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Why It’s So Important For A Stock Operator To ‘Know Thyself’

“A stock operator has to fight a lot of expensive enemies within himself.” -Jesse Livermore

Over the weekend I came across a brief interview with Bill Gross published in the New York Times, in which he says, “There was an old dude, Jesse Livermore, who wrote a great book that said the most important thing in investing was to know yourself — your weaknesses, your flaws and your strengths.”

I thought about that for quite a while after reading it. I read Reminiscences of a Stock Operator a long time ago and didn’t quite remember the book the way Gross did. But thinking about the Gross quote, I realized that all of my greatest trades have been the result of taking advantage of my greatest natural strengths. All of my greatest mistakes have been the result of not recognizing quickly enough the natural weakness that was at the root of the losing trade.

I decided to actually put pen to paper to consciously explore what I believe are my natural strengths and weaknesses. This, to become more acutely aware of them in order to better actively take advantage of my natural strengths and avoid or ameliorate my natural weaknesses.

Here’s what I believe are my natural strengths:

  1. A willingness to go against the herd. More so, a natural skepticism toward what’s popular.
  2. An ability to see points of view or arguments on their merits, without logical biases.
  3. Confidence in my own research and abilities.
  4. A natural inclination towards unloved and overlooked opportunities.
  5. A deep passion to constantly learn and improve.

Here’s what I believe are my natural weaknesses:

  1. I have a hard time staying with there trend, especially once it becomes popular.
  2. At times I can be too skeptical or focus too much on worst-case scenarios.
  3. I can be overconfident even when the market tells me I’m wrong.
  4. I tend to look for confirmation of my point of view rather than opposing views.
  5. At times I seem to care more about being right than making money.

Over the years I’ve managed to address many of these weaknesses. There isn’t any trader who is even mildly profitable who hasn’t been able to do this at least to some degree. But writing them down, putting them on paper somehow helps to compartmentalize them and, more importantly, address them directly.

I realized that consciously addressing them by coming up with tactics to ameliorate them might give me the opportunity to turn my natural weaknesses into developed strengths (as opposed to natural ones). This is something I’ve also done subconsciously to an extent but to do it consciously and methodically could potentially magnify the benefits.

Taking each natural weakness one by one:

  1. Hard time staying with the trend – Modify my sell discipline to take advantage of the long-term trend. So long as there is no compelling reason to sell we will continue to hold until the long-term trend changes.
  2. Too skeptical – Don’t let macro worries get in the way of good micro opportunities. It’s okay to ‘worry top down’ so long as you continue to ‘invest bottom up.’
  3. Overconfidence – Confidence is great and even necessary but humility is just as important. You must respect the market even if you don’t defer to it.
  4. Confirmation bias – The greatest investors regularly seek to understand the other side of a trade even better than those taking it. Spend far more time studying the opposing view.
  5. Being right versus making money – Regularly admit you’re wrong even in the smallest cases. Make it a habit so that acknowledging a mistake and moving on can happen very quickly.

These natural weaknesses are precisely the “expensive enemies” Livermore wrote about. But by ‘keeping your friends (natural strengths) close and your enemies (natural weaknesses) closer,’ in this way I believe a stock operator gives himself the best opportunity to find success in the markets in his own unique way.

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Why A Stock Market Crash May Once Again Be Inevitable

Don’t confuse brains with a bull market. -Humphrey B. Neill

Spending as much time as I do on social media, namely Twitter and StockTwits, I’ve been absolutely astounded by how many traders have begun to “confuse brains with a bull market.” We joke about it on these platforms but there is an amazing amount of hubris out there right now.

One of my favorite investing quotes comes from an interview Paul Tudor Jones gave just after the financial crisis had ended:

Clearly, many fundamental investors were caught off guard by the crisis. Stocks they thought were cheap in 2007 got far cheaper over the coming couple of years. Being unable to “read the tape,” these investors suffered the full force of the stock market crash.

As a response to this failure, many investors have seemingly tried to adapt by becoming “tape readers.” Most notably I have seen an explosion in the number of traders calling themselves, “trend followers.”

Now I have great respect for trend-following. Some of the greatest investors on the planet are trend followers, employing a very simple yet very effective and intuitive strategy across a wide variety of markets.

That said, the problem with most of these newbie trend followers is they ignore one of the key components of the strategy: diversification. They are involved only in one asset class, the stock market. Though they respect the trend, they don’t appreciate just how exposed they are to liquidity risk right now, something experienced trend followers ameliorate by broadening out into as many uncorrelated asset classes as possible.

Emboldened by 3+ years of very low volatility, these traders have become the exact opposite of what PTJ was referring to. Their inability to understand the fundamentals, relying solely on the trend, puts them at great risk, especially in an environment of problematic liquidity.

