ReadingOur church and my Sunday school class are collecting 700 books for children and teens, as poor families have only one book per every 300 children — staggering! If children don't have the opportunity to learn to read when small they will never have the reading skills to read Vic and Laurel's fine books or anything else. Most of us have hundreds or thousands of books in our homes. I have over 600 books on checkers alone. I have a good checker friend in Temecula, CA who has over 20,000 books in his home! About 2,000 on the game and the rest on everything else you can imagine. My parents taught me to read at a very early age and I have benefited from that early training/learning all of my life. Just as I have from all the varied postings on this site. I may not understand everything written, but can read everything easily.

Abe Dunkelheit adds:

"In my whole life, I have known no wise people (over a broad subject matter area) who didn't read all the time — none, zero." [Charles Munger in: Poor Charlie's Almanack, 2nd edition, p. 6]



 Errors are rewarded in strange fashions, ways which are abnormal and thus unperceived by individuals with normal perceptions; meaning a right-minded person does not expect strange types of reinforcements to be in the mix of rewards.

One instance of strange reward I know of is referred to in some circles as a drive for self-destruction. Normal individuals perceiving an individual persisting in error that is harmful will not catch on that the error is accomplishing a reward, that reward being harm, and harm not generally acknowledged as a reward.

The hawkers of doom who get paid for their opinion to be persistently gloomy are being rewarded by an audience who appreciate the darkness. These readers return again and again to renew subscriptions with enthusiasm and this rewards the hawkers. In brief, doom hawkers speak to an audience of believers.

Stefan Jovanovich writes: 

Marshall McLuhan's theory was that the advertisements in the newspaper were the "good" news; the "doom" was the necessary bad news that allowed the ads to stand out. I suspect that, if McLuhan were alive today, he would stand by his theory but point to Google instead. The news is usually gloomy but the paid search ads promise wealth, happiness and good looks all for the low, low price of $xx.99. McLuhan would probably also suggest that the relative decline of newspapers' ad revenues compared to their Internet competitors was an indication of the fact that "good" news these days was more about price and less about image -just as it had been in newspapers' heyday (1870-1925).

Victor Niederhoffer adds: 

A correspondent from Canada writes to me that the move today in oil up and down in the five minutes after the Ahmadinejad awarding of the medal, lead him to query ways of generally profiting from such false and ephemeral signals.

I immediately thought of the many times that it looked like a vivid event that had been associated with the tremendous market decline might be occurring again, and the many opportunities that provided. Indeed, I have a confession. During the summer there was a time that I was short a line of stocks. And a former Yankee pitcher played too near an apartment building. The rest of the story is too sad to tell. However, all parents should play "a boy stood near a railroad track" for their kids.

But this method must be generalized. It only happens about five times a year, and the 50 or so points you'll make from it each year must be counterbalanced against the expert sage Mohammed's view that big risks are not properly priced so that the one time you lose, let's say in 10 years, it will be more than 500 points.

Here's one attempt. I wonder if there is a very big list out there in cyberspace of people who like to read about scandals and failings among liberals, and negativity. Much of the economic news on such a list I would presume is planted. I would assume that the source might not be an overly reliable in informant or forecaster for various reasons. These include the lack of evidence of forecasting ability of the planters, their temptation to feather their own nest (except for their high moral turpitude and altruism and the checks and balances that the receivers and transmitters of such info must have), the anonymity of the source, and their insulation from the consequences of good or bad calls.

I would speculate that such economic news would tend to lead to ephemeral moves that are copperful to the caned when directed south. Such would happen, I would speculate, much more often than 10 times a year.

However, one seeks to generalize on this subject. We all know such people. Why can some people be wrong so often and yet maintain a following? We all know such people, the financial weekly news columnist for example is one icon in this regard. The economist who is always bearish in public but even more bearish in his private briefings is another. The technician who always sells the lows and buys the highs is another. The person who writes a book that's very persuasive and then starts a fund and loses hundreds for his clients but then rises up again and again like the Phoenix in another context. A consultant is another (doubtless many of my enemies will use this opportunity to say this about me). The self-indulgent authoritarian chief executive with a terrible management philosophy who hangs on and on is another.

Still another is the old eminence Arcadian who hasn't changed his views about anything and wants to do things the same way as the past and who eschews modernity like Chair Volcker (who, when I saw him in 2004, told me he sees no need for modern things like tape recorders).

I have written on Delphic forecasts. A condition for these people to hang on is often the couching of their statements in fuzzy irrefutable terms. That would apply to most of the ones I know.

But also, the ability to retaliate with force when their views are found to be falsified. This would apply to the Jonestown type error person as well as to the adviser who will sue you if you say anything about their record.

I would add that in the cases where the errorful have good motives their inabilities seem to be inordinately associated with a lack of education. They tend to be unaware of current scholarly work in their field, but hide behind a veneer of pseudo scientific talk as described by Marin Gardner and exemplified by Velikofsky, et al.

