Posts filed under “Rules”
I had a conversation with a friend recently about Wall Street. We discussed some of the odder aspects of the Street, not so much about investing itself, but about having a career in finance.
I have a somewhat skewed and skeptical perspective on Wall Street. I started out as a lawyer (I loved law school but hated practicing); got a job as a trader under very random circumstances; eventually moved to research and then onto asset management.
But I spent a long time learning what this industry was about — reading everything I could get my hands on, critically analyzing what works and what doesn’t. Learning and studying was a crucial aspect of a job in this industry; Long before Malcolm Gladwell wrote about it, I had a colleague who used to say that it took 10 years to become an overnight sensation.
As a newbie, I critically read everything – skeptically, carefully, looking for weakness in the logic. Over that period of study, there were quite a few things I learned about Wall Street that surprised me:
1) Deep thought: Surprisingly few people rolled up their sleeves and thought deeply about why things in market are the way the are. What causes markets to go up and down? Why do things blow up? Why do most investors under-perform markets? Lots of myths and urban legends, not nearly as much quantitative evidence.
If you get really deep about it and study the data, there are some rules to learn. To succeed in markets, one needs to become a philosopher-mathematician.
2) Long-Term Greedy: Too many people went for the easy money, but that was never what motivated me. It was more about intellectual curiosity and honing ones craft, and less about the quick hit. I made less money compared to many of my peers, but I kept more of it and never blew up.
The phrase “long-term greedy” was coined by former Goldman Sachs director Gus Levy many years ago. You can make (lots of) money over time, but only by serving clients’ interests. Its amazing to me that view is so far out of fashion today.
3) Hard Work: There is no other field where a person of average skills and intelligence who is willing to put their head down and work hard can makes 100s of thousands or even millions of dollars a year — but only if they are diligent and patient and willing to put in the hours.
However, most of Wall Street is taught how to sell products to clients; rarely are they instructed what they buy, why they are buying, when to sell (or why). This is the industry’s fatal flaw.
4) Get Rich Slowly: Few people have the patience to get rich slowly — everyone on Wall Street who ever got into trouble was impatient, and couldn’t wait the requisite 10-20 years it took to become a millionaire. They ended up in jail or as mortgage brokers. Patience is virtue.
5) Mentorship: Finance is filled with amazing, generous, really smart people — who mentor and teach and bring along the next generation. I hope the crisis & collapse and bailouts and mergers didn’t ruin that — My fear is that has gotten a lost over the past decade.
I have found Wall Street, warts and all, to be a deeply satisfying place to work, filled with intellectual challenges, wonderful people, and deep rewards. Sure, there are frustrations, and there are people who focus on the piles of money to be made, to the detriment of all else.
If that’s your focus, you will have missed out on some very important life lessons.
From Jesse Livermore comes these Reminiscences of a Stock Operator: With New Commentary and Insights on the Life and Times of Jesse Livermore 1. Nothing new ever occurs in the business of speculating or investing in securities and commodities. 2. Money cannot consistently be made trading every day or every week during the year. 3….Read More
Joe Fahmy has guided his hedge fund to outperformance over the past 13 quarters. He has been sharing his trading skills to a novice to intermediate traders based on his 16 years of trading. This is our their attempt at creating bite size, easy to understand, bullet points for traders. The prior posts are here…Read More
Nice list from Jeremy Grantham, via Marketwatch: 1. Believe in history “All bubbles break; all investment frenzies pass. The market is gloriously inefficient and wanders far from fair price, but eventually, after breaking your heart and your patience … it will go back to fair value. Your task is to survive until that happens.” 2….Read More
I met Joe Fahmy a few years ago at Lindzenpalooza. He has a great way of communicating his trading skills to a novice to intermediate traders based on his 16 years of trading. Fahmy has guided his hedge fund to outperformance over the past 13 quarters. As previously mentioned, I wanted to present something less…Read More
David J. Merkel is a CFA, FSA. His forthcoming equity asset management shop is tentatively called Aleph Investments. From 2008-2010, he was the Chief Economist and Director of Research of Finacorp Securities.where he researched a wide variety of fixed income and equity securities, and trading strategies. Until 2007, he was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. From 2003-2007, he was a leading commentator at the investment website RealMoney.com.
These are his Eight Rules of Investing:
My objective in guiding investors is to teach them how to tilt the odds of success in their favor. As a value investor that rotates sectors, I have eight methods that each tilt the odds a little in my favor. Individually, each tilt is worth a little. As a group, they have been very powerful for my past results. Unaudited, these methods have allowed me to beat the market since the strategy started in September of 2000.
- Industries are under-analyzed, relative to the market on the whole, and relative to individual companies. Spend time trying to find good companies with strong balance sheets in industries with lousy pricing power, and cheap companies in good industries, where the trends are not fully discounted.
- Purchase equities that are cheap relative to other names in the industry. Depending on the industry, this can mean low P/E, low P/B, low P/S, low P/CFO, low P/FCF, or low EV/EBITDA.
- Stick with higher quality companies for a given industry.
- Purchase companies appropriately sized to serve their market niches.
- Analyze financial statements to avoid companies that misuse generally accepted accounting principles and overstate earnings.
- Analyze the use of cash flow by management, to avoid companies that invest or buy back their stock when it dilutes value, and purchase those that enhance value through intelligent buybacks and investment.
- Rebalance the portfolio whenever a stock gets more than 20% away from its target weight. Run a largely equal-weighted portfolio because it is genuinely difficult to tell what idea is the best. Keep about 30-40 names for diversification purposes.
- Make changes to the portfolio 3-4 times per year. Evaluate the replacement candidates as a group against the current portfolio. New additions must be better than the median idea currently in the portfolio. Companies leaving the portfolio must be below the median idea currently in the portfolio.
Each of these rules enforces a discipline on the overall portfolio that most professionals and individual investors do not possess. It takes the emotion out of investing, and forces us to think like risk-sensitive, profit-seeking businessmen. I agree with Buffett when he said, “I am a better businessman because I am an investor, and I am a better investor because I am a businessman.” The two disciplines mutually reinforce each other, leading to better results.
Part II is after the jump
Ed Easterling of Crestmont Research boils down his views on long term markets to 12 rules of secular stock market cycles. In case you are unfamiliar with Ed’s work, several books, including Unexpected Returns: Understanding Secular Stock Market Cycles; he also wrote Probable Outcomes. Here are Ed Easterling’s 12 Rules of Market Cycles: 1. Secular cycles…Read More
Last month, we put together a full run of Trading Rules & Aphorisms. In the intervening weeks, I discovered I overlooked quite a few lists that are on the site.
Here is the updated version:
• In Defense of the “Old Always” (Montier)
My (Ritholtz) own rules
After this run, I plan on updating this list every quarter . . .
Books after the jump
Raymond James’ P. Arthur Huprich published a terrific list of rules at year’s end. Other than commandment #1, they are in no particular order: • Commandment #1: “Thou Shall Not Trade Against the Trend.” • Portfolios heavy with underperforming stocks rarely outperform the stock market! • There is nothing new on Wall Street. There can’t…Read More
Its been two years since the Madoff crime erupted across headlines. The massive theft punctured what little faith investors had in the markets, investment firms and regulators. Fraud rarely has a silver lining, but the least we can do is try to learn from other people’s mistakes. There were many many lessons to be learned…Read More