which brings us back to the hubris of the aforementioned fund manager. I see three error related problems he is suffering from:

1) He is focused on short term outcomes, rather than longer term processes;
2) He does not believe he is wrong, or apparently, deluded himself into thinking he cannot be wrong;
3) He is unaware of his own meta-error.

This is a recipe for investing disaster. We humans make 6 billion errors per day, at the very least. The biggest one is not acknowledging them . . .


BTW, the headline of this post is wrong. There are 6.69 billion people on earth; we should reach 7B until sometime in 2011. The management apologizes for the error . . .


2009 Investing Mea Culpas (January 7th, 2010)

How Blind Are We to Our Own Shortcomings? (December 26th, 2005)

The Zen of Trading (June 1, 2005)

Category: Apprenticed Investor, Data Analysis, Psychology

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

44 Responses to “6 Billion Errors Per Day, Minimum”

  1. ToNYC says:

    The point you don’t own here is to be always locked into the state of mind of “daring to fail”. Being concerned, worried, is to not be ready to feast on the lessons of the Fail. Get over it. It’s your Fail, and you got to do a Walter Chrysler on its ass. That’s if you want to live by kickin’it or being kicked.

  2. dead hobo says:

    The Fund Manager is a tool. These are the first questions that pop into mind with him.

    1) Is he lying?
    2) Is he fooling himself (Oh, not those stops, they don’t count, I mean all the ones you use)?
    3) Does he work for idiots?
    4) Are the people who work most closely with him as peers and subordinates idiots?
    5) Is he an office bully, since only a bully could cover up mistakes and stupidity with efficiency?


    6) Does he have some amazing technical proficiency where he hedges each market bet and always knows his maximum loss?
    7) Is he financed by the Fed as a market pumper, so the cash is limitless and losses don’t matter?
    8) Was he just fucking with you?

  3. wally says:

    “Good traders know that opportunistic speculation is a process.”

    Personally, I think you’d have a hard time making that case mathematically.


    BR: Perhaps you prefer it phrased thusly:

    To avoid being fooled by randomness, try focusing on the process, rather than any single outcome, in investing/trading.

  4. call me ahab says:


    have you considered that he is just blowing smoke up your ass? Tough man full of swagger when talking with the boys-

    but what he does for real- who really knows- maybe he has conservative stops on everything

  5. When he has a bad year, he uses the market and his charge to be fully invested as his excuse.

    Of course, his good years are because he is a genius…

  6. drewburn says:

    I’ll add a caveat. While traders should probably always consider stops. For investors, who have long term horizons (and playing TAXABLE money) AND who have the discipline to admit when they are wrong (thus selling their losers), it may be a different story. Are stops just a way of not having to admit to yourself you were wrong?


    BR: I think of stops as a discipline to remove emotion, rather than hiding error.

  7. super_trooper says:

    @ dead hobo,
    sounds like you should be looking for a female fund manager. At least you might get pleasure from point 8.

  8. dead hobo says:

    wally Says:
    August 12th, 2010 at 8:34 am

    “Good traders know that opportunistic speculation is a process.”

    Personally, I think you’d have a hard time making that case mathematically.

    No, it’s not that hard. Back when I still had a hobby account, my specialty was finding stocks that had a strong following and a history of a reliable range. Then I would wait for a drop and when the MACD was as low as possible and starting to turn, it was a near 100% money machine. I just had to make sure that there wan nothing hinky in the business model before buying at the bottom of the MACD sine wave. I’ll probably open a new hobby account when the markets someday looks like a safe place so my main buy and hold acct can sit for longer periods without constant management.

  9. NoKidding says:

    It depends a little on whether you view the market as a place to invest in alpha companies or a place to make beta trades.

    In the long run it makes sense to own Exxon-Mobil and collect dividends, ignoring cycles.
    In the short run it might make sense to be double-short the Euro.

    You can make either perspective work if you apply the correct assumptions.

  10. JustinTheSkeptic says:

    Like all good sales work, whoring is whoring, whether walking down some lonely street at midnight or knocking on a thousand dollar a night hotel room door.

  11. spencer says:

    My personal observation is that managers do not underperform because of bad buy decisions– most buy decisions are OK –but because of bad sell decisions.