I'd be interested in augmentations, even example of why errors persist so that we can try to reduce the hard and persistence of same.

Jim Sogi adds: 

It is gratifying to disparage our opponents, however, even as we dismiss the turtles or news oriented lists, breakouts/breakdowns which have not worked for years seem to be occurring more and more as ranges widen again. The market seems "newsie" moving on Fed news, oil news, war news, and economic announcements. Contempt can breed complacency. 

From J.T. Holley:

Two things stick out for me: the lack of recognition of change, and laziness. The pack, herd, society, for the most part, don't like change. They would rather hang themselves and repeatedly take the easy way out than utilize anything remotely scientific that requires blood, sweat, and toil.

Miller's Willy Loman is a wonderful example of this. He would rather stick to his old sales ways than change like the young guns. Get rich quick schemes involving his son show this as well by Miller. Even in the end, Willy tries to leave more for his family by suicide but fails. This was laziness and lack of effort involving changing his ways.

I don't know. My PaPa told me on his deathbed to embrace change. It was like they were the most important words to me than anything else he had taught me up to that point. From that moment on I have always seen that as a sign of success in others, their willingness to be flexible and bend.

The persistence of errors-types would rather die in all forms than change! They'll take their hardheaded ways to the grave. This is laziness. Why else would someone be willing to succumb to such? How could you face the truth dead in the eye and not change? Denial must have its talons deep within people of this nature.

Once a charismatic type possesses both persistence of error disease and gathers a congregation it becomes lethal and the flock thrives.

Guys like us who are individuals, hardworking, non-altruistic, and embrace change, don't have big congregations! We just have empathy to fire us up occasionally.

Abe Dunkelheit writes: 

The errors persist because, psychologically, there is no alternative. One could go on and on, but everything would come back to the same basic thing: the impossibility of living without repression.

"[M]an is the more normal, healthy and happy the more he can … successfully … repress, displace, deny, rationalize, dramatize himself and deceive others." [Otto Rank]

The whole dilemma is perfectly elucidated in the Pulitzer Price winning book The Denial of Death, by Ernest Becker. But I am not sure if one should want to know too much about it.

When we say neurosis represents the truth of life we mean that life is an overwhelming problem for an animal free of instincts. The individual has to protect himself against the world, and he can do this only as any other animal would: by narrowing down the world, shutting off experience, developing an obliviousness [to facts] to the terrors of the world and to his own anxieties. Otherwise he would be crippled for action. (p. 178) 



 Daniel Dennett on YouTube trots out several examples of parasites that turn their hosts suicidal: lancet flukes that turn ants into zombie ants climbing plant stalks for no reason; toxoplasma that turn mice into Mighty Mouse, fearless of cats; and flukes that make fish jump into bird's beaks. His motivation in citing parasites that modify host behaviour is to cast doubt on religion.

Memes seem like a similar kind of parasite, modifying their hosts' behaviour, such as causing people who normally wouldn't presume to have anything useful to say on an esoteric topic to suddenly behave like experts, forcefully arguing the few talking points learned from last night's CNBC show as if they were the conclusions from a lifetime of investigation.

Abe Dunkelheit writes:

Every year I tend to fall for a new meme. Last year a friend of mine called me from Monte Carlo and sucked me into an oil exploration 'insider' deal which lost me 1% of my overall performance in less than five days. This time it was this article on Feb 28, which quoted Thomas Brown, that made me brainlessly buy lend shares two days before they tanked — a tiny position which lost me another 1% in a couple of days. The monetary loss is not even the worst thing. What makes it so bad is the mental turmoil and emotional disequilibrium such a memetic infection can have upon one's psyche, which substantially increases the likelihood of additional misjudgments. It is hellish!

What sucks me in?

I think it may be the following:

First, there is the appearance or mystique of knowledge: "Tiger Management alumnus and former top bank analyst Thomas Brown."

Second, there is a prediction: "Investors with at least a one year investment horizon will be very happy they bought the stock at current price."

Third, this so-called knowledge is conveyed with an unshakable conviction, which turns the prediction into a prophecy: "This is one of those times in investing, I believe, when it will pay to be very, very aggressive."

And forth, there must be a heightened level of emotion, excitability, vulnerability, and/or distraction so as to inhibit the analytical mind from properly functioning and to increase suggestibility.

[I had experienced an unusual amount of emotionally unbalancing news before my memetic infection: (1) I just had made and immediately lost an unusually large amount of money in the previous five days. (2) Before Feb 27th I had the best month ever and outperformed the market by 12 points. (3) I just gained the mandate for a large private investment account. (4) I had won a lawsuit that had haunted me for more that a year and a half. (5) I got very unexpected news of former bank colleagues who had been doing extremely well financially since I had left banking some five years ago, which made me weak and doubtful in a very subtle way. Basically, from what I had heard I concluded that I had missed out on millions, a thought that sort of traumatized me and introduced a sense of urgency into my life for a day or two. This contributed to the reduction of my mental immune system and made me ready for the memetic infection!]

