Are You An Inside or Outside Zebra?

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A favorite value-investing book of mine goes by the title “A Zebra in Lion Country”. It was written by Ralph Wagner who formerly managed the Colombia Acorn Fund where he put together a solid track record of 16.5% CAGR over a 20-year period.

The book gets its title from this metaphor on investing that Wagner shares early on. It goes:

“Zebras have the same problems as institutional portfolio managers like myself.

First, both have quite specific, often difficult-to-obtain goals. For portfolio managers, above-average performance; for zebras, fresh grass.

Second, both dislike risk. Portfolio managers can get fired; zebras can get eaten by lions.

Third, both move in herds. They look alike, think alike and stick close together.

If you are a zebra and live in a herd, the key decision you have to make is where to stand in relation to the rest of the herd. When you think that conditions are safe, the outside of the herd is the best, for there the grass is fresh, while those in the middle see only grass that is half-eaten or trampled down. The aggressive zebras, on the outside of the herd, eat much better.

On the other hand-or hoof- there comes a time when lions approach. The outside zebras end up as lion lunch. The skinny zebras in the middle of the pack may eat less well but they are alive.

A portfolio manager for an institution such as a bank trust department, insurance company or mutual fund cannot afford to be an Outside Zebra. For him, the optimal strategy is simple: stay in the center of the herd at all times. As long as he continues to buy the popular stocks, he cannot be faulted. On the other hand, he cannot afford to try for large gains on unfamiliar stocks that would leave him open for criticism if the idea failed.

Needless to say, this Inside Zebra philosophy doesn’t appeal to us as long term investors.

There are three edges available to investors.

    1. Informational
    2. Analytical
    3. Behavioral

The majority of people fail to beat the market because they consume the same information that everyone else consumes. They think about that information in the same way everyone else thinks about it. And they behave just like all the other punters. Put another way, they’re inside zebras; slowly starving on trampled scraps within the warm confines of the herd.

There’s nothing wrong with that I suppose. But to me, that’s just no way to live…

I mean, if you’re devoting time and energy to the game of investing then I’d think you’d want differentiated returns — or I should clarify —  you’d want positively differential returns. You know, get paid for your hard work.

Since you’re reading this then I assume that describes you. You prefer being an outside zebra. Going to where the grass is lush and plenty.

But, of course, this raises the risk that we get ripped apart by a lion. That’s why we need to go back to our three edges and work diligently to stack them in our favor. This way we can fill our bellies while not raising the risk that we end up being someone’s meal.

Enter our resident value investor, Brandon.

Brandon’s been informally working with us for a few years and he’s been formally with us since he left his job at a large fund a few months ago.

We’re lucky to have him.


The dude is a crazy outside zebra.

He’s always finding the weirdest misvalued stocks.

One month it’s a polish tech firm servicing Fortune 500 companies growing its top line in the double digits annually yet trading for basement level multiples of free cash flow. The next month he’s telling me about a tiny US microcap ammunition maker that has tons of interesting IP, is run by a serial entrepreneur with a looong history of outsized success, and is working on inking major deals with the DoD… Oh, and it’s trading for pennies on the dollar because it’s so small it flies under the radar.

Brandon’s the kind of people I like to surround myself with. He gets way out there, and I mean way out there, far from the herd. It’s like he can’t even help himself. It’s just in his blood to take in different information, look at things from a variant perception, and just all-around approach markets in a way that most others don’t.

And you know what the best part is?

He’s good at it. I mean, really good at it.

Does that mean he hits every single pitch out of the park? Absolutely, not. He’s no trading Jesus. But he is insanely good at uncovering wildly asymmetric investments that you won’t read about anywhere else.

If that sounds like the kind of thing you’d be interested in reading about on a regular basis then go ahead and sign up for his monthly letter, Value Ventures.

Jump in and kick the tires a bit and see if that style of investing is for you. See if you feel comfortable traveling way off the beaten investing path.

He does a great job of not only sharing his research but also his process each month. Which is a grossly neglected topic that’s left out of most newsletters. That actually reminds me of a great quote from Joel Greenblatt who said once that: “Choosing individual stocks without any idea of what you’re looking for is like running through a dynamite factory with a burning match. You may live, but you’re still an idiot.”

I love that.

Anyways, click here to join up for Value Ventures and uncover some really weird overlooked and insanely mispriced stocks each month.

You have until tomorrow, November 10th at 11:59PM to lock in a subscription at the introductory rate of $497/year. After tomorrow the price will revert back to $697/year and will continue to climb into the first half of 2020. Now’s the time to get in and check Brandon’s stuff out!

My Favorite Investing Resources

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I’ve received many questions about where to start, books to read and podcasts to follow for value investing. While the following addresses their specific request, I think this list of resources helps all investors.

Traders learn from value guys. Value guys learn from momentum traders. We all learn from each other.

I’ve broken down my favorite resources into three categories: Books, Podcasts and YouTube. Don’t worry! Each resource has outbound links.

This list isn’t exhaustive — and that’s the beauty of this sport. I’m adding new resources and content each day.

If you think I missed anything crucial, let me know in an email or in the Comm Center. I’ll make sure to add it to the list.

Let’s get to it!



Intelligent Investor, Benjamin Graham

    • One Sentence Summary: The bible that tells you everything you need to know about the psychology of investing.

Security Analysis, Benjamin Graham

    • One Sentence Summary: Ben Graham lays out exactly how he analyzes businesses, stocks and bonds with brutal

The Dhando Investor, Mohnish Pabrai

    • One Sentence Summary: Investing framework for thinking in terms of “heads I win, tails I don’t lose much.”

The Education of a Value Investor, Guy Spier

    • One Sentence Summary: How one man spent $650K to learn all of life’s lessons from Warren Buffett.

You Can Be a Stock Market Genius, Joel Greenblatt

    • One Sentence Summary: How to find corners of the market where you can make money.

The Little Book That Still Beats The Market, Joel Greenblatt

    • One Sentence Summary: Quantitative framework for finding businesses that generate excess returns.

100 Baggers: Stocks That Return 100-to-1 and How To Find Them, Christopher Mayer

    • One Sentence Summary: Common themes and how to profit from companies that can return 100-to-1 on your initial investment.

The Most Important Thing, Howard Marks

    • One Sentence Summary: The most important thing is to be contrarian and be right.

Mastering the Market Cycle, Howard Marks

    • One Sentence Summary: Markets move in cycles, and if you know where you are in the cycle, there’s opportunity.

One Up On Wall Street, Peter Lynch

    • One Sentence Summary: Invest in what you know so that you can explain your thesis to a five year old.

Common Stocks and Uncommon Profits, Philip Fisher

    • One Sentence Summary: Think like a stock investor, not a stock trader.

The Outsiders: Eight Unconventional CEOs and Their Radical Blueprint for Success, William Thorndike

    • One Sentence Summary: Thorndike highlights CEOs that acted differently, yet generated tremendous value for shareholders.

The Acquirer’s Multiple, Tobias Carlisle

    • One Sentence Summary: On the back of Joel Grenblatt’s research, Tobias reveals why deep value investing still works today.

Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Companies, Tobias Carlisle

    • One Sentence Summary: There’s value in bad, failing businesses; Tobias helps you find it.

Value Investing: From Graham to Buffett and Beyond: Bruce Greenwald, Judd Khan, Paul Sonkin, Michael van Biema

    • One Sentence Summary: Incredible base-level framework for value investing with more conservative valuation techniques.

The Richest Man in Babylon, George S. Clason

    • One Sentence Summary: Some of the best financial advice is the oldest advice.

Financial Statements: A Step-By-Step Guide to Understanding and Creating Financial Reports, Thomas Ittelson

    • One Sentence Summary: This book breaks down the fundamentals of accounting and bookkeeping.

Margin of Safety, Seth Klarman

    • One Sentence Summary: Value investing’s cult-like relic that will cost you an arm and a leg.

