In the book, Hedge Fund Market Wizards: How winning traders win, Jack D. Schwager interviews successful hedge fund managers and traders who have outperformed the market for a considerable amount of time. What I found fascinating from the book was the variety of trade strategies they used. Every trader had a different approach. Jack D. Schwager summaries this at the end of the book:
Find a Trading Method That Fits Your Personality
Traders must find a methodology that fits their own beliefs and talents. A sound methodology that is successful for one trader can be a poor fit and a losing strategy for another trader. O’Shea lucidly expressed this concept in answer to the question of whether trading skill could be taught: If I try to teach you what I do, you will fail because you are not me. If you hang around me, you will observe what I do, and you may pick up some good habits. But there are a lot of things you will want to do differently. A good friend of mine, who sat next to me for several years, is now managing lots of money at another hedge fund and doing very well. But he is not the same as me. What he learned was not to become me. He became something else. He became him.
Schwager, Jack D.. Hedge Fund Market Wizards: How Winning Traders Win (p. 490). Wiley. Kindle Edition.
Jack’s son, Zachary Schwager, explained the same principle in the book’s epilogue:
There is no single right way to make money. Those who succeed do so because they find what works for them. Trying to replicate someone else’s method almost always results in failure. All successful traders have their own methodology, an approach that makes sense to them and that they are comfortable with.
Schwager, Jack D.. Hedge Fund Market Wizards: How Winning Traders Win (p. 511). Wiley. Kindle Edition.
The same principle applies to the process of analysing an investment. It should fit your personality.
Someone working as an engineer in the aerospace industry has a different circle of competence than an IT consultant working in India.
The engineer is probably more comfortable with numbers and uses various types of excel sheets for his analysis. For the IT consultant it comes much easier to read annual reports, proxy statements and other filings.
In The Big Short: Inside the Doomsday Machine – Michael Lewis explains how Michael Burry was probably the only person, beside the lawyers who set up the prospectus, who would be able to go through all the CDO1) “Collateralized Debt Obligation (CDO) – Investopedia.” http://www.investopedia.com/terms/c/cdo.asp. Accessed 20 Apr. 2017. and subprime mortgages2)“Subprime Mortgage – Investopedia.” http://www.investopedia.com/terms/s/subprime_mortgage.asp. Accessed 20 Apr. 2017. This was due to Burry’s exceptional ability to focus intensely on topics of interest to him for very long periods of time. It was just his luck that his interest was in investing, specifically in this case, shorting the Subprime mortgages with CDS (Credit Default Swaps)3)“Credit Default Swap (CDS) – Investopedia.” http://www.investopedia.com/terms/c/creditdefaultswap.asp. Accessed 20 Apr. 2017..
This ability to focus on volumes of detailed information on a relatively narrow topic is often a feature of Asperger’s Syndrome, a condition which Burry is believed to have. While this intense focus came naturally to him, other skills such as socialising and interacting with people were things he had to learn:
On the other hand, it explained an awful lot about what he did for a living, and how he did it: his obsessive acquisition of hard facts, his insistence on logic, his ability to plow quickly through reams of tedious financial statements. People with Asperger’s couldn’t control what they were interested in. It was a stroke of luck that his special interest was financial markets and not, say, collecting lawn mower catalogues. When he thought of it that way, he realized that complex modern financial markets were as good as designed to reward a person with Asperger’s who took an interest in them. “Only someone who has Asperger’s would read a subprime mortgage bond prospectus,” he said.
Lewis, Michael. The Big Short: Inside the Doomsday Machine (pp. 183-184). Penguin Books Ltd. Kindle Edition.
Getting to know your own personality, traits and skills is only part of the equation when it comes to determining what kind of investor you are. Before starting to invest the most important question that you should ask yourself is:
How much time am I willing to spend analysing?