    Interestingly Fidelity has observed that over the years when they create new funds they almost always outperforms for the first two years. Why? Part of it is that the new portfolios are stuffed with the institutions best buy idea.
    But part of it is that the portfolio does not own stocks that once did great and are now doing poorly and the manager refuses to recognize that things have changed and those once great stocks are no longer good ideas.
    In other words a lack of a sell discipline.

  12. wally says:

    “No, it’s not that hard. Back when I still had a hobby account, my specialty was finding stocks that had a strong following and a history of a reliable range.”

    The game isn’t just to move upward; the game is to move upward more than other investors. Otherwise, you are really standing still. In any given market, such as the steady-state condition you describe, people are doing just what you describe, You are keeping up with them. The history of both approaches to investing, long term, really doesn’t show any advantage either way. If it did, everybody’d do it that way and then they would, again, just be keeping up. There will always be an outlier, of course, and it might be you. Or it might not.

  13. Petey Wheatstraw says:

    dead hobo Says:

    “I just had to make sure that there wan nothing hinky in the business model before buying at the bottom of the MACD sine wave.”

    If you are any of the following:

    A business owner
    A stockholder
    A voter
    A consumer
    A citizen
    A natural Human being

    then things are already pretty “hinky” in any potential model you might be evaluating. There is obviously no hink-free zone in our economic model.

  14. constantnormal says:

    I make it a point to perform 6 impossible mistakes before breakfast …

  15. Joe Retail says:

    And remember, as we used to say in the business, “it would take a team of humans working day and night for twenty years to make the mistakes a computer can make in a millisecond.” So the algos are really leveraging our human capacity to mess up …

  16. “econokic”

    There, you got another mistake out of the way, and early. And I believe the 7 billion figure by 2011 is a bit high, but I quibble on both accounts.

    I think the whole idea of beating the market is the source for many mistakes that follow. You can only beat an enemy (the markets) when you know as much about your enemy as you know about yourself. In most cases, retail investors know neither their enemy nor themselves. It is a recipe for tears.


    BR: heh heh — I’ll put a strike thru that and add ann “m”

  17. ashpelham2 says:

    Some might say that a mistake is a mistake, and make no distinction between human error, bad judgement, uncontrollable circumstances, etc…I think the main difference in all of those and more is how it is dealt with. Is it a teachable moment, to borrow coachspeak? If it’s an error or judgement, then, yeah, I guess it is. We can use that to not make the mistake in the future. If it’s unforeseen, uncontrollable things, then really, we can’t change the future outcomes, and we can’t prepare ourselves enough to overcome it. If it happens, it happens.

    The issue that is center to all of it is the FUTURE. We are already uncertain of what tomorrow will bring, so we prepare to avoid the most common errors, but we are still susceptible to the ways of nature.

    Man, that felt deeply philosophical. One more thing: that fund manager is either lying to you or is going to be unemployed very soon.

  18. Bruman says:

    A+ post, Barry. I like the emphasis on conviction on the process vs. convictions on trades. It’s one of my favorite themes from Michael Mauboussin’s work too.

    The big challenge I see is: how does one market oneself effectively in this industry while accepting that one can be wrong, and even, on occasion, quite spectacularly so. Investors somehow gravitate to the confident manager who assures people he/she knows everything that’s going on, yet from the risk management side, a dollop or two of humility is likely to preserve capital better.

    You seem to have found a happy medium… care to share any insights on that?

  19. The game isn’t just to move upward; the game is to move upward more than other investors.


    Not for me. For me the game is to beat the economy. As long as my (future, full time) trading puts food on the table and pays the bills then it is a win

  20. wally says:

    Same thing.

  21. sparks says:

    I’d be interested in some analysis showing that a monkey using stop-losses in general makes more money than a monkey not using stop-losses. Where’s the data for that assertion Barry?

    “A good process can be replicated, a random spin of the wheel cannot.”

    Again, is there some research paper showing that a “good” process in general outdoes a random process (say throwing darts at a list of stocks)?

  22. Not all investors are the economy Wally

  23. obsvr-1 says:

    using stop loss is a great tool to preserve capital, preserve gain and reduce loss — not using the tool would be one of the mistakes in your day(s) that you don’t want to make.

    The trader likely in and out of the market so often he doesn’t believe a sell (w/loss) is actually a stop.

    6) Does he have some amazing technical proficiency where he hedges each market bet and always knows his maximum loss? —- That would be GS.