Superforecasting: The Art and Science of Prediction,  Philip Tetlock

    • One Sentence Summary: Learn to unlock the power of feedback in your prediction process.

Thinking Fast and Slow, Daniel Kahneman

    • One Sentence Summary: Start thinking with your System 2 Brain, making slower, more deliberate decisions.

Intelligent Fanatics: Standing On The Shoulders of Giants, Ian Cassel and Sean Iddings

  • One Sentence Summary: What makes an intelligent fanatic, how to find and invest in them.

Principles: Life and Work, Ray Dalio

    • One Sentence Summary: Radical transparency and truth improves your personal and business life.

Hedge Fund Market Wizards, Jack Schwager

Market Wizards: Interviews with Top Traders, Jack Schwager

    • One Sentence Summary: Schwager interviews those that win BIG in financial markets from traders, scalpers to value investors.

Insider Buy Superstocks: The Super Laws of How I Turned $46K into $6.8 Million (14,972%) in 28 Months, Jesse Stine

    • One Sentence Summary: The man who returned over 14,000% in 28 months shares how he did it, and how you can too.

Alchemy: The Dark Art and Curious Science of Creating Magic in Brands, Business and Life, Rory Sutherland

    • One Sentence Summary: Thinking outside the box can result in money saved, projects improved and alchemy created.

Expectations Investing: Reading Stock Prices For Better Returns, Alfred Rappaport, Michael Mauboussin

    • One Sentence Summary: Stock prices aren’t functions of underlying fundamentals, but of embedded expectations.

The Success Equation: Untangling Skill and Luck in Business, Sports and Life, Michael Mauboussin

    • One Sentence Summary: Mauboussin exposes the role luck has in business, life and sports achievements.

The Joys of Compounding, Gautam Baid

    • One Sentence Summary: Gautam takes you through over 200 years’ worth of examples on the power of compounding.

The Rebel Allocator, Jacob Taylor

    • One Sentence Summary: A fast-paced, action-packed adventure into the world of effective and value-creating capital allocation.

Harvard Business Review’s Guide To Buying a Small Business, Richard Rubak and Royce Yudokff

    • One Sentence Summary: This book teaches you how to buy a small business, and in turn, reveals how to analyze micro-cap stocks on public markets.

Technical Analysis and Stock Market Profits, Richard Schabacker

    • One Sentence Summary: The bible for classical charting principles.

Diary of a Professional Commodities Trader, Peter Brandt

    • One Sentence Summary: While not directly related to value investing, there’s always something to learn from a 30%+ compounder of capital.



Focused Compounding, Geoff Gannon and Andrew Kuhn

    • One Sentence Summary: Geoff and Andrew talk all things value investing with a gear towards education for beginners.

We Study Billionaires, Preston Pysh and Stig Brodersen

    • One Sentence Summary: Preston and Stig collect information about the world’s best (and richest) investors and distill the information down into podcast episodes.

The Acquirer’s Podcast, Tobias Carlisle

    • One Sentence Summary: Deep value investing concepts from Tobias and well-known investors.

Master in Business, Barry Ritholz

    • One Sentence Summary: Barry dives into macro and micro business topics with top-notch thinkers in economics, business and corporate finance.

Macro Ops Podcast, Chris D.

    • One Sentence Summary: Need we say more???

Invest Like The Best, Patrick O’Shaughnessy

    • One Sentence Summary: Directly from the podcast: “Exploring the ideas, methods, and stories that will help you better invest your time and money.”

Chat With Traders, Aaron Fifield

    • One Sentence Summary: Learn how a diverse mix of traders went from zero to hero and how they successfully trade markets today.

Planet MicroCap Podcast, Bobby Kraft

    • One Sentence Summary: The best podcast for all things micro-cap investing.


YouTube Channels

Investors Archive

    • One Sentence Summary: The best collection of interviews with the worlds best value managers, traders, private equity managers and real estate moguls.

Focused Compounding

    • One Sentence Summary: Along with full podcast episodes, Andrew breaks down value investing concepts in quick-hit videos.

Curreen Capital

    • One Sentence Summary: Christian Ryther of Curreen Capital provides breakdown on investing strategies, best practices and advice to wanna-be fund managers.

Tech Charts

    • One Sentence Summary: One of the best resources for learning classical charting principles (yes, value investors can use classical charting!).

Aswath Damodaran

    • One Sentence Summary: The OG of valuation posts entire curriculums, for free.

Talks at Google

    • One Sentence Summary: Be a fly on the wall as you learn alongside Google employees from experts in many domains.

Mohnish Pabrai

    • One Sentence Summary: Excellent collection of interviews with Mohnish Pabrai.

Bloomberg Quint

    • One Sentence Summary: Bloomberg for Indian financial markets.

Chat With Traders

    • One Sentence Summary: Aaron’s podcasts uploaded to YouTube.

Real Vision Finance

    • One Sentence Summary: Global macro focused finance channel (make sure to check out AK!).


    • One Sentence Summary: Ian doesn’t post many videos, but the ones on his channel are gold.

GreenWood Investors

    • One Sentence Summary: Steven Wood of GreenWood Investors posts stock pitches and interviews.

AK Fallible – Financial Entertainment

    • One Sentence Summary: Macro Ops’ own AK provides entertaining (and informative!) videos on stocks, finance and popular finance-related shows.

SNN Network

    • One Sentence Summary: Bobby Kraft posts interviews of his podcast episodes (Planet MicroCap).

MOI Global

    • One Sentence Summary: The Warren Buffett 1998 speech video alone is worth the sub.


Plato’s Cave and How I Lost $127,562.06

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Click here to join our Collective of elite traders and investors from around the world 

Are you familiar with Plato’s allegory of the man in the cave?

It’s about a man deep in a cave who’s been chained to a wall his entire life. He’s never seen the light of day and doesn’t know there’s an outside world.

In this cave, out of the man’s purview, there’s a fire with people moving statues in front of it, casting shadows on the wall which the man sees.

The man believes these shadows are real things. He sees shadows of lions and thinks they’re real lions, he sees shadows of people and thinks they’re real people… you get the idea. The shadows are his reality.

This story is meant to show the natural state of ignorance man is born into and in which most live — where they spend their days looking at shadows thinking they’re real…

This is exactly how my trading career started out. I was that ignorant bastard chained to a wall ogling shadows. I didn’t know jack. But because of my professional background and my previous successes, I thought I was pretty smart. I was even a bit arrogant.

This arrogance, mixed with my ignorance, cost me a LOT of money. $127,562.06 to be exact.

Here’s the quick story of how it happened. This is how I hit rock bottom, plunging to the darkest depths of the cave of ignorance… and how this painful failure pushed me to discover the key to beating markets going forward.

Let’s go back in time to two years before I lost the $127,562.06 gambling in markets.

I had been trading for a number of years by that point. I worked a full-time job in an unrelated field but spent nearly every minute outside of work on markets. I was hooked. I read all the classic trading books you’re supposed to and scoured the farthest reaches of the internet for anything that would give me an edge.

Through all this work and study, I became decent… or at least I thought so. I only lost a little bit of money while occasionally hitting winners when I got lucky. But like I said, I was arrogant. Every win, no matter how small and infrequent, sparked grand visions of me soon being praised as the next George Soros… but with Ed Thorpe’s quantitative know-how and Dan Loeb’s jawline.

I’m not joking. I really believed Market Wizard status was right around the corner, even though I had barely made a penny trading and was by no means consistent.

I figured the only thing holding me back from becoming a trading legend was the size of my stake. I needed a real bankroll. I mean who can be expected to do anything amazing when they’re piking around with $15K. That’s play money. If I could get a six-figure line, then I would really buckle down and make a killing.

So I went to the Middle East. A war zone in the Middle East to be exact. Not a normal place to build a trading stake, but with my background, it made sense.

To quote Liam Neeson, I have “a very particular set of skills. Skills I have acquired over a very long career. Skills that make me a nightmare…” You get the point.