In religion, we have a similar structure. First, there is the appearance of knowledge [the priest caste]. Second there is a prediction regarding the future. Third is the prediction revealed in a do-or-die urgency ["Believe me or die"]. And forth, emotional excitability, vulnerability, and distraction are strongly triggered by all sorts of techniques like induction of mass hysteria, forced confessions, dehydration, sleep deprivation, induced fear and guilt, peer-pressure, induced imaginations and phantasmagorias [the promises of hurries in Paradise and the vivid depiction of the pains of Hell], predictions, awe, synchronicities, interpretation madness [everything appears to be significant in some higher sense], etc. Often the victim has already suffered from an emotional destabilization in their life like a divorce, job loss, a rejection, etc.

What makes the meme so dangerous is that when the prediction turns out to be wrong [and they tend to be wrong all the time] the meme-infected mind has the tendency to 'explain' the failure away and that has the effect of sucking the person in even more! [See: Leon Festinger, When Prophecy Fails (1956), and also the recent documentary "Waiting for Nesara" ].

In, The Psychology of Human Misjudgment, Warren Buffet's life long friend and partner Charles Munger writes:

"Pure curiosity made me wonder how and why destructive cults were often able, over a single weekend, to turn many tolerably normal people into brainwashed zombies and thereafter keep them in that state indefinitely. I resolved that I would eventually find a good answer to this cult question if I could do so by general reading and much musing."

Abe Dunkelheit continues:

Not only does information help the public very little, but instead it helps predators! (This is a very rough calculus; I know that even between predators Pareto law applies).

Information has no implicit value. The value of any information is relative to the person's experience structure, which in turn depends on the person's relative position inside of the social fabric, and on hereditary factors.

There are no winners because it ends with death. But there are relative winners [predators] and losers [prey] in relation to each other. And that relation is relatively rigid. It doesn't change in one's lifetime. Ninety-five percent are food. Only five percent can be helped, which in turn seals the fate of the other ninety-five percent.

Free dissemination seems not to reduce the paretian effect, but on the contrary seems to help make things still worse. So what to do?

The question is rhetorical, because one cannot be interested in any serious solution. If one really wants to reduce harm simply stop educating stupidity! Don't do anything and don't go anywhere. It is almost certain that this way one would outperform any other solutions. But nobody can be seriously interested in such a solution.

So one will come up with lots of justifications why it is good to do something, anything, and thereby seal one's and everybody else's fate. Here is mine: I have no conflict with reality. (Implicit assumption: I will be saved from the cruel fate of the ninety-five percent. In fact, everybody will be saved.)

Hope and wishful thinking can be wonderful things. They can make things happen!

Alston Mabry adds:

In nature, predators are not "winners," nor are prey "losers." Being preyed upon by lions does not make zebras into losers. The lion, too, will eventually be food for another creature. The zebra does not compete with the lion, but with his fellow zebras and other herbivores. Likewise, the lion competes with the neighboring pride, the leopard, or the pack of hyenas. And when the watering holes dry up, they all die.



 I am both an investor and trader. But looking at my results I should probably only be an investor. It is not easy to trade with a full-time job on the side.

As an investor I am 100% long with my stocks. I will stay 100% long no matter what. I can sell a stock, but only if I am able to find a better one to replace it. I am not going to sell because of the overall market. Actually, I could sell if it goes up 130% like Shanghai last year. But I am never going to sell because it has been going down.

Today, my investments are down 2% from 12/31/2006, and down 10% from February intraday peak equity. I don't care the slightest bit. They could go down 30% and I wouldn't care either.

I am not crazy. There is a very good reason for this stubbornness.

I started investing seriously in stocks in 1996. Since then there has been a crisis in 1997, another one in 1998, and one of the biggest bear markets in history in 2000-2002. I was investing with a mix of stock picking, market timing, style timing, and small/big timing. Believe it or not my market timing allowed me to sell at all the intermediate tops in 1997, in 1998, and in March 2000. It allowed me to avoid the bulk of the bear market in 2000-2002. I came back too early in August 2002, sold in September, came back at the exact bottom in March 2003!

With this nearly perfect timing, you would think I have impressive compounded returns. That couldn't be further from the true. At the end in 2005, I did a complete audit of my 10-year record. It was prompted, among other things, by some things I read on the Spec List, mostly from the Chair but not only from him. So thank you guys for your down-to-earth audit-prompting approach.

