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How To Trade Like Stan Druckenmiller, George Soros And Jim Rogers

The first thing I heard when I got in the business, not from my mentor, was bulls make money, bears make money, and pigs get slaughtered. I’m here to tell you I was a pig. And I strongly believe the only way to make long-term returns in our business that are superior is by being a pig. I think diversification and all the stuff they’re teaching at business school today is probably the most misguided concept everywhere. And if you look at all the great investors that are as different as Warren Buffett, Carl Icahn, Ken Langone, they tend to be very, very concentrated bets. They see something, they bet it, and they bet the ranch on it. And that’s kind of the way my philosophy evolved, which was if you see – only maybe one or two times a year do you see something that really, really excites you… The mistake I’d say 98% of money managers and individuals make is they feel like they got to be playing in a bunch of stuff. And if you really see it, put all your eggs in one basket and then watch the basket very carefully. -Stan Druckenmiller

This quote comes from a speech Druck gave at the Lost Tree Club back in January. I’ve read the speech twice now and I’m sure I’ll read it many more times (and recommend you do the same – here’s the link). For those who don’t know, Druck generated 30% average annual returns at his hedge fund over a period of 30 years and never had a single down year – possibly the best track record ever.

I’m sharing this quote with you here because I think it’s central to what we are trying to accomplish. I want to help you close the gap between being an average investor and being a phenomenal investor. That’s my whole purpose with this thing.

But there’s one huge road block we run into. Being a “pig” isn’t easy. For many people, it may not be possible. As Druck explains in his speech, when he and Soros famously shorted the British pound they put 200% of the fund into that one trade. 200%! They put every penny into the trade and then borrowed against every penny to lever up their returns. That’s what he means by ‘being a pig.’ How many people could put this trade on and still sleep at night? This also goes against everything we are taught when learning how to invest. Step one is to diversify, right? What they don’t tell you is the greatest investors of all time look at step one and call, “bullshit.”

The reason phenomenal investors are able to forego diversification like this is because their skill set is different. They are capable of doing the research such that they can have a high level of confidence in an idea. And when they are very, very confident about an idea they can afford to swing for the fences because their batting average with high confidence ideas is very, very good (and, probably even more important, they’re also willing to admit when they’re wrong and get out quickly). And why put any money into anything else when you have one really, really good idea?

Most investors can’t do this simply because they just don’t have very good batting averages. So bridging the gap between being an average investor and being a phenomenal one is first raising your batting average. This requires both knowledge and experience. The second step is trusting your knowledge and experience when you find a high confidence idea (while also limiting the damage when you’re wrong). And when I say, “high confidence idea,” I’m thinking of a quote from another Soros disciple, Jim Rogers:

One of the best rules anybody can learn about investing is to do nothing, absolutely nothing, unless there is something to do… I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up… I wait for a situation that is like the proverbial “shooting fish in a barrel.” -Jim Rogers

You have so much confidence in an idea that it feels like a “sure thing” or as sure of a thing as there possibly can be in the financial markets. This is how I felt about Herbalife back in January and that’s exactly what I did. I put about half of my own personal liquid assets into that one trade. That’s what “being a pig” meant to me.

Bridging the gap between being an average investor and phenomenal investor is a process. The average investor should be diversified in order to protect them from their own lack of investing skill. But the phenomenal investor throws it out the window and says “I’ll just be in cash until there’s a trade opportunity so compelling that I simply can’t resist. Then I’ll back up the truck.” (This is probably why guys like Jeff Gundlach and Mohamed El-Erian are mostly in cash right now in their personal accounts – they’re waiting for a compelling opportunity and don’t feel compelled to hold anything just to stay invested.)

It’s up to each individual to determine where they are in the process and how their personal risk tolerance should dictate how they implement these ideas in their own investments. A broad ETF portfolio, like any of the models presented in Meb Faber’s new book, is ideal for a beginning investor or one with a very low tolerance for risk. Just via the cost savings versus traditional investment methods this will vault her performance far ahead of most other individual investors. More advanced and aggressive investors, however, should focus more on the most attractive individual risk/reward opportunities they can find based upon their own analysis because that’s where I believe the Druck/Soros/Rogers-type returns lie.

A version of this post first appeared on The Felder Report PREMIUM

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This Chart Suggests A Bear Market Could Be Lurking

As most of you probably know, I decided back in late September last year that I wasn’t shaving until we saw another 10% correction. Although, the stock market typically sees about one per year, it’s been about three years now since we’ve seen a correction of that magnitude.

Jim Paulsen of Well Capital recently published a very interesting study on the strength and significance of this trend over the past three years. He finds that the unusual stability and persistence of the trend is a clear sign of euphoric sentiment:

Investor sentiment is currently at one of its highest levels since 1900! There have been only 14 periods since 1900 when the R-squared has risen above 90% and today it is near an all-time high record at slightly above 97%! …The stock market has typically struggled once the R-squared (investor sentiment) has risen above 90%. While the 13 previous cautionary signals since 1900 suggesting investor sentiment was too high have not been perfect, they have proved to be fairly good warning signs. For eight of the 13 signals, the stock market either immediately or fairly soon suffered a bear market (i.e., 1906, 1929, 1937, 1946, 1956, 1965, 1987, and 2007).