Certain companies are willing to pay people with my skill sets buku bucks to operate in a warzone (all perfectly legal, above board, and in support of the US of course).

So I packed my backpack along with a 120-pound trunk full of trading books (Kindles weren’t really a thing yet) and set off to the other side of the world.

I spent a year working 12+ hours a day, 7 days a week, in a hot and shitty desert, only to go back to my trailer and study/trade markets for another 4-6 hours. I was dead set on becoming the next PTJ.

After the year was finally up, I came back with the six-figure trading line I always wanted. I was 100% ready to fulfill my “destiny”. It was finally time to become the next Market Wizard

And then the absolutely worst f*cking thing happened to me.

I started winning. And I mean A LOT.

I was minting money on nearly every trade.

It was ridiculous. I made more than my previous annual salary in just a few months. And in less than six months, I had more than tripled my money. I was like the guy from that old E-Trade commercial getting wheeled into the ER with money coming outta my wazoo!

It was the worst…

Now you’re probably wondering why the hell this is a bad thing.

Well… remember those visions of grandeur I had before? They multiplied 100 fold.

I began believing I was the love child of Livermore and Buffett… the living, breathing trading Jesus born to bless markets with his divine mouse click and great hair. Every time the phone rang I fully expected it to be Jack Schwager asking for an interview.

Maybe you can see where this is headed…

Anyway, after all that winning, the tide eventually began to turn (as it always does in markets) and I started losing.

At first, it was just a little bit. But then it became alotta bit.

It just didn’t make sense. Trading Jesus didn’t lose… how was this possible? So, of course, like a jackass I upped my risk and started trading more. I NEEDED to make back the money I lost and do it fast.

This is when I began my journey to traders’ hell, where I visited all of Dante’s eight circles, enjoying each as much as the original protagonist. Every day I woke up to my P&L bleeding red. And as the losses kept piling up, I felt more and more physically sick.

After my legendary year, it took me just THREE MONTHS to give back $127,562.06 in profits.

This was no small beans for me. I was a 20-something at the time and this was by far the most money I’d ever had.

The fact that I felt like a market god after my astounding year made this fall all the more painful. That’s why I said winning like I did was the worst thing that could’ve happened to me.

At some point, I finally hit rock bottom — total utter despair. I realized my Market Wizard year was just a lucky streak and that I was still a shoddy trader. I can’t remember exactly what did it, but I eventually called my broker and had him send my remaining balance back to my bank account. I was done.

This experience was more than humbling, it was downright brutalI mean it was knees-to-the-mat-delusion-busting-4am-wakeup-call kind of brutal. The emotional rollercoaster rocked me. And I don’t get rocked easily. I’ve been in some pretty sticky situations overseas and have been trained to handle my emotions. But this was something completely different. I was honestly shocked by the effect it had on me.

And that’s when it hit me.

Markets are nothing more than a bunch of people like me, trying to manage their emotions. And these emotions are really just a result of their beliefs. Together, these beliefs and subsequent emotions make up the pricing mechanism we call the “market”.

So really, if I wanted to succeed in markets, I didn’t need to worry about finding the “correct” price of an asset. I just needed to understand the other emotional sons of bitches I was trading against!

It was so damn obvious once I realized it.

The majority of my professional training, whether as a spec ops sniper, military interrogator, or government counterintelligence specialist, all focused on psychology over everything else. It wasn’t just about managing my own psychology, but understanding the psychology of my opponent as well. The goal was always playing the player.

Hell, even outside my military experience, anything I ever strived for, whether it be a new job, a lovely lady, or even a discount at the car dealership… it was all about playing the player. And if the market is just a giant version of these one-on-one interactions, with beliefs and emotions all mixed in, then what was the difference?

It was this realization that helped me finally break the chains keeping me inside Plato’s cave of ignorance.

I finally learned what it meant to be a contrarian. And not a twittering holier than thou trend fighting finger missing knife catching “contrarian”… But an actual Keynes’ ‘Beauty Contest’ fourth-degree playing patient salmon type contrarian — you know, the kind that actually makes money.

I had to earn this realization, with plenty of blood, sweat, and tears — on top of a pile of lost money.

But it was necessary. Necessary because that is part of the Trader’s Journey. The trader’s journey is a lot like Joseph Campbell’s Hero’s Journey. We go out into the world and venture into the unknown, accept challenges and stare into the abyss, make discoveries, learn from our mistakes and return a better person with newfound knowledge and skills.

That’s what the Macro Ops Collective is all about, facilitating this Trader’s Journey.

If you choose to embark on this journey and do it well. You have to step off knowing there is no there there. It’s an endless spiral of growth and evolution. There are always new challenges to tackle, problems to solve, mistakes to be made, and goals to strive for.

This is why the MO Collective is not just another newsletter giving stock picks. Yeah, sure, we provide regular research from Brandon (value investing focused), ChrisD (systems+technicals), and myself (a bit of everything). But that’s just a small bit of our value proposition, to be honest.

I mean, show me one person who’s become rich after signing up to a newsletter? Exactly… Do you want to know why that is? It’s not just that most newsletters are really disguised investo-tainment. Services that spin good yarns but are only as valuable as monkeys throwing darts when it comes to  your P&L.

The bigger reason is that newsletters are all — and I mean all — focused on the wrong thing. Wanna know what that is?

Stock picks and market predictions — the same damn thing that every other trader and investor focuses on.

The funny thing is if you talk to any pro – and I mean a real pro, not some guy who wears a necktie and regularly appears on CNBC but somebody who actually consistently carves out profits from the market for a living. They all say the same thing: “trade picks are maybe 10% of the game, predictions are detrimental to your bottom line, and trade management is EVERYTHING”.

Trade management is about having a watertight process. One that you follow day in and day out. It’s position sizing, risk management, and entries/exits — and more position sizing. That’s it. Nothing flashy or glamorous. The truth is successful trading and investing is fairly mundane. At least it is if you’re doing it right.

And that’s why we not only give you fish but teach you how to do so yourself.

If you want to join us on the journey, learn to fish, and hopefully catch a few whoppers along the way. Then go ahead and click this link and sign up. You can come in and try us out for 60-days risk-free. If you realize it’s not for you, no hard feelings, we’ll give you a refund in full and hope you continue to enjoy our publicly available work. Simple as that. No downside, life-changing upside potential = a very asymmetric trade.

I hope you enjoy the rest of your Sunday.

If you’re interested in joining our group of macro traders and investors then sign up for
The Macro Ops Collective before this Sunday, October 13th at 11:59PM!

Question EVERYTHING: A Recent Thing I From One of the Better Traders I Know

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There’s been a few things that have been rattling around in my brain-housing group that I wanted to get down on paper and share with everybody.

What sparked this flywheel of thought is something my buddy and resident systems trader here at MO, ChrisD (@ChrisDMacro) tweeted a few weeks ago. Here it is.

Chris joined our team late last year. I am unbelievably lucky to have him as a partner. Let me tell you why and then we’re going to get to the above tweet and talk about a number of “aha!” moments I’ve had lately.

ChrisD. is no sh*t probably in the top 0.1% of traders in the world. That’s not an exaggeration. It’s not hyperbole. And he’s going to hate this email if he sees it because he’s a modest low-pro type of guy. But it’s absolutely true.

Chris regularly puts up annual returns in the triple digits. He does this not by leveraging to the gills and swinging for the fences. Quite the opposite, actually. He accomplishes it through a maniacal devotion to trading his systems.

You see, Chris has been at this for a while. He’s been trading for two decades. He’s built and managed hedge funds, consulted for quant firms on building systems, and now mostly manages his family office and works with us here at MO while he and his wife fly around the world living out of fancy Airbnbs. He’s an interesting dude, but I digress…

The thing that Chris does better than almost anybody I know, and which I think is a key reason behind his incredible trading success, is the fact that he questions everything. Literally everything… He takes nothing at face value no matter who’s saying it, how many people accept it as true, or how long it’s been touted as wisdom.

