A peek into the high stakes world of Investing & Trading

There must be some kinda way outta here.. There’s too much confusion.. Yes there’s reason to get excited (sic).. Actin’ Funny, I don’t know why?

Thanks to Jimi Hendrix for providing the perfect context to sum up the essence of speculating or investing in the Financial Markets. How Do The Pros Make Money? Can you become a pro? Can you emulate the pros? What on earth is a pro anyway?How do you do it? Buy ULIPS? Or TULIPS? SIPs? Mutual Funds? Or Stocks? If stocks, which cap would you like to wear? Small? Mid? Large? Heck, there’s even Micro? Or some hybrid of them?

Do you want to make enough money to retire in your mid 30s without worrying about your next three generations having to work? (I hear some people scream ‘YESSS’ and some screaming ‘SCAM SCAM SCAM’). The answer isn’t a resounding no. Nor is it a resounding yes.

Arrgggh… This is getting too complicated. Fear not, brethren (and sisteren), if you’re confused already, I’ve partially succeeded.  Because that’s what this world is like.

Warren Edward Buffett agrees with me on this when he says, “There seems to be some perverse human characteristic that likes to make easy things difficult.”

To start with let’s have a look at the colourful lives of some of these Investors, Traders and Speculators.

Jim Rogers formed one-half (George Soros was the other half) of the phenomenally successful Soros Fund. During his tenure, 1969-1980, the fund was up 3365% vs. the S&P composite’s gain of 47%.

John Templeton is the dean of global investing. His investing record  shows  that  for  thirty-one  years  his  performance  has averaged  an  annual  increases  of  15%,  versus  7%  for  the Standard  &  Poor’s  Index.  He managed  $6  billion  for  the Templeton Funds before “retiring”.

Warren Buffett started Buffett partnership at the age of 25 with $100,000.  In 1969  when he  liquidated  the  partnership  at  the speculative  market  peak,  it  had  grown  to $100,000,000. Buffett’s take – $25,000,000. His investors earned 30 times their original investment. Today he runs Berkshire Hathaway and his investors continue to benefit from his stellar performance.

Paul Tudor  Jones earned over a million dollars in commissions in his second year in the business as a  commodity broker.  In 1980  he  switched  to  the  floor  of  the  New  York  Cotton Exchange  and made millions during  the  next few  years.  As Chairman  of  Tudor  Investments,  each  $1,000  invested  with him  in 1984 had grown  to more than $17,000 by 1988. Michael Steinhardt has one of the best 20 year track records in investment history.  $10,000  put in his hedge fund  at its 1967 inception grew  to over $1,000,000  20  years  later,  achieving  a compounded  annual  growth  rate  of  30%.  Over  the  same period,  $10,000  invested  in  the Standard &  Poor’s 500  Index grew to only $64,000.

A few other illustrious personalities in this list  include Marty Schwartz, Peter Lynch, Roy  Neuberger, the  Chairman  of  Neuberger-Berman  & Company, Bernard Baruch and W. D.  Williams, who have been successful in their Trading & Investing endevaours.

We now proceed to compounding the confusion that pervades this complex maze (Don’t worry, Part 2 will be DA climax).

Broadly, there are two approaches taken to evaluate a financial security. Fundamental and Technical. Let us say you want to buy oranges for end consumption. You care about the nutrition it provides and how it tastes. That is fundamental analysis. When you buy a stock of a company, you look at it as if you owned and ran it; The profits it produced, the quality of its product, and such. However, if you’re an orange trader, your chief concern is what price you buy and sell at. Your aim is to buy at the lowest possible price and sell it at the highest possible price (and pocket the spread). This is the sort of analysis that technical traders do. Again, standing on the shoulders of a giant, Warren Edward Buffett, “Price is what you pay. Value is what you get.” In the financial markets, very often price and value diverge, because market participants have both the incentives – capital gains as well as dividend or interest, depending on whether the security is a stock or a bond, respectively. Imagine a 100 rupee note being sold for 50 rupees. As counterintuitive as this idea sounds, the financial markets are crazy places and crazy things happen. Looking for explanations might result in schizophrenia.

Study the best investors and traders from Wall Street and La Salle Street:  Peter Lynch, Bernard Baruch, Jim Rogers, Paul Tudor Jones, Richard Dennis and many more. After all, when you’re sick you want to consult the best doctors,  and when you’re in trouble you want the  advice  of  the  best  lawyers.  So,  we  consult  what  the successful pros have to say about making money in  the markets. If we could figure out how they did it, we could get rich. Below is some of the advice the pros offered for making money. I hope you’re familiar with these names and their stature from Part 1.