As I’ve demonstrated over the past several months, this stock market is one of the most overvalued, overbought and overbullish in history. Julian Robertson, Stan Druckenmiller, Ray Dalio, Mohamed El-Erian and other super-investors have recently warned about this in one way or another.

However, when I have shared the their concerns via social media, I’m regularly met with dismissal or disdain. These trend followers have become so emboldened by the bull market that they now believe their brains to be even bigger than these giants of the industry.

I have been bearish but have avoided using the “c-word” until now because crashes, by their nature, are impossible to predict. But the hubris on display in the market by those who believe themselves immune to these massive risks has me wondering if some sort of liquidity event in the stock market isn’t inevitable.

If everyone is a trend follower and the stock market begins to sell off, how can everyone get out at the same time? And in a market already plagued by severe liquidity challenges? It seems to me that there is a lesson here that should have been learned a long time ago.

The quote above comes from a fantastic piece Mark Yusko recently wrote about his personal experience with Julian Robertson, who recently said it is, ‘not at all ridiculous to expect another 2008-style decline in the stock market.’

To turn the PTJ quote on its head, counting on being able to sell once it’s clear to all that the trend has shifted may be precisely how those in the trend following space get annihilated in the future. Certainly, we have seen this movie before. Doesn’t anyone else remember “portfolio insurance”?

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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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The True Secret To Success In The Financial Markets

You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right. In the world of securities, courage becomes the supreme virtue after adequate knowledge and a tested judgment are at hand. -Ben Graham

There are plenty of folks out there that want you to believe that there’s only one way to make money in the markets (and they’re only too happy to show you how). This is just not true. I truly believe that there are as many ways to make money in the markets as there are unique human beings on the planet.

One thing I hear more and more, especially on social media, is that when it comes to investing, “one size fits all.” Usually, this takes the form of some sort of “passive” program akin to what the robo-advisors are doing. (In other cases, and this is far worse, somebody’s got a “secret sauce” to sell you. When you hear this you should grab your wallet and run the other direction.) And if you’re not doing it their way you’re an idiot.

Now I believe that the growth of index investing is a good thing, generally, and I’m especially excited about the fact that investment costs have been plummeting lately. This has huge benefits for individual investors. But don’t feel bad if it’s not for you.

The problem I have with the way some programs or services are being promoted by some is that one of the biggest mistakes I see investors or traders make is trying to be someone they’re not. They try to assume someone else’s investment style and it just doesn’t work for them. They eventually find themselves in an uncomfortable or painful situation. They don’t handle it well and they make a costly mistake.

So-called “passive” investing may be suitable for lots of people. But just because it may be the right thing for many, it may not fit the unique dispositions of another group of individuals. That doesn’t make them idiots. On the contrary, understanding what best suits your own sensibilities before you run into the inevitable bumps in the road makes you wiser than most, in my book.

If there’s one lesson to be learned from Jack Schwager’s terrific “Market Wizards” series of books it’s that there are a million different ways to be wildly successful in the markets. Every “wizard” does it differently. If there’s one thing they have in common it’s that they’re all unique.

The true secret to success in the financial markets is to find your own unique style, your inner market wizard. Find a style that suits your unique values and natural abilities – your personal circle of competence. In fact, the only way to achieve your own idea of success in the markets is to develop your own style that you can have complete confidence in. And don’t let anyone tell you you’re an idiot for trying.

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Respect The Trends In These “Widowmaker” Trades

“Bull-markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria.” -Sir John Templeton

There are a couple of trends out there in the markets right now that are becoming so-called “widowmakers.” Specifically, I’m referring to oil and long bonds.

Oil has been crashing while long bonds have been soaring. Oil is way oversold and long bonds are way overbought. They should both probably retrace a bit of their recent moves simply because they’re both so overextended right now.

However…

See the massive inflows into the oil ETF in the chart above? That is not the sort of “pessimism” that forms a major bottom.

Conversely, in bonds…

Investors have been drastically underweight and heavily short bonds for over a year now. This is why I’ve been writing for some time that bonds may be more likely than stocks to see a “blow off” sort of move.

Now traders are clearly trying to anticipate a trend change in both of these asset classes. They are getting heavily long oil and they remain heavily short long bonds. Now, to be clear, I think they may revert a bit if only to work off their overextendedness (if that’s even a word).

But the big problem with these trades is that the trend is plain as day and traders shouldn’t forget, “the trend is your friend!” Oil is nowhere close to breaking out of its downtrend and long bonds are nowhere close to breaking down out of their uptrend.

Trying to anticipate these trend changes must have been inordinately painful for these traders over the past few months. And the odds are neither of these trends will actually change until we see some real despair in oil and some true euphoria in long bonds, as witnessed in ETF flows or some other similar indicator. At least, that’s what I imagine the brilliant Sir John would have told us.

Follow me on Twitter: @jessefelder

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