He rigorously tests all assumptions. As in, he’ll spend days manually — and I can’t stress the importance of this point enough, the guy spends days living in excel going through charts bar by bar —  backtesting ideas, systems, beliefs about the market etcetera…

Now think about most market participants. They tend to be high on opinions and low on supporting evidence, right? There’s not a lack of false confidence out there. You can choke on it if you expose yourself to the Wall st. noise long enough.

Here’s the thing. These people — as in the vast majority of people — never truly try to figure things out. I mean, really truly look into something, interrogate the hell out of it, and chisel down to the core of the matter.

Nah… The modus operandi of the masses is to start with a belief. One that is almost always given to them, not independently formed. And then subconsciously or consciously seek out confirming evidence.

How does one get rich playing in markets they ask themselves?

Well, you do exactly what Warren Buffett did and what all the other 50 million Buffett fanboys around the world try and do every day.

If Buffett’s style of long-term investing isn’t for you then go and try and be George Soros. You know, try and outsmart central bankers by making big leveraged bets against their currencies. Really learn economics so you can talk the language, sound smart amongst your macro peers, and discuss complex things such as the inner-workings of the repo market. That’s how you do it, right?

Over the last couple of month’s I’ve fallen down the Rene Girard rabbit hole — if you’ve been reading my work lately, then you’ve heard me talk Rene and his theories more than a few times.

Rene was a French philosopher who taught at Stanford. His big idea was “mimetic desire”. Mimetic desire states that people only desire things because other people desire them. Basically, we’re hard-wired to imitate others. There’s little true free will or original thinking involved in our decision making. Rather, most if not all of our decisions are driven by our desire to be like someone else and that someone else’s decisions are driven by their desire to be like someone else, ad Infinium.

We want things because others want them. We want to do things because others do them. And then we provide ourselves with post-rationalizations to trick ourselves into believing they were our own desires all along!

This theory has largely been confirmed by brain scan studies, such as this study that was titled “Memetics Does Provide a Useful Way of Understanding Cultural Evolution.” Here’s an excerpt from the report (emphasis by me).

“A common objection to memetics is that it undermines human autonomy and the creative power of consciousness, and treats the human self as a complex of memes without free will. These ideas follow naturally from the universal Darwinism on which memetics is based. That is, the idea that all design in the universe comes about through the evolutionary algorithm and is driven by replicator power. This means that human creativity emerges from the human capacity to store, vary and select memes, rather than from some special creative spark, or power of consciousness (Blackmore 2007).”

Here’s an interesting thought.

This idea that “human creativity emerges from the human capacity to store, vary, and select memes…” aligns with much of the work that is coming out on what top performers from various fields hold in common.

The book Range by David Epstein (one of my fav reads of the year) gives a number of examples that support the idea. Here’s one of my highlights from the book (emphasis by me).

“Scientists and members of the general public are about equally likely to have artistic hobbies, but scientists inducted into the highest national academies are much more likely to have avocations outside of their vocation. And those who have won the Nobel Prize are more likely still. Compared to other scientists, Nobel laureates are at least twenty-two times more likely to partake as an amateur actor, dancer, magician, or other type of performer. Nationally recognized scientists are much more likely than other scientists to be musicians, sculptors, painters, printmakers, woodworkers, mechanics, electronics tinkerers, glassblowers, poets, or writers, of both fiction and nonfiction. And, again, Nobel laureates are far more likely still. The most successful experts also belong to the wider world. “To him who observes them from afar,” said Spanish Nobel laureate Santiago Ramón y Cajal, the father of modern neuroscience, “it appears as though they are scattering and dissipating their energies, while in reality they are channeling and strengthening them.”

The main conclusion of work that took years of studying scientists and engineers, all of whom were regarded by peers as true technical experts, was that those who did not make a creative contribution to their field lacked aesthetic interests outside their narrow area. As psychologist and prominent creativity researcher Dean Keith Simonton observed, “rather than obsessively focus[ing] on a narrow topic,” creative achievers tend to have broad interests. “This breadth often supports insights that cannot be attributed to domain-specific expertise alone.”

I don’t think Epstein, or anybody else I’ve read, has made the connection. But don’t these two ideas fit nicely together.

If the evolutionary algorithm underlies all of the universe and is driven by replicator power. And human creativity is born not from original thought pulled from the ether but rather emerges from the combining of knowledge teased from the collective consciousness. Then wouldn’t it make perfect sense that one of the most statistically attributable commonalities amongst all top performers be that they’ve dabbled in a wide range of fields; often disciplines that have no apparent connection to their own.

Isn’t the combining of memes really just reasoning by analogy? Johannes Kepler, the father of planetary motion, wrote in his personal journal “I especially love analogies… my most faithful masters, acquainted with all the secrets of nature… One should make great use of them.”

When Kepler was working on his grand scientific breakthrough of “action at a distance”, the theory which spawned astrophysics. He routinely turned to analogistic reasoning (aka relational thinking) to help him stitch together his theory; using available ideas around odor, heat, and light to magnets and the current a boatman draws while steering through a canal to help him dream up a theory about how the planets revolve around the sun.

Okay, now let me bring this wide arcing circle back to our original topic; trading and investing.

Suppose that mimetic desire is real, which I believe it is — and the 40,000+ “contrarians” who travel every year to Omaha to worship at the feet of their Guru pretty much confirms that it is so. Shouldn’t we take a serious step back and ask ourselves what we’re chasing. I mean, really think about what exactly it is we desire?

If our desire is to be a successful investor like Buffett then I have a counterintuitive thought for you.

Don’t follow the herd and try to be like Buffett.

You know why? Because Warren Buffett didn’t start out trying to be like Warren Buffett. He became successful because he learned what he could from Graham and then paved his own path, no doubt utilizing relational thinking from his wide-ranging studies to help him arrive at truth.

He wasn’t trying to imitate anybody, that’s the point. This liberated him to focus on being someone who makes a lot of money from the market precisely by doing what no one else was.

Do you catch my drift? Are you picking up what I’m putting down?

If you try to imitate, you’ll end up average. Like everybody else, because that’s exactly what they’re doing. The market is literally made up of averages. If you’re reading this, I’m guessing you don’t want that to be you. Because why spend your Saturday’s reading my ramblings if you’re just going to make the return of the S&P?

Now back to Chris and his habit of questioning everything.

You can think of the commitment to not taking anything at face value, of examining everything for its utility or lack thereof to your goals, as a kind of way to channel and leverage your mimetic desiring cognition.

Instead of trying to be like someone else and blindly following what you think they do. You can instead, state a goal and then work backward. Think of it as a kind of reverse engineering to get you to where you want to go — which in the markets, should be making high risk-adjusted returns.

Trading great, Ed Seykota once said: “Win or lose, everybody gets what they want out of the market.” That quote baffled me for the longest time. I just didn’t get it, who the hell wants to lose? But now it makes perfect sense.

For most people, being like somebody else, trading or investing like how they think their idol trades and invests, is more important to them than making money — plus it’s a LOT easier to not have to think for themselves

Would they ever admit that to themselves? Not likely. It’s a painful truth to have to accept. But an absolutely necessary one if you want to break the chains of mediocrity, climb out of the cave of ignorance, and burst free from the confines of the muddling masses.

And that’s been my big “AHA!” from working alongside ChrisD over the last six months. At times I’ve felt like Neo after having taken the red pill. I’ve been forced to reinspect and subsequently tear down many of the false idols I once clung to.

I’ve refocused my effort on eschewing conventional wisdom, spending more time on thinking exactly what it is I’m trying to accomplish, and then creatively (using relational thinking) testing out various ways and means to get there.

The late Bertrand Russell once said “In all affairs, it’s a healthy thing now and then to hang a question mark on the things you have long taken for granted.”

I’m curious, what things do you think you’ve “long taken for granted” and should perhaps “hang a question mark on”?

You’ll be surprised by the results once you start seriously exploring this path of inquiry. It’s a deep-deep rabbit hole, my friend. But one that is certainly worth falling down.