Advice and Dissent

“I haven’t met a rich technician. ” – Jim Rogers

“I always laugh at people who say, ‘I’ve never met a  rich  technician.’ I love  that!  It is  such  an arrogant,  nonsensical  response.  I used fundamentals for nine years and then got rich as a technician. ” – Marty Schwartz

Not very encouraging!  Okay, so maybe the key to success wasn’t whether you were a  fundamentalist  or  a  technician.  Maybe another  topic would begin  to reveal the pros’ secret.

Diversification

“Diversify your investments.”- John Templeton

All  right!  Now  we are getting  somewhere (or are we?).  This strikes a familiar  chord.  Or it looks that way until we read the following:

“Concentrate  your  investments.  If you  have  a harem  of 40 women you never get to know any of  them very well. “
-Warren Buffett

Buffett has made billions  in  the market. Who are we to disagree with him?  But Templeton is also one of the greatest investors alive and he said something totally opposite of Buffett. Okay, so maybe diversification wasn’t the answer either. Maybe you could put all of your eggs in one basket and still get rich by watching the basket very closely. Perhaps the topics we  have  selected  so  far  were  too  broad  in  their  implications. Certainly  the  pros  would  agree  on  the  more  specific  and practical applications of  investment and trading mechanics.

Top and Bottom Picking

 “Don’t bottom  fish. “
– Peter Lynch

“I believe the very best money is made at  the market turns. Everyone says you get killed trying  to  pick  tops and bottoms and you make all the money by catching the trends in the middle. Well, for twelve years I have often been missing  the meat in  the middle, but I have caught a lot of  bottoms and tops.”
-Paul Tudor  Jones

Spreading Up

“Whether I am bullish or bearish, I always  try to have both long and short positions- just in case I’m wrong. “
– Jim Rogers

“Many  traders have  the  idea  that when  they are  in a commodity (or stock), and it starts  to  decline,  they can hedge and protect themselves, that  is,  short some other commodity (or  stock) and make up  the  loss. There is no greater mistake than this. “
-W.D.Gann

We  expect that there might be  some  subtle  differences among  the  pros.  After  all,  some were  stock market moguls, while  others  traded  options  or  futures  contracts.  But  didn’t these guys agree on anything?  Based on the examples above, they sounded more  like members of a  debate  team  trying  to score points against each other. We  have  to  find  out  how  the  pros  made  money  in  the markets.  We have to learn the secret that all of them must know. But if  the pros  couldn’t  agree  on how  to make money,  how are we going to learn their secret?

And then it began  to occur to me:  there was no secret. They didn’t all do the same thing to make money. What one guy said not to do,  another guy said you should do. Why didn’t  they  agree?  I mean,  here was a group  of  individuals  who  had  collectively  taken  billions  of dollars out of the markets and kept  it. Weren’t they all doing at least  a  few  things  the  same when  they made  their money? Think about it this way; if one guy did what another said not to do, how come  the first guy didn’t lose his money?  And if the first guy hadn’t  lost, why didn’t  the second guy? If  imitating the pros was supposed to make you rich and not  imitating them was supposed to make you poor, then each one of these guys should have lost all his money because none of  them  imitated  each  other.  They  all  should  be  flat  broke because  they very often did  things opposite of  each other.

It finally  occurred  to me that maybe studying losses was more important  than  searching  for  some  Holy  Grail  to  making money.  So  let us read through  all  the material  on  the pros again and noted what  they had to say about  losses.

Losses

”I’m  always  thinking  about  losing  money  as  opposed  to  making money. Don’t  focus  on making money; focus on protecting what you have. “
– Paul Tudor  Jones

“One investor’s two rules of  investing:
1. Never lose money.
2. Never  forget rule #1.”
– Warren Buffett

“The majority of  unskilled investors stubbornly hold onto their losses when  the losses are small and reasonable.  They could get out cheaply, but  being  emotionally  involved  and  human,  they  keep  waiting  and hoping until their loss gets much bigger and costs them dearly.”
-William O’Neil

Now we are getting somewhere. Learn about how to not lose. The  pros  could  all  make money  in contradictory ways because  they  all  knew how  to control  their  losses. While one person’s method was making money,  another person with an opposite approach would be losing — if the second person was in  the market. And that’s just it; the second person wouldn’t be in  the market. He’d be on  the sidelines  with  a  nominal  loss.  The  pros  consider  it  their primary  responsibility not  to lose money.

The moral, of course, is that  just as there is more than one way  to  deal blackjack,  there  is more  than one way  to make money  in  the markets. Obviously,  there  is  no  secret way  to make  money  because  the  pros  have  done  it  using  very different,  and  often  contradictory,  approaches.  Learning how not  to  lose money  is more important than learning how  to make money. Unfortunately, the pros didn’t explain how to go about acquiring this skill.

That’s it for now. Apologies for the abrupt ending. I hope you have started seeing the proverbial light at the end of the tunnel. Now hold on to your horses for Part 2 titled ‘The adventures of a retail investor with the bikini clad supermodel at a beach’.