Results of the 10-year audit:

Market timing resulted in dramatically lower volatility and draw-downs than the market; but who cares? It resulted in only a 2% over-performance compared to the index. In terms of absolute returns, beating the index by only 2% is ridiculous. It is incredible that even though I caught most major tops and bottoms in 10 years, I only over-performed by 2%. Even more sobering is that if I had kept the first 10 stocks I ever bought and never sold them, forgot them and never done anything else, my over-performance would have been 4%.

How could this happen? Well, that's very easy:

First, I caught all the actual tops, but also about 10 of them which never turned out to be tops. The market continued higher and I missed part of the move. Second, even when the top was an actual top and I was flat, it created the problem of knowing when to get back in, which in most cases occurred a bit too late. Third, buying and selling too much is created a lot of friction in the form of commissions. Over 10 years, the amount paid in commissions can be really impressive.

Based on this I decided to be always 100% long. I am not timing the market, styles, or anything any longer. I still hope to continue beating the market by a couple percent a year from stock-picking (probably more beta than alpha). I don't care if the results are more volatile. This is largely compensated by a huge decrease in workload and worry. Freed time can be dedicated to more useful pursuits, like learning to trade.

Jaime Klein writes:

I have, well, had, two now only one extremely financially talented relatives. The late one, when told I was going into the financial business, laughed rather rudely, I thought. And noting so many of my family members were already in that line of work, he asked me who was going to bring home the bacon. Well, he said, seeing as you're determined, I'd give you this bit of advice: Never buy a stock if in your lifetime you don't see it returning your original investment to you annually in dividends. And if they're any good, they only pay two percent.

Absurdly enough, his own results were so far beyond this as to make this counsel seem the most conservative expectation possible. He was probably 30 years ahead of the sage into Coca Cola, which he obtained by selling Minute Maid to them for stock. He never sold it except to buy the occasional Goya or Renoir, or make a charitable donation to Harvard or MIT.

I was aware of only two other plays: one was a quick flip which his partner told me netted over 100X in less than three years. The other was selling United Fruit, which I imagine he paid near nothing for, to Eli Black, right at the top back in the conglomerate heat of the '60s. I can't remember much about the foolish and ill-fated acquisitor except that he defenestrated himself shortly thereafter, taking his briefcase along with him.

Anyway, it's been my pleasure, while unfortunately lacking in outstanding talent myself, to have met so many ingenious and interesting people in my all too brief 65 years. One of these days I'm hoping I'll learn something from them. But in the meanwhile, it's always fascinating, albeit particularly in the political and religious arenas sometimes quite alarming, to see how clever so many people are.

From Scott Brooks:

Volatility is a terrible measure of risk. There is no risk on the upside of volatility. The goal should be to reduce all down side volatility, thus my patented investment strategy of buy low and sell high (Green List/Red List post from several months ago).

In all seriousness, I am fixated on the discovery of ways to mitigate downside volatility while participating in most of the upside of volatility. But since I'm far from the smartest person on this list and have been told in no uncertain terms that it can't be done, I feel like I'm fighting an uphill battle. Still, who knows, maybe there is a way!

I've never been one to give up just because others say it can't be done. If I listened to others (like my guidance counselors), I'd probably be laying carpet back in Maplewood, going to the corner bar, watching COPS every night, and aspiring only to be the "Maplewoods, King of White Trash."

From Craig Mee:

I accept these results, however…

Plenty of you know a lot more about stocks then I do. But I would like to offer here that a two percent increase in returns and with this, the opportunity to be out of the market in major declines, represents to me some nice sleepy nights.

With a bit of fine-tuning maybe marks can be picked slightly better on entering and exiting longer term positions. But on that black swan event, when something may drive the market into a huge selling spiral, I believe for me at least it may be worth that extra agro.

From Kim Zussman:

Similar but less quantitative self-assessments:

1. At least in US, taxes bite deeply into putative alpha (or masquerading beta) if you trade vs buy and hold.

2. Concur that most effect was lowering volatility. You will get lower volatility with stocks<100%, and pretty much always lower returns. Looking back, you will regret not being 100% stocks, but during the ride you live happier <<100%. Thinking about a big down year as a future possibility feels a lot different than having one.*

3. Besides drift, the reason buy and hold works is that there is too much temptation for the vast majority of people to time the market. It is unnatural not to check your investments, and not to be tempted to act on them. People don't like it when their million $ port becomes worth $800,000, and sell before "losing it all". Then it turns around and people don't like missing up 30% years, and buy back in. The hope-panic-irony cycle makes the market rise over time only for those not riding the emotocycle.

* The abstraction of future pain and foolish willingness to fall in love is nicely summarized by the late Sam Kinnison.

Jack Tierney adds:

I was invited to a dinner party but expected very little. The guests were getting thin on top and hefty through the middle. Our host was dressed in colors that defy the known spectrum and civility was to be shown the greatest horse's rectum. So we mingled and we spoke and mentioned our positions. I mooted that I was all in cash and was swarmed by five physicians. "Perhaps an evil humor attacked him on his flight or maybe he's an infidel who has yet to see the light." Their concern was very real and they needed to be consoled so I admitted that in addition I owned a little gold. Screams and wails followed and the panic gained momentum.