If you’re interested in joining our group of macro traders and investors then sign up for The Macro Ops Collective before this Sunday, October 13th at 11:59PM!

Side note:
If you find any of this stuff interesting and want to pop the MO red pill — a decision that will open your eyes to a new way of thinking about investing and markets, then sign up and take our Collective for a spin.

The Collective is made up of a wide range of members; from HF managers who swing lines in the billions to college students trying to learn the game. We have macro traders, value investors, and short-term systems traders and everything in-between. The one common denominator amongst all of us is that we’re crazy about this game. That’s it. We all love the game of speculation. Our community is bar-none the best out there. No question.

That’s my favorite part about this whole MO gig. I get to wake up every morning and interact with some of the most interesting and passionate people around the world. And we all get to channel and feed off each-others energies while chasing the same objective — unwinding the riddle of the market for fun and profit.

It’s the reason I decided to turn down a high paying job at a large HF (a place that was once my dream job) to start this website. A website that I wanted but didn’t exist. That was nearly 4-years ago to this very day. It’s been a hell of a ride but the future is even more exciting. There’s a lot more we want to do, to create, so as to better provide value to the group. It’s a long and endless journey but one that’s absolutely worth walking.

One of the things that gives me the most pleasure is when members write us saying that we’ve given them “a super-charged MBA in actual investing for a fraction of the price” or like a recent email we received from a mid-sized quantitative fixed income shop that said the work our team is doing has “completely shattered their previous illusions of how to think about markets” and “has led to them totally reevaluating their approach.”

After all, we live for these “aha!” moments. The more like-minded people we can share them with, the better.

If you’re interested in joining an elite group of macro traders then sign up for The Macro Ops Collective before this Sunday, October 13th at 11:59PM!

Ditch the Predictions and Play the Odds

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We are in the business of making mistakes. The only difference between the winners and the losers is that the winners make small mistakes, while the losers make big mistakes. ~ Ned Davis

When I became a winner, I said, “I figured it out, but if I’m wrong, I’m getting the hell out, because I want to save my money and go on to the next trade.” ~ Marty Schwartz

When I see or hear of someone pushing a gigantic market call, talking as if they know exactly what’s going to happen in some well-extended time frame, my inner skeptic has a field day.

There is a HUGE difference between odds-based scenarios and needlessly gaudy predictions… and I tend to trust gaudy predictions about as far as I can throw them.

I mention this in light of three “big calls” that, though not exactly new, have garnered fresh media attention in recent weeks.

I’ll avoid naming names here, as specifics aren’t so important.

Let’s just say one of these guys is a well known perma-bear who’s been screaming about a recession over the last 10-years and now sees — can you guess? — a catastrophic recession around the corner. Another is a popular perma-bull who hasn’t seen a dip that shouldn’t be bought since he first opened his etrade account in 2000… the third is a media-hungry academic who thinks now is a “great time” to be a buy and hold investor.

Useless. All of ‘em.

It’s Not About Being “Right”

As a general rule of thumb, I could care less what media-hungry attention seekers think. The manufactured certainty is more than a bit off-putting, as is the cozying up to quote-hungry news outlets. In the swirling sea of uncertainty, here are a few things the MO trader knows to be true:

    • The vast majority of “big calls” are an annoying waste of time.
    • Being “right” or “getting a big call right” has little to do with real trading.
    • Great traders have balls, but they sure as hell ain’t crystal.
    • Being right and making money are two completely different things.

Why are table-pounding market calls – especially ones spoon-fed to the media for the sake of garnering attention – more often than not a waste of time?

Aside from rampant cherry-picking – step right up and pick an opinion! – one big reason is because successful trading is NOT about prediction (i.e. being “right”). Instead, it’s about seeing the markets as an odds game, and understanding the full implications of what that means.

First and foremost, seeing the markets as an odds game means constantly putting the odds in your favor.

Always acting pragmatically… always in concert with the dictates of observation and experience… always aligned with the twin goals of maximizing profits and minimizing risk (as applied over the full spectrum of trades).

In actual, real-world, day to day execution – something far too many pundits have far too little knowledge of! – this means cultivating a ruthless focus on making money, with being “right” so far down on the trading priority list it’s practically an afterthought.

Because, think about it – if you’re emotionally and intellectually focused on being “right,” then you aren’t truly focused on making money, are you?

Or, if you’re captivated by all the dough you’re going to make by being “right,” then you are probably hopelessly enmeshed in confirmation bias and grossly neglecting the downside risk.

P&L First!

On the other hand, let’s say your primary trading focus is indeed on making money (as it should be). Let’s further say a handful of new trades are not acting right (or that the market script is otherwise going off-kilter).

Well, if P&L (i.e. making money) is the ruthless focus, what are you going to tell yourself when things get iffy? That you should stick to your guns and keep those funky-smelling positions on because, dammit, you are “right” and the market is wrong?

No way José. A truly good trader will act in the best interests of P&L first… even if that means admitting being “wrong” in one’s initial assessment of a trade. For discretionary traders, i.e. those forced to make a steady stream of decisions as part of their discipline, this kind of thing happens all the time.

In other words, being “right” takes a backseat to making or preserving $$$ every time a market shift behooves a change of mind. (And yet, the table-pounding types NEVER seem to change their minds. Notice that?)

There is simply no way around it: Being right and making money are competing priorities… and a focus on one greatly diminishes the other.

Prediction versus Conviction

Something else: It’s important to distinguish between flashy calls and high-conviction probabilistic assessments based on accumulated evidence and a clear read of market conditions. The first is an ego trip; the second is betting with the odds in your favor.

A damn good trade is like a damn good poker hand. You rarely if ever have 100% certainty (and you certainly don’t pretend that you do)… but you can most definitely know, based on the situational dynamics of the hand, when it’s time to bet big.

John Hussman explains the conditional probability concept well (I know, Hussman? The irony doesn’t escape me but that doesn’t detract from this explanation it just means he can’t follow his own advice):

From a Bayesian standpoint, if you always observe a certain combination of information when X occurs, and never observe that same data when X is not present, then even if X is hidden under a hat, you would conclude that X is most likely there. If I see clowns walking around the grocery store buying peanuts, and there’s a big top tent with two unicycles in front of it in the middle of what is usually an open field, I’m sorry, I’m going to conclude that the circus is in town.

Cutting Through the Crap

One final thing. Let’s say there are two opposing scenarios, both of them plausible (a fairly regular phenomenon in markets). Plausible scenario A says market “Up.” Plausible scenario B says market “Down.” Which do you choose?

Easy – you don’t worry about it. You watch and wait… and let price action be your guide.

One of the great things about price action is the way it cleaves through “analysis paralysis” like a hot knife through butter.

Simply put, price action cuts through the bullshit. It’s a lamp unto our feet (or rather, our P&L).

We can make the most of price action signals, you see, because as MO Traders we are nimble and liquid. We are speedboats, not aircraft carriers. Not for us the problems of the hidebound pension fund, the mammoth Fidelity manager who has to buy $200 million worth of stock just to move the needle, or the glacier-slow advisory board that takes three months to make a decision. Being small and fast, we can turn on a dime in real-time… and thus bypass the lumbering constraints that plague the big and slow.

So, forget prediction – and tune out anyone who tries hard to get your attention by making one. Focus on odds and gaming out the various scenarios instead, and be wary of anyone who “knows” what’s going to happen.

If you want to be consistently successful as a trader – to carve out large chunks of profit in the MO style – here is how it’s done:

You invest time and energy developing a flexible forecast – be it for an industry, a commodity, a currency, or even the broad market itself.

You digest info from high-quality sources, but with the intent of getting in tune with the market, not embracing some iron-clad far-off prediction that can’t possibly account for the dynamic nature of markets in the first place.

You do your fundamental homework and your due diligence legwork, gathering useful data to give you a sense of conditional probabilities and odds-based assessments. You work with probabilities, not certainties, in mapping out your potential trade setups.