I decided it might be interesting to overlay Doug Short’s valuation model on top of Paulsen’s trend model (black lines at the bottom of the chart) in order to see what happened to those markets that were both overbullish and overvalued:

valuations and trend

Of the 13 prior occurrences in Paulsen’s study when stocks became overbullish, 6 also marked times when the stock market was significantly overvalued, as represented by one standard deviation above average. These times are marked with red lines on the chart – 1906, 1929, 1937, 1965, 1998 and 2007. Every one of these occurrences was followed by an almost immediate bear market. (Though the internet bubble didn’t peak in 1998, the stock market did fall 22% that year from high to low, the widely accepted definition of a bear market.)

Today marks only the 7th time since 1900 that stocks have become both extremely overbullish and extremely overvalued based on these measures. If today’s occurrence is anything like those prior 6 we should be wary of the possibility of an impending bear market.

A version of this post first appeared on The Felder Report PREMIUM.

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TIME Magazine Tells Reader To Go “All In” In Stocks

When I first saw this article from Time magazine I had to check the date to make sure it wasn’t an April fool’s gag (hat tip, @caret311). File this under “things you don’t see at the bottom.”

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The advice in this article is literally, ‘don’t worry about dollar cost averaging or even diversifying. Put all of your money in the stock market and do it today.’ It justifies the advice by suggesting the person has such a long time frame that this is really not very risky at all.

I hope somebody shows “Rod” what the real risk/reward setup looks like in the stock market right now. It might make him rethink going “all in.”

Screen Shot 2015-04-13 at 2.57.03 PMChart via GMO

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StockTwits Q&A

Last week I did a question and answer session over at StockTwits. I thoroughly enjoyed it and sincerely hope it helped a few folks. Here’s a teaser:

We’ve written about Jesse Felder before. In-fact, we’re giving away $1,000 to the charity of your choice if you get this question right. Business Insider has a post up about this story too – Felder is growing his beard out until the next 10% correction. We recently sat down with Felder and talked about his beard, and thoughts on the next 10% correction:

Check out the highlights over at my Tumblr: jessefelder.tumblr.com

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Playing Defense In The Stock Market Right Now Doesn’t Make You An Idiot

I’ve taken some flak recently for my persistently bearish views of the stock market over the past year. Rightfully so. I’ve been dead wrong. And with a record level of bulls it should come as no surprise that they’d like gloat.

But I’d like to make a few things clear. First, I’m not a perma-bear. Far from it. I was rip-snorting bullish on stocks back in early 2009 when it was very painful and lonesome to be such. And when the broader stock market presents investors with another good buying opportunity I won’t hesitate to get bullish again.

Second, just because I “worry top down” that doesn’t prevent me from successfully investing “bottom up.” I was very bullish on Apple a couple of years ago when it was also painful and lonesome to be such. I also turned very bullish on Herbalife earlier this year. Even if these trades were fully hedged they would have crushed the S&P. My worries are also one reason I’ve been bullish long bonds, another trade that has crushed the stock market.

I really find it funny that stocks are the only asset class where if you don’t own them – and today that means owning the index – when they go up you’re an idiot. What about those who didn’t own gold in the 2000’s? Or those who didn’t short financials in 2008? Or those who haven’t owned long bonds over the past few years? Why aren’t you an idiot for missing these trades?

Right now there’s a zeitgeist. It’s a mantra among investors that if you don’t own stocks 100% of the time you’re a loser. To me this is asinine. There have been plenty of times throughout history where owning stocks was a loser’s game and today has all of the makings of another one. And the zeitgeist, itself, is compelling anecdotal evidence of that!

One of the best rules anybody can learn about investing is to do nothing, absolutely nothing, unless there is something to do… I just wait until there is money lying in the corner, and all I have to do is go over there and pick it up… I wait for a situation that is like the proverbial “shooting fish in a barrel.” -Jim Rogers in Market Wizards

I look for compelling risk/reward setups. That’s my personal style and it works for me. As I see it, the current risk/reward equation for owning an equity index fund is all risk and no reward. And some very smart people agree with the idea.

Ultimately, I still believe it’s time to play defense:

Marks became bearish on “riskier debt markets” way back in 2004. Just because he was three or four years early does that make him an idiot? Of course not. Did playing defense cost him performance during those years? Yes. But was it worth it? Absolutely. Playing defense was critical to surviving the financial crisis.

Knowing when it’s time to play defense versus offense is critical to staying power in this game. I’ve been through a number of cycles now in my career. I’m not going to simply decide one day to ignore the risks I see just because they haven’t materialized over the past 12 months. I don’t need to own an S&P 500 index fund to make money when there are plenty of other far more compelling ways to do so.

And the single reason I continue to share my bearish views on stocks is that I truly care about trying to help long-term investors avoid another painful lesson. In fact, that’s exactly what I’ve been doing here for nearly a decade now.

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