To quell the crowd I shouted, "Wait, I also own argentum." Now that they were fully aware of these judgmental flaws they ripped away my velvet gloves and exposed my hairy paws. They marched me toward the door when the host yelled out to quit, "Why this poor benighted soul has never heard of drift."

So began my lessons and I've brought them to the south, a bearish thought may cross your mind but never cross your mouth.

Abe Dunkelheit adds:

 Bruno's post was very interesting. I made exactly the same observation. Market timing lowers volatility but doesn't guarantee any substantial out performance. And yes, one's first ideas tend to be much better researched than all these other in and out decisions. Never to sell them would have turned out the best in my personal case also.

And there seem to be people who don't make any professional impression and live a very retired life who tend to buy and hold and accumulate incredible returns without doing much.

I know about a guy in Switzerland who was retired and did it with wine. He bought all these Chateau Mouton Rothschild wines for USD 500 a bottle 10 years ago and they now go for USD 10,000 at auction because rap stars and Russian mafia are pushing prices up. I only know about this guy because I was one of the sellers. I had bought my bottles for USD 300 and thought a cool 60% gain in less than two years could not be wrong. He had an incredible cellar with all these wines, but his house and car and his whole appearance were very modest.

Another example I know about is a guy who was jobless and lived on social security, but had saved several hundred thousand euros [back then deutschmarks] and invested them through the accounts of his children. He put it all into Deutsche Telecom at the IPO and cashed in a 600% profit during the Internet boom. That was his one and only investment.



I consider myself lucky that my studies of the markets began with Investments by Bodie, Kane, and Marcus. Then before I could be corrupted, I started reading Vic and Laurel's books. The study of "Investments" begins by reading the difference between "real assets" and "financial assets". Then it explains their relationship to each other. How financial assets are used to transfer real wealth. This foundational underpinning often will clarify the fallacy in the arguments of the prophets of doom.

When the doomdayist is the photographer, one of the most common deceptions is to magnify the problem, then focus on only one side of the picture completely blurring the other side. He artistically crafts this clear snapshot of one side of the current state. Then he imagines a future world with both sides, but doomed to failure because of its imbalance.

Being interested in demographics, I often will read articles about the impending boomers retirement. This also is one of the doomsdayist most fertile grounds. The USA's boomers, the most productive generation in history will go from being a net producer of wealth to a net consumer. Transfers of this wealth will occur, either through boomers life or at their death. Because many in this generation have amassed a fortune, framing such pictures to imply your prophetic ability is a rich field. Also boomers want to know how this transfer will occur, to determine how to position their wealth. Do you hold "real assets" or "financial IOU's"?

Because of this great wealth, it is the rare author that will take a balanced look at how this transfer of wealth will occur. Often I find articles that will use the actuarial approach to the boomer's problem, that is taking the present value of future benefits then look at the current US debt and add it on to this social security present value and perhaps throw in a the present value of other future government debts.

All of this is put in fiscal terms, with mind numbingly large numbers even the most numerically literate has trouble understanding. The real wealth currently held by the US and the boomers is an ignorable blur. The conclusion is that the only solution is to devalue this debt by inflating your way out of it. Therefore you hold "real assets" such as gold, a doomsdayist favorite. This is of course what every generation X, Y, and Z'er will want; gold, hard assets.

This perhaps shows the brilliance of Mr. Gross's recent article No Cuts, No Butts, No Coconuts. He, like a good doomsdayist photographer, magnifies the problem. But unlike the fiscal doomsdayist, he focuses on the real imbalance. That is that the boomers have the real wealth, and the demand for that wealth will decrease. He uses housing as the basis for every real assets. He insist there will be a slowing of demand for housing therefore implies a slowing of demand for everything real. He implies that you especially do not want to hold a real company producing real wealth. He implies you certainly do not want to bet on the US, the current largest holder of the world's real wealth.

The intended message of this deflation is of course you want to hold bonds, or fiscal assets. Remember he is the biggest bond salesman around.

I would suggest that the truth lies somewhere in between. Boomers will have to transfer that wealth to someone. Generation X, Y and Z'ers clearly will not have to work as hard to obtain that wealth as the boomers did.

However, much of this ease in effort to meet needs will be due to increases in productivity, not totally inflation. There will be a slowing of demand for some assets, and a growth in demand for others. The more we look to the emerging markets to make up the shortfall in human capital, the more basis goods will be in demand. The more we look inward the more scientific discovery, quality and artistic expression, the human element, will be valued.

The younger generation will not lose an interest in obtaining wealth once their survival needs are meet. The US will not suddenly lose its real wealth advantage to motivate others. Neither will it loses its foundational ability to through creative destruction and nurturing of the individual spirit to produce wealth.