You make it your primary focus to get a handle on the scenarios – to synch up with the ‘market script’ – as opposed to consulting a crystal ball. You regularly consult the charts and maintain a general awareness of how other market participants are positioned. You overlay all such activities with a ruthless focus on MAKING MONEY as opposed to being “right.”

And then, when your trading vehicle of choice approaches an actionable juncture, you watch and you wait… and you let the price action tell you what to do.

A favorite trading quote of mine comes from Bruce Kovner of Market Wizards fame. He put the job of a trader as this.

One of the jobs of a good trader is to imagine alternative scenarios. I try to form many different mental pictures of what the world should be like and wait for one of them to be confirmed. You keep trying them on one at a time. Inevitably, most of these pictures will turn out to be wrong — that is, only a few elements of the picture may prove correct. But then, all of a sudden, you will find that in one picture, nine out of ten elements click. That scenario then becomes your image of the world reality.

Another Wizard profiled in Schwagger’s iconic series is Stan Weinstein (he authored an excellent trading book titled “Secrets for Profiting in Bull and Bear Makrets”). Anyways, Stan who’s motto was “The tape tells all” was an incredible market timer — he made a LOT of money playing the big swings in the market.

He didn’t do this by being an ideologue, having an opinion on the market’s direction and then seeking out confirming data. He looked at what he called the “weight of the evidence”, which for him was a dashboard of 48 technical market indicators that looked at everything from margin debt levels to credit spreads, call-put ratios, odd-lot short sales, and more.

These indicators never gave him a “sure bet”. They were just data points that added up to odds in a constantly evolving continuum where the tape was the final arbiter.

Quite a different process than the one practiced by those who’ve been confidently predicting a recession since the last one, isn’t it?

In the following series of posts, we’re going to imagine alternate scenarios and evaluate the weight of the evidence by going through our process for pulling signal out from all the noise.

Stay tuned…

The Evolution of Political Regimes

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Plato, using Socrates as his mouthpiece, wrote the following condemnation of Athenian democracy in his Republic:

[The citizens] contemptuously rejected temperance as unmanliness… Insolence they term breeding, and anarchy liberty, and waste magnificence, and impudence courage… The father gets accustomed to descend to the level of his sons and to fear them, and the son to be on a level with his father, having no shame or fear of his parents… The teacher fears and flatters his scholars, and the scholars despise their masters and tutors… The old do not like to be thought morose and authoritative, and therefore they imitate the young… Nor must I forget to tell of the liberty and equality of the two sexes in relation to each other… The citizens chafe impatiently at the least touch of authority, and at length…. They cease to care even for the laws, written or unwritten… And this is the fair and glorious beginning out of which springs dictatorship… The excessive increase of anything causes a reaction in the opposite direction;… dictatorship naturally arises out of democracy, and the most aggravated form of tyranny and slavery out of the most extreme form of liberty.

Plato reduced the evolution of political regimes to a sequence of monarchy, aristocracy, democracy, and dictatorship. In the excerpt above he’s commenting on the fraying democracy in Athens that was driven by a widening gap between the rich and poor… sound familiar?

The wealth disparity drove the poor to try and enlarge their cut of the pie through legislation, taxation, and revolution. The rich banded together to protect themselves and their money. This division fractured Athenian society and opened the door for Philip of Macedon to invade and conquer Greece.

Greeks had grown so despondent with their political system that many actually welcomed his conquest. Greek democracy transitioned to dictatorship.

Nearly 300 years later we saw a similar sequence play out in Rome. The Roman Republic created enormous amounts of wealth through its vast control and exploitation of foreign lands. The new aristocrats curried favor with the leaders on Palatine Hill through bribes and political support. Over time, the government began to work for the special interest of the few.

In response, the commoners supported Julius Caesar who seized power and established a popular dictatorship. He was then stabbed in the back (literally) by the aristocrats and replaced by another dictator, Gaius Octavius. Democracy became a dictatorship which then became a monarchy.

Political regimes like much of nature seem to oscillate between extremes (democracy and autocracy), where each extreme sets the conditions for the inevitable transition towards the other. How a nation’s wealth is divided amongst its people is one of the biggest drivers of this constant pendulum.

In Will and Ariel Durant’s The Lessons of History they write that “inequality is not only natural and inborn, it grows with the complexity of civilization. Hereditary inequalities breed social and artificial inequalities: every invention or discovery is made or seized by the exceptional individual, and makes the strong stronger, the weak relatively weaker.”

This fact keeps the political system in oscillation between extremes. Where — again quoting both Durants—  “…freedom and equality are sworn and everlasting enemies, and when one prevails the other dies. Leave men free, and their natural inequalities will multiply almost geometrically, as in England and America in the nineteenth century under laissez-faire. To check the growth of inequality, liberty must be sacrificed, as in Russia after 1917. Even when repressed, inequality grows; only the man who is below the average in economic ability desires equality; those who are conscious of superior ability desire freedom; and in the end superior ability has its way.”

When economic prosperity is relegated to a few, society’s desire for political freedom becomes merely a conciliatory afterthought. This arises not so much through the wealthy’s direct exploitation of the poor but rather due to the increasing complexity of the economy and government. This complexity puts an additional premium upon one’s superior ability to navigate it, which further amplifies the concentration of wealth and political power.

Running under all of this is the Bridgewater style long-term debt cycle. The wealthy are the creditors that hold the assets, the poor the debtors who suffer under the liabilities. The larger the balance sheet grows, the more complex the economy and the more enriched the wealthy and the more financially strangled the masses become. Until of course, a natural limit is hit… equality pushes back at freedom… and democracy inches towards autocracy.

The Durant’s note that when “our economy of freedom fails to distribute wealth as ably as it has created it, the road to dictatorship will be open to any man who can persuasively promise security to all; and a martial government, under whatever charming phrases, will engulf the democratic world.”

The interesting political events of late (ie, Brexit, Trump, the rise of nationalist parties in Europe etc) are not causes but rather effects of the debt cycle and the natural evolution of the political sequence as described by Plato some 2,400 years ago.

That is not to say we are going to see a shift to dictatorship or anything of the kind in the near future (we aren’t)… nor am I saying that is what Trump in any way represents (he doesn’t). Rather, I’m talking about the large tidal forces at work; the historical cogs that are turning and driving the current rise in populist sentiment and which will play out for many years to come.

We are witnessing the battle between two opposing forces of political and economic nature unfold. Neither is good or bad, they both simply are. Each is embedded in the evolution of our natural system where equilibrium is merely a concept and constant change a reality.

It is with that understanding that we must judge and assess things to come. Taken in this context, the current insanity of the world begins to make a lot more sense.

The course we are on now is not a sustainable one.

I fear the rise in populist politics is only just beginning. Let’s hope we don’t swing too far back in the other direction…

Adaptability Versus Optimization: The Cockroach Approach

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As we trudge onward in the longest bull market in US history, I thought it wise to share with you a section from an old article, written by Richard Bookstaber, titled “Risk Management in Complex Organizations”.

The article talks about risk. Particularly, that most pernicious kind of risk… The kind we can’t foresee.

Volatility selling, FAANG hodling, growth at any price investing… any strategy that’s become over-optimized for the current market regime faces a high susceptibility of risk of ruin in the next. For those of you heavily involved in such activities, it may be time to learn some lessons from the lowly cockroach. Here’s Bookstaber:

“We can manage risks only when we can identify them and ponder their possible outcomes. We can manage market risk because we know security prices are uncertain; credit risk because we know companies can default; operational risk because we know missteps are possible in settlement and clearing. But despite all the risks we can control, the greatest risks remain beyond our control. These are the risks we do not see, things beyond the veil. The challenge in risk management is how to deal with these unidentified risks. It is more than a challenge; it is a paradox: How can we manage a risk we do not know exists? The answer is that we cannot manage these risks directly, but we can identify characteristics of risk management that will increase our ability to react to the risks. These characteristics are easiest to grasp in the biological setting, where we are willing to concede that nature has surprises that are wholly unanticipated by life forms that lack total foresight. A disease that destroys a once-abundant food source, the introduction of chemicals in a pristine environment, the eruption of a volcano in a formerly stable geological setting are examples of events that could not be anticipated, even in probabilistic terms, and therefore, could not be explicitly considered in rules of behavior. They are nature’s equivalent to the unforeseeable risks for the corporation.

