Is successful investing, a matter of luck and destiny? Or can it be learnt and executed successfully. In an industry where chance can play a big role, are there methods by which we can reduce the role of chance in our work?
Yes, there are.
Taking inspiration from the “Turtle Traders” and Richard Dennis we can learn methods and principles which have stood the test of time. For those of you who haven’t heard of the “Turtle Traders”, they were a group of layman traders chosen randomly to be coached by the trading pioneer, Richard Dennis, also known as the “Prince of the Pit”.
The story is such, back in the 80’s Richard had already made more than $ 100 million trading in the markets and he was convinced that anyone who was taught the right techniques could become a successful trader. But Eckhardt (his partner) argued that his investing success was a result of his inborn skill and it would be difficult for someone to replicate. The two men figured that the only way to come to a conclusion would be by conducting an experiment. For this they picked a group of ragtag students from various backgrounds and set out to train them to be full time traders.
They called the students ‘Turtles.’ Dennis, who says he had just returned from Asia when he started the program, explains that he described it to someone by saying, ‘We are going to grow traders just like they grow turtles in Singapore.’
Dennis taught these students for just 3 weeks and then left them out in the open with no more guidance. But in these three weeks he taught them the right principles to follow and if followed correctly each one of the traders could turn out to be highly successful. Each one of them received $1 million to trade after the training (they would be working for Dennis) and almost all of them made more than 150% for 4 years in a row. Of them, the most well-known was Jerry Parker who went on to set up his hedge fund in 1988 and continued having an exceptional track record.
So, what are the investing principles that we can apply even today?
- Rules Based Systems
Having rules or a mechanical system was the primary and fundamental concept Dennis taught his students. Without rules you head nowhere. He believed that when you work with a rules based objective system you are less prone to making errors. For example, Warren Buffett has framed his rules for investing and one major rule would be never to invest in Tech businesses. It does not necessarily mean all tech companies are bad, but it’s just that he never managed to understand tech businesses and it never fell under his circle of competence. He never broke this rule. In fact, from 1995 to 2001 he under-performed the markets every year, because tech companies were doubling year after year. But he stuck to his process and in 2002 the tech bubble burst and Buffett managed to outperform. Rules and objective decisions always win over subjective emotional decisions because with objective systems: the same input always produces the same output.They don’t get bored, they don’t get mad, they don’t get distracted and they don’t have off days. Most importantly they don’t fall prey to cognitive biases.
- Process over Outcome
“Games are won by players who focus on the field, not the ones looking at the scoreboard”. – Warren Buffett
This especially applies to the world of investing, a world where the scoreboard fluctuates at the blink of an eyelid. The problem with the scoreboard is that it only has the ability to tell you what is happening at the moment rather than what will happen in the future. When we wholly focus on a result we are less willing to try long shots, less inclined to experiment, less open to serendipity and less likely to stumble upon a better outcome than the one we are aiming for. This is what separates genius from the ordinary.
Tiger Woods does not play golf for the money. Warren Buffett does not need the money, yet he invests. Focusing on the process puts you in control. You only have partial control over the outcome, but you have complete control over the process. Focus on the process and the outcome will take care of itself.
- Keeping it simple
Applying a complicated solution to a complicated problem is an understandable approach but it is flawed. Parts of a complicated system will interact with each other and reduce our ability to envision a possible outcome. Focus on the critical variables and the macro points. Do not pay too much attention to unnecessary information.
One of the greatest and my favorite example to a rules based system would be the S&P 500 Index fund. The S&P 500 index fund is a simple fund which selects stocks based on a few filters like market cap, volume and traded turnover of a stock. It’s probably one of the most simple and unintelligent systems, but yet it has managed to outperform 85% of the fund managers over the past 20 years.
- Emotional Intelligence and Perseverance
Everything said and done, trading isn’t going to be easy. There is no holy grail. You will see periods of large losses and that’s a part of the business. Marc Faber once said “The world is mad, stocks will be dropping 30%, and then rallying 20%, and then dropping another 30%- that’s going to be the pattern. Whoever can’t live with that shouldn’t be buying equities at all.” So the question remains, how should we deal with such volatility? The Answer lies in managing your emotions.
Have you heard of Mensa? Mensa is a society whose membership is limited to those with an IQ of 148 or greater, which makes only 2% of the population eligible. Currently they have 110,000 members across 100 countries. The cool part is that Mensa has an investment Club. In the most obvious scenario, the most brilliant minds in the world should be holding the most beautiful performance record? But, sadly that’s not true. Mensa has done 2.5% annually since inception whereas the S&P 500 index fund has done 7.5%. A whopping 80% under-performance. In investing,your IQ does not hold as much importance as does your EQ. If you can stay emotionally strong and have the ability to keep going after every fall, you will succeed.
Ultimately, you have to cultivate the extra drive. You have to keep reading and feeding your mind with good books. Charlie Munger once said “ 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”. Most people do not want the real work that comes with real success. The bottom line is that the market doesn’t care about you personally. It doesn’t care about your gender, culture, religion, or race. It’s a business that has no entry barrier but success would require a high level of skill. Being an investor is very similar to being a surgeon. Great surgeons are the ones who are industrious and boneheaded enough to working day and night for years on end. Talent is not born, it’s grown.