There will always be problems to solve and people reaching for the stars. In fact I would argue that, in a world where the fundamental shortage is human capital, in this world the wealthiest nations will be those that give the individual spirit the most freedom, not just the nations with the most humans.

Scott Brooks adds:

I have said this before, and I will say it again (even thought I am resoundingly ridiculed for saying it); losses hurt you more than gains help you.

If the premise of the long term positive drift of the market is true (which I believe it is), then getting good returns is simply a function of "showing up at the party". All one has to do is be there to get good returns. Unfortunately, getting good returns is not good enough.

Human beings are ruled by a two sided coin: greed and fear. When things are going well, we and forget the adage that "things are not as good as they seem", or worse yet, we think we are smarter than we really are. So we get greedy. "Hey, look at my returns, I'm pretty smart…so If I'm smart enough to get these returns, then why not go on margin, leverage the money and double, triple, quadruple my returns!"

And of course, you remain a genius, and/or your intelligence increases in direct proportionality to the acceleration or momentum of the "positive drift of the market" until the momentum or positive drift stops. Then you find out, in a very painful manner, what a margin call is.

Maybe you are not leveraged, maybe you just bought into the "safe stocks", argument, or the "new economy" stocks argument, or the "positive earnings" argument. And your newly acquired personal genius told you to hold onto to Cisco at 50 because it was recently up at 80 and it should be worth at least that much. Or Coca Cola, because it had positive earnings growth all thru '00, '01, '02. Or because the long term positive drift of the S&P 500 said keep being "long" even though the 1550 high ('00) is where it should be and not at 755 ('02) it got down to or even the approximately 1300 it is at now.

You see, it is during these times that the other side of the human nature coin rears it ugly head. Fear! Fear leads to rationalization. It leads some to be afraid to sell for fear of missing out on a big run … and thus they ride Cisco down to 12, or Enron to pennies, or Global Crossing to zero! Or maybe you sell after losing half your stake, and you become fearful and indecisive as to when to buy ever again, and the first time the market hiccups, you panic and have sleepless nights, and ulcers.

It does not matter how well you do when times are good. It does not matter how much you make during the market that has such a "positive drift" that tow truck drivers can buy an island, or dot com companies can advertise a monkey playing around in a suburban home garage for 30 seconds during the Super bowl and not even mention their name or what they do (or when tulip bulbs go from $1 to $600 and someone named Newton who missed out on the rise from 1 - 600 finally decided to jump on the tulip bandwagon). It does not matter during those times. What matters is how good you are during the bad times!

It does not matter what you make, it matters what you keep. It doesn't matter if you get 10,000% return, if you lose it all during a market hurricane.

The beaches of Florida may have long term positive effects on human beings (sunny days, warm weather, refreshing water), but you better get your butt off that beach when a hurricane is coming. Why? Because its hard to enjoy the beach if you are dead.

It is hard to enjoy the long term positive drift of the market if you have lost your nest egg, seed money, portfolio, clients, etc. Therefore, I submit to the site that the most important activity for any of us, is to become absolute experts at determining what is the likelihood that the markets are likely to decline. Therefore we should discuss what are appropriate courses of actions to take during those times. How do we recognize them? How do we know that the risk levels in the market are elevated?

What I am saying has nothing to do with being a bear, or discussing fear. It has to do with reality. How do we achieve good solid returns during the good times, and then preserve those gains during the bad times so that when the bad times are over, we have our portfolio intact and we can ride the new long term positive drift (the next wave) of the market again.

Why do I suggest this? Because losses hurt you more than gains help you!

Steve Leslie comments:

Nietzsche said that which does not destroy you makes you stronger. I say that depends on a person's evaluation of the experience. It hurts more when it is personalized.

Behavioral psychologists tell me that people avoid pain more than they seek pleasure. Or more importantly perceived pain. I am not a behavioral psychologist so I will allow some others to chime in.

After a plane crash people are reluctant to fly in a plane even though they stand a far greater chance of being killed driving to the airport. From personal experience I know that losses stay longer in your memory than wins. I can tell you every bad hand that has knocked me out of a major tournament. Or the putt I missed that cost me the club championship.

Everyone says they want the ball at crunch time but only a few of them really mean it. The rest hope that they are not called upon to face Mariano Rivera with the game on the line. Or having to make a knee knocker to go into a playoff with tiger Woods. (See Chris Dimarco at the Masters).

How about this one. Get a 50 percent return for 2005 receive your industries highest award CTA of the year, and then have a few months of drawdowns. Now you are a heel. It goes with the territory. Schadenfreude is ubiquitous.

It is a lot easier to be average or above average than it is to be exceptional or superior. It takes different wiring. Most analysts and all Re-elected politicians understand this, at least those who have long careers.