The best measure of adaptation to unanticipated risks in the biological setting is the length of time a species has survived. A species that has survived for hundreds of millions of years can be considered, de facto, to have a better strategy for dealing with unanticipated risks than one that has survived for a short time. In contrast, a species that is prolific and successful during a short time period but then dies out after an unanticipated event may be thought of as having a good mechanism for coping with the known risks of one environment but not for dealing with unforeseeable changes.

By this measure, the lowly cockroach is a prime case through which to study risk management. Because the cockroach has survived through many unforeseeable changes — jungles turning to deserts, flatland giving way to urban habitat, predators of all types coming and going over the course of the millennia — the cockroach can provide us with a clue for how to approach unanticipated risks in our world of financial markets. What is remarkable about the cockroach is not simply that it has survived so long but that it has done so with a singularly simple and seemingly suboptimal mechanism: It moves in the opposite direction of gusts of wind that might signal an approaching predator. This “risk management structure” is extremely coarse; it ignores a wide set of information about the environment — visual and olfactory cues, for example — which one would think an optimal risk-management system would take into account.

This same pattern of behavior — using coarse decision rules that ignore valuable information — appears in other species with good track records of survivability. For example, the great tit does not forage solely on the small set of plants that maximize its nutritional intake. The salamander does not fully differentiate between small and large flies in its diet. This behavior, although not totally responsive to the current environment, allows survivability if the nature of the food source unexpectedly changes. We also see animals increase the coarseness of their response when the environment does change in unforeseeable ways. For example, animals placed for the first time in a laboratory setting often show a less fine-tuned response to stimuli and follow a less discriminating diet than they do in the wild.

The coarse response, although suboptimal for any one environment, is more than satisfactory for a wide range of unforeseeable environments. In contrast, an animal that has found a well-defined and unvarying niche may follow a specialized rule that depends critically on that animal’s perception of its world. If the world continues on as the animal perceives it — with the same predators, food sources, and landscape — the animal will survive. If the world changes in ways beyond the animal’s experience, however, the animal will die off. Precision and focus in addressing the known comes at the cost of reduced ability to address the unknown.”

Investors who pile into trendy strategies simply because they’ve worked so well in the recent past run afoul of mistaking the unknown for the nonexistent as Nassim Taleb puts it.

Strategies predicated on simple “coarse decision rules” on the other hand, may not be the best performing approach in any single environment but they lend themselves to being more robust and adaptable, which in the long-run means greater odds of survivability and in investing that means staying in the game.

Choose adaptability over optimization. Be more like the cockroach.

How to Identify the Consensus

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Here’s John Percival, writing in his book The Way of the Dollar, describing how to identify the Consensus and act as a Contrarian. 

“Remember the last time you sold a currency at what proved to be the bottom, or bought at the exact top? That wasn’t just bad luck — nor even just foolishness. You and the crowd caused the bottom, or the top

The Consensus. 

I know of one top equity fund manager who has no other rule for handling the currency markets than to go against the consensus. It’s common sense. We must be ‘contrarians’, if we are to survive in financial markets in general and the currency markets in particular. During the great bull market in the dollar in 1981-5, it was the one single rule that assured survival. If you have any problem with that, I suspect there is no solution but to observe markets till it’s no longer a problem; for the shifts from pessimism to optimism and back are what bull and bear markets are about. 

The difficulty is to define “the consensus”. The crowd isn’t always wrong. When a price movement gets going, the crowd as often as not will line up in the direction of the movement. But standing against the crowd, at times can be as desirable as standing in the way of an express train. This is the drawback of such objective measures of opinions as Market Vane — a well known American service which measures bullish opinion among traders. If you poll traders, most of them will point in the direction of the trend. Bullish opinion as measured by Market Vane tells us the direction of prices over the past week, but not necessarily a lot more. 

Perhaps Bruce Kovner, of Caxton, nailed the problem when he said that what he was looking for was the consensus that is not confirmed by price action. That covered the entire 1981-5 bull market in the dollar when the consensus was constantly bearish. It also covers the price extremes, when the consensus is wrong by definition. 

Whether we are looking at the underlying multi-month/ multi-year trend or the intermediate multi-week moves, there are usually two phases when the consensus is not confirmed by price — early in the move and at the end of the move. Soon after a price reversal, majority opinion is usually aligned with the previous trend, i.e. the consensus lags. Similarly, majority opinion strengthens along with the on-going trend, trending to reach peak consensus at the price extreme. So the ideal position is to be contrarian at the beginning and end of a move, and pro-consensus in the middle. Nice work if you can get it so right. 

Never forget that the consensus 

usually includes you.

The consensus gauge is a subjective gauge. We read the papers and specialist commentators and we talk to people, and we conclude that most punters are facing one way. If we are facing the same way, we have to reconsider the situation in the light of our other sentiment gauges and cut back if they are flashing yellow. In the heat of a powerful favourable price move, we are often lulled into complacency: at that point, consulting the consensus is an essential discipline — it often comes as a shock to discover that we are in with the herd, and it can be very costly if we fail to make this discovery. When we diagnose a situation where the consensus is not confirmed by price, we should not just cutback but try facing the other way, to see whether anything clicks. If the market action feels right; if the open interest is extended; and if we can find a fitting rationale, we can reverse our position… 

Helpful Images

There is another description of the consensus-that’s-not-confirmed-by-price. It consists of two images that have become part of the ancient lore of Wall Street, the Wall of Worry and the River of Hope. A bull market we recall, “climbs a wall of worry” ; and “a bear market flows down a river of hope”. In point of fact, the description normally only applies to the early and middle stages in bull and bear markets. So we can be very comfortable when we diagnose a wall or a river — assuming we’re climbing and flowing respectively. 

In the later stages of the trend, things change. The worriers capitulate to the up-trend; and the hopers throw in the towel and give up the fight against the bear. At this stage, in a bull market, we find die-hard bears saying that, well, we are heading for a collapse, but prices are going to go up further before they head down. And in a bear market die-hard bulls assert that prices are far too low — but they can go lower still. The conversion process is nearing its end. Now we have to get a little wary, for obviously we are in the region of consensus. And this is a very dangerous region because nobody on earth can tell how far things can go. Currencies, stocks, commodities — it makes no difference. In this respect they’re all the same. 

It is said of Joseph Kennedy, father of President John Kennedy, that when he was having his shoes shined one day in autumn 1929, he was astonished to hear the shoe shine boy tip him a hot stock that was sure to go from 160 to 2000 or whatever. That was all Joe K needed. If shoe shine boys (or elevator attendants, or hairdressers, the cover of Newsweek or whatever) were tipping stocks, it was time to get out. So Joe K started selling short and thus laid the foundation of the family fortune — so the story goes. But if it’s true that Joe K went short at that moment then he was lucky. The sucker buys at the top of the market; geniuses and liars sell at the top of the market; but the super-sucker sells short at what he thinks is the top of the market. 