  24. wngoju says:

    br – great post! A friend is what I like to call a Custer (Geo Armstrong) investor. Very very smart, but so very attached to the idea that once he has made an investing decision, it is utter blasphemy to reverse said decision. I keep trying, over the years, to edge him away from that. Lately he seems to be softening some. He is beginning to see the downside. Ie, no matter how good the original decision is, you (whether you are a computer or John Paulson) can’t know enough to make an infallible decision. blah blah blah

  25. eurostoxx says:

    BR – as a ft trader I totally agree with your comments, though I would like to add that ‘value investors’ dont always adhere to stop losses, especially if they still believe the underlying fundamental story. For them stop losses have more to do with fundamentals rather than JUST market price. I believe this is a sound strategy as well. Though the manager you talked with doesnt appear to follow such a strategy.

  26. “One of the painful things about our time is that those who feel certainty are stupid, and those with any imagination and understanding are filled with doubt and indecision.”

    - Bertrand Russell

  27. WFTA says:

    I hire mutual fund managers to make my errors.

  28. blueoysterjoe says:

    I know this is a money site, but I think this applies to product development as well. To often, our systems of production assume that all the assumptions are right, and when one thing goes pear-shaped, the whole system goes pear-shaped. I think it’s better to reward processes and employees that take the inevitable error, assimilate it, and continue than those who pretend to know the perfect solution, and fall apart when the perfect solution falls apart.

  29. “When he has a bad year, he uses the market and his charge to be fully invested as his excuse.

    Of course, his good years are because he is a genius…”

    ” “Stops are for losers””

    if Joe & Jane 4p understood how prevalent that type of ‘tude is, among the AUM ‘crowd’, they, just, might start ‘rolling their own’..

  30. nofoulsontheplayground says:

    A trader once told me, “My stop is smarter than I am.”

    That’s the best way to put it in a nutshell.

    Always use stop losses.

  31. stops are great…..except in flash crashes

  32. MelJ says:

    The post you refer to is dated August 2nd, 2010, ten days ago. The NASDAQ is down 4.23% and the S&P 500 down 3.37% and the DJI is down 3.00% since that date. Does that mean you changed your mind about “selling into any rallies” to selling into declines? There’s nothing wrong with that, but it wasn’t clear from this post.


    BR: You need to read the very next sentence “Since then, we have sold some winners outright (PWER), cut back other positions, and been stopped out completely of losers; win some, lose some.”

    We sell when stocks hit our upside targets (ie, a specific name rallies), or we get stopped out. I thought the sentence was clear, but I apparently was too ambiguous . . .

  33. JustinTheSkeptic says:

    The Curmudgeon, pretend they know, pretend, they are the elite, pretend, because their parents taught them too….pretend.

  34. JustinTheSkeptic says:

    No one knows the struggles i’ve seen. Unless they were partying with me on fifth-ave.

  35. ToNYC says:

    Synthetics are not for nothing. Hedging your Long exposure by selling OTM Calls and using the proceeds to buy the same size and expiry OTM Puts is a way to keep your position and bearings through the storm.

  36. Captain Jack says:

    Bruce Kovner, founder of Caxton Associates, who has pulled billions from the markets over decades of trading:

    Whenever I enter a position, I have a predetermined stop. That is the only way I can sleep. I know where I’m getting out before I get in. The position size on a trade is determined by the stop, and the stop is determined on a technical basis… the point about a technical barrier — and I’ve studied the technical aspects of the market for a long time — is that the market shouldn’t go there if you are right.

    Caveat: For those who shun stops, it is fair and noteworthy to admit that trading and long-term investing are two different disciplines, and that a disciplined approach to risk management and situational assessment can replace use of the traditional stop loss. And yet, even for investors, two words to deeply ponder: BILL MILLER. Consider what happened to the guy who was willing to buy “until there was no longer a price quote” (his words), the conceptual arrogance such a stance entails, and the place it led him. KnowwhatImeanVern?

  37. DanielHess says:

    Hey Barry!

    It has been a joy to profit from guys like you in the past and it will continue to be a joy to profit off of guys like you in the future.

    Here’s how a stop-loss sends your money my way: during a downward move such as when the market gets a little jittery, your stop loss causes you to disgorge your stocks when they are down (your loss, ha ha), leaving your stocks, sold cheap, for me to pick up.

    Seriously, I guarantee you Warren B. never uses stop losses. He isn’t gonna let some computer sell his stocks low every time the market hiccups!

