Don't Confuse Brains with a Bull Market!
Some quick reminders before we get into it since there are more of you reading this now than there were last week. First, this is my diary on the market. It is in no way shape or form investment advice. These are the conversations that I am having with myself as I take in all that is happening in the market while trying to square it with the prevailing narratives and fundamentals. I do this to give some clarity to my thoughts. If you like what you are reading, please consider passing it along to others who might like it as well.
Next, if you have an opinion, I would love to hear it, especially if you disagree with something that I am thinking. I promise you that after starting in this business as a summer intern at the New York Stock Exchange when I was 16 years old, I have extremely thick skin.
Finally, nothing I write here should be considered investment advice. It is highly likely that I have a different timeframe and risk profile than you do.
Ten days, that’s how long I managed to “get away.” I am actually proud of myself for not being all that engaged with the market while I was “off.” I enjoyed the holidays, time with my family, Sonya’s 10th birthday and the remainder of the first weekend of the new year. But it was too long. I guess I love what I do.
I am not going to make predictions on how I think 2021 will play out. Predictions have never been my thing. Plus, we, as people are pretty bad at it. Go back and look at what was written a year ago about 2020 and let me know if anyone was even close. Predicting implies being able to see the future, and if I could do that, I would not share my secrets with anyone. So if you were looking for Dan’s Best Ideas for 2021, sorry to let you down.
Instead of the five charts to start the week, let’s get a few resolutions out of the way. Not the normal, lose weight, workout more type of resolutions. I am actually happy to say that I am down weight since COVID began. I was really impressed when I learned that Nike unlocked their training club app during quarantine. Pull up the Nike app on my Apple phone and stream the workouts to the TV in my home gym and we were on our way. I also happen to own both stocks, NKE and AAPL. I don’t own a Peloton (PTON) but I do own the stock. I was surprised to see ads on Facebook (FB) where Peloton was offering two months of their service for free. I actually wondered if that bullish, bearish or neutral for the stock (feel free to let me know what you think in the comments).
Anyway, back to the resolutions as they relate to investing. The first:
Stop Resulting. In her great book, Thinking in Bets, Annie Duke (a champion poker player) highlights the key difference between process and outcome. The main point is that we can control the former but not the latter. To illustrate, she uses the much criticised decision by Pete Carroll to pass the ball from a second and goal situation on the opponent’s one-yard line. We all know what happened, the pass was intercepted and the Seattle Seahawks lost Super Bowl 49 and Pete Carroll is widely recognized as having made “the worst” call in the history of sports. This story has been told numerous times and I am most likely not going to change your mind if you believe that this was not the right call. But if you look purely at the odds and all of the possible outcomes, Pete Carroll made the proper call . . . he just got a bad result.
A good trade can lose money and we should not become discouraged because it didn’t work out on this this one occasion. On the flip side, a bad trade can be a winner but the result can be attributed to luck. If we have a proven process which we follow on every trade/investment then every time we implement it, it is a good trade by definition, regardless of the outcome. The point is that if we follow the process over long periods of time, we are likely to come out ahead in the long run. However, if we negate our process to enter a trade based on the latest tip or fad, it is a bad trade even if we make a profit on it because those results are likely not repeatable in over an extended time frame.
This seems like a good one after 2020. The reason is, after March it became fairly easy to make money in the market. The liquidity that was pumped into the market and economy ignited the animal spirits. Risk was on and taking risk was rewarded. SPACs, IPOs, Innovative Technology, Biotechnology, Bitcoin…if it was risky and you bought it, you probably got paid. In fact, for many new comers, it might have been easy to feel like a genius. Open an account on Robinhood, buys stocks, watch them go up. I will admit, that this part felt like the 90’s, when unfortunately, we did not have the app, but we did have the computers in the college library. There were plenty of times when I blew off a class to go trade Microsoft. This was another time when it was very easy to make money…it is also when I first heard the term “don’t confuse brains with a bull market.” It probably came from my father, he was quoting someone else but anyone who knows my father, knows that that sounds like something he would say to me after coming in and telling him what a genius I was for making 50 cents a share day-trading Ebay.
In 2020, you could make mistakes and have the market bail you out. Just because you make money does not mean that you made the right decisions. I have spent a lot of time going over my ideas and found more than a few where I know Mr. Market bailed me out. If I am being honest with myself, I know that the results of those ideas was different from the process. This is not to say that I invested this way all year, but there were times when I would catch a ticker on Twitter or through a conversation and just put a little on. That’s dumb, regardless of if it was profitable.
That leads into the second resolution…
Wait for Premium Set-ups. Legendary investor Warren Buffet is famous for saying that “they don’t call balls and strikes on Wall Street. So you don’t have to swing at everything—you can wait for your pitch.” I have attended presentations by members of the team at Fidelity Investments who refer to “the Fidelity Fat Pitch.” It does not matter what you call it, it is simply a rule for getting into an idea. I have my rules. They are coded into the software that I use. Every night I run a screen on a universe of stocks. The stocks that pass the screen are eligible for addition to my portfolio. These are the ideas that I deem have edge, where the odds are in my favor. This will be the only way that an idea gets into my stock portfolio in 2021.
Bringing us to number three…
Know What You Own. A raging bull market makes it easy to hear about a stock, buy it, make money and feel smart…that’s not smart, that’s luck. And it’s not a recipe for long-term success. Now, I like to understand businesses and I try to never own a stock unless I know what the company does, how they make money, where they have leverage in the model and who are the competitors. But, in 2020, there were a few times where I heard a pitch and jumped in. This makes it hard to have conviction in the idea, making it harder to have a big position. So even if the idea works, how much can you really make if you don’t size it right? But, when you do the work, you can bet bigger and feel confident. I did this with CRISPR Therapeutics (CRSP). I became fascinated by the technology and spent three nights reading about it. I started buying the stock in October under $100 and it is now one of my larger holdings. I will be doing much more of this in 2021 and beyond.
Finally, I will leave you with my favorite topic of all…risk management. I have written about this before, here. But I love how Bruce Kovner combined it with the point above about knowing what you own, in this interview.
The first rule of trading — there are probably many first rules — is don’t get caught in a situation in which you can lose a great deal of money for reasons you don’t understand…Whenever I enter a position, I have a predetermined stop. That is the only way I can sleep. I know where I’m getting out before I get in. The position size on a trade is determined by the stop, and the stop is determined on a technical basis.
Here is one of the best hedge fund managers in the world, telling us to know what we own (ie: don’t be in a position to lose money for reasons that you don’t understand). And, even when he does know what he owns, he never enters without know where he is getting out if he is wrong.
These are the investment resolutions that I will work hard on this year and going forward. Notice, I said investment. This does not apply to all market participants, short-term traders can probably get away with not being deep in the weeds on a stock since they will probably not own it long enough to matter. The rest may be helpful to all.
I hope that everyone had a great holiday season and that the new year is off to a good start…it is if you own bitcoin (something else where I made sure to know what I own) but we will get into that later in the week.
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