In 1979, the then financial editor of Britain’s Daily Mail newspaper, Patrick Sargent (later to be a founder of Euromoney), called the top of the gold market at around $450. It was a perfectly sound call, in the light of the speculative heat in gold at the time especially from one who had been bullish of gold for a good time. Yet gold was to climb a further $400 by early 1980, when speculation turned from red-hot to white-hot. Imagine being short at $450! As I say, no-one on earth knows where a speculative trend will end — except with hindsight… 

This brings us to the question how you can distinguish a minor multi-week extreme from a major multi-month or multi-year extreme. The late stages in that great dollar bull market of 1980-5 provide a clue: you watch the way the conversion process trickles down through the different categories of currency observers. In mid-1984, the world was still full of die-hard dollar bears who had considered the currency overvalued ever since 1981. Who were they? It wasn’t the dealers, who are not and do not need to be overly concerned with underlying value; nor was it the trend-followers. It was the value-oriented analysts — researchers and economists by profession — with a long-term orientation. What happened was that some time during the autumn of 1984, the bearish consensus among this category turned round; and it happened relatively suddenly. You will see it quite clearly if you go back over the research material turned out by major banks at the time. “The dollar is grossly overvalued at DM 3.00, but we think it will head further up before it collapses”, that kind of thing. 

In other words, it’s just as you would expect. When the long-termers who were formerly skeptical at last capitulate to the trend, then you have a total consensus and the end is nigh for the major multi-month / multi-year move. Nigh, but not necessarily over. At this point one of our sentiment gauges comes into its own. We have to watch market action: the way the markets react in relation to the background and to news events.”

Michael Lewis wrote in his book Liar’s Poker that: 

Everyone wants to be, but no one is, for the sad reason that most investors are scared of looking foolish. Investors do not fear losing money as much as they fear solitude, by which I mean taking risks that others avoid. When they are caught losing money alone, they have no excuse for their mistake, and most investors, like most people, need excuses. They are, strangely enough, happy to stand on the edge of a precipice as long as they are joined by a few thousand others…

It’s incredibly difficult to identify the consensus and act as a contrarian in markets. A good first step is to acknowledge that you suffer from the same base cognitive impulses that drive the rest of the herd — we’re ALL part of the Dumb Money crowd. 

As soon as you accept this, you can then go about learning some tools to help you step back from the crowd and better understand the popular narratives and emotions that are driving prices. Doing so is more art than science and it takes a lot of work. But it’s better than standing on the edge of a precipice… 


There Are No Limits

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“Bruce [Lee] had me up to three miles a day, really at a good pace. We’d run the three miles in twenty-one or twenty-two minutes. Just under eight minutes a mile [Note: when running on his own in 1968, Lee would get his time down to six-and-a-half minutes per mile]. So this morning he said to me “We’re going to go five.” I said, “Bruce, I can’t go five. I’m a helluva lot older than you are, and I can’t do five.”

“He said, “When we get to three, we’ll shift gears and it’s only two more and you’ll do it.” I said “Okay, hell, I’ll go for it.” So we get to three, we go into the fourth mile and I’m okay for three or four minutes, and then I really begin to give out. I’m tired, my heart’s pounding, I can’t go anymore and so I say to him, “Bruce, if I run any more,” — and we’re still running — “if I run any more I’m liable to have a heart attack and die.” He said, “Then die.”

“It made me so mad that I went the full five miles. Afterward, I went to the shower and then I wanted to talk to him about it. I said, you know, “Why did you say that?” He said, “Because you might as well be dead. Seriously, if you always put limits on what you can do, physical or anything else, it’ll spread over into the rest of your life. It’ll spread into your work, into your morality, into your entire being. There are no limits. There are plateaus, but you must not stay there, you must go beyond them. If it kills you, it kills you. A man must constantly exceed his level.”  ~ John Little, The Art of Expressing the Human Body

Calvin Coolidge once said “Nothing in the world can take the place of Persistence. Talent will not; nothing is more common than unsuccessful men with talent. Genius will not; unrewarded genius is almost a proverb. Education will not; the world is full of educated derelicts. Persistence and determination alone are omnipotent.”

Growth lives in the space beyond your comfort zone. Persistence and determination is the only way to travel there.

How are you exceeding your level?

Trader Vic’s Market Methods

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I first came across Trader Vic over a decade ago while meandering through an old book store. My dog eared and excessively highlighted copy still sits on the bookshelf next to my desk. It’s one of the few trading books I regularly turn to for a reread. The book covers everything from trade management to market psychology, to technicals and fundamentals, and even some economics.

Below are a few of my notes from the book.

On Thinking in Essentials

“If I had to reduce all the components of my methods to a single phrase, it would be thinking in essentials.

It’s not necessarily how much you know, but the truth and quality of what you know that counts. Every week in Barron’s there are dozens of pages of fine print summarizing the week’s activities in stocks, bonds, commodities, options, and so forth. There is so much information that to process all of it, and make sense out of it, is a task beyond any genius’s mental capacity.

One way to narrow down the data is to specialize in one or two areas. Another way is to use computers to do a lot of the sorting out for you. But no matter how you reduce the data, the key to processing information is the ability to abstract the essential information from the bounty of data produced each day.

To do this, you have to relate the information to principles — to fundamental concepts that define the nature fo the financial markets. A principle is a broad generalization that describes an unlimited number of specific events and correlates vast amounts of data. It is with principles that you can take complex market data and make it relatively simple and manageable.”

This is why we at MO practice Ruthless Reductionism. Einstein said, “Everything should be made as simple as possible, but not simpler”. Your information intake is a key part of your process. Strip away the fat, know what you consume and why you consume it, search for key principles and let them guide your way.

A Business Philosophy for Consistent Success

“I base my business philosophy on three principles, listed here in order of importance: preservation of capital, consistent profitability, and the pursuit of superior returns. These principals are basic in the sense that they underlie and guide all of my market decisions. Each principle carries a different weight in my speculative strategy, and they evolve from one to the other. That is, preservation of capital leads to consistent profits, which makes pursuit of superior returns possible.”

Preservation of Capital

“Preservation of capital is the cornerstone of my business philosophy. This means that, in considering any potential market involvement, risk is my prime concern. Before asking, “What personal profit can I realize?”, I first ask, “What potential loss can I suffer?”

… In my terms, money isn’t green… it’s either black or white. Black and white have come to be associated with false or true, wrong or right, bad or good. In ethical terms, most of society has been taught that ‘there are no blacks and whites — there is only gray’: gray — the mixed and contradictory — the lack of absolutes. But on a ledger sheet, htere are nothing but absolutes: 2+2 is always 4, and 2-6 is always -4! Yet, in a subtle way, the modern investor has been taught to accept gray by the money management community. He is encouraged to rejoice if his account goes down only 10% when the averages are down 20% — after all, he has outperformed the averages by 10%! This is B.S., plain and simple.

There is one, and only one, valid question for an investor to ask: “Have I made money?” The best insurance that the answer will always be “Yes!” is to consistently speculate or invest only when the odds are decidedly in your favor, which means keeping risk at a minimum.”

Consistent Profitability

Obviously, the markets aren’t always at or near tops or bottoms. Generally speaking, a good speculator or investor should be able to capture between 60 and 80% of the long-term price trend (whether up or down) between bull market tops and bear market bottoms in any market. This is the period when the focus should be on making consistent profits with low risk.

Consistent profitability is a corollary of the preservation of capital. Now what do I mean by a corollary? A corollary is an idea or a principle. IN this case, consistent profitability is a corollary of the preservation of capital because capital isn’t a static quantity — it is either gained or lost. To gain capital, you have to be consistently profitable; but to be consistently profitable, you have to preserve gains and minimize losses. Therefore, you must constantly balance the risks and rewards of each decision, scaling your risk according to accumulated profits or losses, thereby increasing the odds of consistent success.

…Anyone who enters the financial markets expecting to be right on most of their trades is in for a rude awakening. If you think about it, it’s a lot like hitting a baseball — the best players only get hits 30 to 40% of the time. But a good player knows that the hits usually help a lot more than the strikeouts hurt. The reward is greater than the risk.

Pursuit of Superior Returns

As profits accrue, I apply the same reasoning but take the process a step further to the pursuit of superior returns. If, and only if, a level of profits exists to justify aggressive risk, then I will take on a higher risk to produce greater percentage returns on capital. This does not mean that I change my risk/reward criteria; it means that I increase the size of my positions.

Trading is a business and should be treated as such. Know your edge, play the game of making money versus trying to be right, and don’t take unwarranted risks.