Dr. Kim Zussman contributes:

One hypothesis is that bull and bear markets have some correlation with the investment lifetimes of generations living through various markets.

For example my parents, who lived through the depression, did not own stocks when they were young because (besides not having much money) they had directly witnessed ruin. It was not until a close family friend did well in the bull of the early 1960's that they bought in the late 60's, and held down through the mid-70's. Thus from then on they eschewed stocks, pronouncing the mantra "Lost $20,000 in the stock market".

Undoubtedly there were many families burned like ours who got and stayed out by the end of the 1970's. By then, boomers only vicariously touched by the bad market of the 70's were becoming flush enough to buy stocks and help fuel the great bull that ensued.

So if painful memory of investment losses has lifetime effects in many people, this could explain some of the decade-length duration of bull and bear markets. And what effect, if any, the 2000-03 decline will have on the current cohort would seem to be a vital question.

Scott Brooks replies:

All good insights, but I am not talking about just having some losses, I am talking about having a methodology to measure risk and the likelihood of downturns. How does one survive 1968 - 1982, or 1939 - 1946.

It seems to me that long term secular bear markets can be devastating to the long term drift theory. Just as a hurricane can damper the Florida beach experience. Markets seem to go thru long term secular trends. The last great bull basically lasted from 1982 - 1999, the one before that from 1950 - 1967.

If one looks at a chart of the long term market one will see that the long term bull cycles are punctuated by basically smooth sailing with the wind blowing pleasantly in the direction that we want to go. All one has to do in those markets is basically index and let the markets blow you to prosperity.

But if one looks at the long term bear cycles (for the sake of this discussion, a long term bear cycle is one where the market goes down and then takes many years to get back to its past high levels…i.e. it hit a high in 1968, proceeded to go down, and then did not get back to that high until 1982), one will notice that they last a long time (usually longer than a long term secular bull cycle) and one will notice that, unlike the smooth sailing of the long term bull markets, they are punctuated with extreme volatility.

Now I know that there are/were big downturns in the last bull market (1987, 1990, 1994, 1998 just to name a few) but they were quick. They went down, and within a short period of time (less than 18 months in the case of 1987) they were back to new highs. All I am saying is that there has to be a way to preserve capital during these downturns. There has to be a way of measuring the likelihood of their occurrence.

Make no mistake about it. I am a bull. But it is my job to be realistic about the markets, asses them and figure out a way to make my clients money. I do not care if the market is going up or down. It is my job to:

  1. Preserve my clients capital
  2. Grow my clients capital
  3. Perform actions 1 & 2 with the least amount of risk necessary

So, my questions to the are simply:

How do we reliably measure risk? How do we manage the portfolio's during higher risk times? How do we make a profit when conventional methodologies (i.e. long term drift) is out of favor, or when our personal pet systems, markets, sectors, regions, investment types, are out of favor, because they are experiencing a long term secular bear market?

Abe Dunkelheit contributes:

Marcel Duchamp, the famous French artist, was sharply criticized for his attitude towards the French Resistance in WWII. Instead of fighting against the Nazis he emigrated to the United States. In an interview he explained his attitude. He said to him it appeared that in any conflict there is a third alternative besides fighting for or against a perceived evil, which is withdrawal! Of course 'withdrawal' is a highly individual response to conflict; it cannot be the strategy of a whole nation. No wonder that such an attitude must seem to be anti-patriotic from the group's point of view.

The idea of long term investment is an illusion because investors as a group cannot survive the bear market periods. (The individual can but not the investors as a group.) The paradoxical situation is that the illusion of long term investment is necessary to keep the economy going. If we look at the wealth of the nation as an aggregate we see it growing; but if we look at individual lives we see much misery. Why is that? Because the wealth of the nation comes at a price! The price is the sacrifice of personal happiness. The welfare of the group depends on behavior that is not good for the individual! For the whole nation the investment meme is good but for the individual it is not!

What can one do? One can develop extremely individual solutions. I think one must become extremely individual in order to survive bad things which tend to hit whole nations. One must totally stay away from the crowd and eradicate anything which is crowd-like in one's own bosom. A lot of unconventional thought must go into the question of 'investment' but nothing definite can be said in an email.

There are many unpleasant truths and one must look at them. "When killers stop killing they get killed." (A wise gangster in a movie.) I do not know if I can make myself understood. What I am basically saying is that 'investment' cannot work for the many, not in the way it is advocated; it works only for the few, but in order to work for the few it needs the many. The whole thing, from a humanistic point of view, is perverse. Trading is not 'human', neither is 'life'. Yet, paradoxically, the long term effect of this 'inhumanity' is economical growth and prosperity, which is good for the group, at least in theory, but comes at a price, which is the sacrifice of the individual, because the individual member of the group ('the many') must be tempted to act in ways which are, from the individual point of view, not good.