    Keep on being my little b@#$%! I need to put my kids through college!!

  38. Daniel Hess,

    We don’t actually enter Stop Loss ORDERs, we have a price we sell at and a discipline to follow that.

    I started in this business as a trader, and I have known devious little fuckers like you specialists my whole career. That is why you typically see me use the phrase “Stops”or “Stop Losses” but not really use the phrase Stop Loss “Orders.” (Yes, I do know who the criminals are !)

    Or are you referring to merely buying stocks others are selling? I am not sure precisely what you are referring to . . .

  39. DanielHess says:

    Dear Barry,

    Boy, I sure got your boxers in a bunch!

    You are awesome. You make your money selling books and that is about the hardest thing that there is on the planet. I am sincerely envious. The rest of us have to find other ways to make money.

    That said, stop losses are the perfect way to be ruined by volatility. If a stock opens and closes at the same price but is really choppy in the middle, a stop loss could mean you sold at the low point of the day.

    If something was good to buy at a higher price I always thought it is even more of a bargain at a lower price.

    I am not sure if you are were implying that I am a criminal. Or that you even know me. Not at all. I am just a leisured value investor who slowly wades in once in a while when prices get really compelling, mostly because guys named Barry Ritholtz automatically sold into a crash. So far its been quite profitable and rather legal.

  40. DanielHess:

    Since this post is all about errors, allow me address a few of yours!

    1. Buying stocks merely because they are cheaper in price during a secular bear market is a recipe for disaster. Check out most Value Investors’ returns for 2007-08-09;

    2. I earn my living as an asset manager; whatever revenues the book through off — at $16 hour — was gravy (See Bookonomics).

    3. We were 100% Cash prior to the flash crash . . . and nearly all cash thru out 2008.

    4. The specialists who move markets down to execute stop loss orders, then move prices back up, ARE criminals. I thought you were claiming to be that sort of devious little fucker.

    5. I am not awesome, I just try to be informed about what I write about.

  41. OT: The quote of the day sounds like something you’d hear on Oprah (who William F Buckley hilariously described as “that black woman on TV who is alternately fat and thin”):

    “Before you speak, listen. Before you write, think. Before you spend, earn. Before you invest, investigate. Before you criticize, wait. Before you pray, forgive. Before you quit, try. Before you retire, save. Before you die, give.” —William A. Ward

  42. DHess:

    Did I misread your position?

    I thought you were implying you were a specialist

    My apologies if I misunderstood your comment . . .

  43. DanielHess says:

    I apologize too. I guess I wanted to get your attention.

    To give you a little background on me, I am a value investor with a day job that is unrelated to finance, who has been a longtime accolyte of Warren Buffett and the value investing camp. I spend a long time researching stocks and then occasionally buy what I think are undervalued things to hold for months or years.

    For me, stop losses would have been very destructive. I have not once or twice but many times ridden my stocks down and ridden them all the way back up just by not touching them. Stop losses would have stuck me with permanent losses. It’s not just the big flash crash but also a dozens of smaller fluctuations along the way.

    I do know stocks as businesses have an intrinsic value (leaving aside bank stock which I can’t figure out at all). This gives me the courage to do without stop losses. I also know that Bernanke and Co aren’t dumb enough to let asset prices completely collapse 1930s-style and would do helicopter drops of money straight into the real economy before that happens. A deflationary collapse is therefore off the table.

    I am convinced that a stop loss will make me sell at just a time when it is better to buy. I also think that stop losses across the market are deeply destabilizing andd cannot work for everyone (witness 1987). In a real crash stop losses will fail as they did then.

    Most importantly to my heart (and yours too?), I do not want any more wealth to land in the clutches of Goldman which is what happens with stop losses as (you point out) disgorged cheap stocks land in the paws of specialists who flip them when they bounce back.

    Ok, I confess I am usually not that clever, fast buyer who gets in right after the crash. I am usually too slow for that. But I do know the best time to buy is when valuations are cheap. Those buyers after a crash aren’t crooks as far as I can tell as long as they didn’t start the fire. What they do is legal and actually stabilizing for the market. (Not talking about flash traders, who belong in the Ft. Leavenworth Federal Pen.).

  44. No worries –

    I sift thru 1000 emails a day

    its becoming an occupational hazard  – reading too fast, misunderstanding too much

    Ironically, on a post about how we all make too many errors!