Benjamin Graham explains in The Intelligent Investor that there are three types of investors:
It has been an old and sound principle that those who cannot afford to take risks should be content with a relatively low return on their invested funds. From this there has developed the general notion that the rate of return which the investor should aim for is more or less proportionate to the degree of risk he is ready to run. Our view is different. The rate of return sought should be dependent, rather, on the amount of intelligent effort the investor is willing and able to bring to bear on his task. The minimum return goes to our passive investor, who wants both safety and freedom from concern. The maximum return would be realized by the alert and enterprising investor who exercises maximum intelligence and skill.
Jason Zweig continues explaining this principle in the commentary:
How aggressive should your portfolio be?
That, says Graham, depends less on what kinds of investments you own than on what kind of investor you are. There are two ways to be an intelligent investor:
- by continually researching, selecting, and monitoring a dynamic mix of stocks, bonds, or mutual funds;
- Or by creating a permanent portfolio that runs on autopilot and requires no further effort (but generates very little excitement).
Graham calls the first approach “active” or “enterprising”; it takes lots of time and loads of energy. The “passive” or “defensive” strategy takes little time or effort but requires an almost ascetic detachment from the alluring hullabaloo of the market.
As the investment thinker Charles Ellis has explained, the enterprising approach is physically and intellectually taxing, while the defensive approach is emotionally demanding 4)For more about the distinction between physically and intellectually difficult investing on the one hand, and emotionally difficult investing on the other, see Chapter 8 and also Charles D. Ellis, “Three Ways to Succeed as an Investor,” in Charles D. Ellis and James R. Vertin, eds., The Investor’s Anthology (John Wiley & Sons, 1997), p. 72.
Graham, Benjamin; Jason Zweig. The Intelligent Investor, Rev. Ed (Collins Business Essentials) (Kindle Locations 10093-10095). HarperCollins. Kindle Edition. . If you have time to spare, are highly competitive, think like a sports fan, and relish a complicated intellectual challenge, then the active approach is up your alley. If you always feel rushed, crave simplicity, and don’t relish thinking about money, then the passive approach is for you. (Some people will feel most comfortable combining both methods— creating a portfolio that is mainly active and partly passive, or vice versa.)
Both approaches are equally intelligent, and you can be successful with either— but only if you know yourself well enough to pick the right one, stick with it over the course of your investing lifetime, and keep your costs and emotions under control. Graham’s distinction between active and passive investors is another of his reminders that financial risk lies not only where most of us look for it— in the economy or in our investments— but also within ourselves.
Graham, Benjamin; Jason Zweig. The Intelligent Investor, Rev. Ed (Collins Business Essentials) (Kindle Locations 1625-1630). HarperCollins. Kindle Edition.
Before you start investing, think about what type of investor you are based on your strengths, and how much time you are willing to commit. It could for instance be trading in derivatives or index investing with ETF’s, both are ok, as long as you’re honest with yourself and stick to your process.
References [ + ]
|1.||↑||“Collateralized Debt Obligation (CDO) – Investopedia.” http://www.investopedia.com/terms/c/cdo.asp. Accessed 20 Apr. 2017.|
|2.||↑||“Subprime Mortgage – Investopedia.” http://www.investopedia.com/terms/s/subprime_mortgage.asp. Accessed 20 Apr. 2017|
|3.||↑||“Credit Default Swap (CDS) – Investopedia.” http://www.investopedia.com/terms/c/creditdefaultswap.asp. Accessed 20 Apr. 2017.|
|4.||↑||For more about the distinction between physically and intellectually difficult investing on the one hand, and emotionally difficult investing on the other, see Chapter 8 and also Charles D. Ellis, “Three Ways to Succeed as an Investor,” in Charles D. Ellis and James R. Vertin, eds., The Investor’s Anthology (John Wiley & Sons, 1997), p. 72.|
Graham, Benjamin; Jason Zweig. The Intelligent Investor, Rev. Ed (Collins Business Essentials) (Kindle Locations 10093-10095). HarperCollins. Kindle Edition.