As an example for unconventional ways of thinking/acting I studied how to lose money. It is said, people hold on to losers and cut winners. Some time ago I opened an FX account and traded such a strategy: buy low, sell high, based on hunches, otherwise hold (no stops). I did 100s of trades - and broke even! I had a dozen big losers which offset the 95% small winners. Now that was a basis to work from; I gained some highly precious insights from this experience. I learned, for example, that it is not wrong by default to hold on to losers and cut winners; what is wrong is doing this without regard to the liquidity process.

Among many other things, I noticed the unhealthy tendency to increase exposure after a particular market had gone up! In my opinion that is the real reason why people lose money. They tend to do the right thing after experiencing it was the right thing - only that it is now the wrong thing.

I also noticed that trading in and out of stocks is not increasing profits; but dramatically reduces drawdowns. I further noticed that profits tend to come 'like thieves in the night' - rather unexpected. I learned I cannot predict and do not predict. 90% of what I am doing is exposure (or inventory) management. No single decision holds meaning to me; I look and think in terms of the 'whole'. My trading tended to be highly fragmented and I had to stay focused all the time which was draining. Now I am still trading very actively but with a detached attitude, rather disinterested in any particular move. I hardly ever react. Almost all of my trades (entry/exit) are placed before the markets open. I also noticed that when the markets turn busy that this does not necessarily mean I will trade more; it means I will think more!

Finally, I was surprised how small but good decisions can add up to quite substantial profits. There is more to it, like a positive attitude; also useful is following news in conjunction with particular moves. I noticed that moves in individual stocks are often explained by news that are already known to the market for a week or more (like DELL); also that stocks can go up with hardly any comments (like EBAY). I also realized that it seems to be a good time to buy a stock now and not later when people recommend to buy it not now but later (like AMD).

Tom Ryan mentions:

In reply to Scott, it seems to this rather sunbaked speculator that there is an inherent conflict in logic here in the sense that having a long term goal, in this case growing capital, but an operational plan that is geared to minimizing a negative event in the very short term (preserve capital), well this will always produce a sub-optimal solution. if a client comes to me and says five years from now I want to look back and have made a 15% CAGR (doubled my money) but I don't want to suffer more than a 25% loss in any one year, then the reply has to be that really, they do not have a five year plan, they have a one year plan for each of the next five years. In other words the short term operating constraint always overrides the long term plan. Always.

As for risk, there is absolutely no reason for anyone to hire a money manager in order to pursue below average market risk as anyone can do that by calling 1-800 VANGUARD and apportioning the appropriate %s to stock and short term bond index funds to get whatever risk level they want. The only reason to hire a money manager is, to use Tim's phrase, to "pursue alpha". Now all strategies to pursue alpha boil down to one of two things, either selective/focus of positions (hopefully into things that will do better than the market average), or increased turnover of positions (trading). Theoretically, therefore, it is not possible to pursue alpha without above average risk. And yes, before I get 15 replies to this email (including from Melvin) it is possible to show in retrospection how someone or some strategy achieved higher returns with below average volatility or risk in the past, but theoretically, from day(0), all alpha pursuing non-indexed strategies have higher than average risk.

So at the end of the day the issue of how to grow and preserve capital at the same time, or grow capital whilst minimizing risk, can not be solved without proper definitions of risk, such as target CAGR, the significant time horizon, maximum leverage allowed, and what constitutes impairment of capital. Even with these factors mathematically defined, the solution will always have to be probabilistic rather than deterministic because we can only use the past behavior to construct general distributions which can guide us as to future expected behavior. Hence we have come full circle to my first assertion that there is a logical conflict between growth and preservation of capital i.e. your items one and two.

As a postscript: I suppose the one other reason for a layperson to hire a money manager even if they are not pursuing alpha would be to avoid fraud risk as brokers are subject to fraud from time to time. but fraud risk is hard to detect beforehand even for professionals as the past 10 years has repeatedly demonstrated. You can probably achieve the same effect much easier simply by some diversification.

Russell Sears adds:

I would disagree, short term draw downs do not always out weigh the long term goals, just usually. To paraphrase a recent conversation I had with Gordon H. "Principle protection is currently the biggest scam on Wall Street." Anybody that understands indexed options could design a plan that maximizes your exposure to a market, but limits your yearly loss.

The problem is two fold. One, doing so causes you to give up tremendous potential earnings, opportunity cost is high, as you suggest. Second, most advisers on Wall Street upon hearing this their mouths will salivate, they spotted the chump at the table.

How, do you get the client to understand you cannot make money without taking risk? And how do you explain that such a "no losses allowed" strategy, is a chump strategy that those without any integrity will gladly execute at your expense?

I wish I knew the answers, to that last one especially. My current strategy is to assume that most people with money are comfortable acknowledging "business risk", and you have to take business risk to make money. So I try to present "investment" risk as diversification of their current risk… it just has solid $ figures attached to it.


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