In months like these, when the waters of the market are getting bloody, I like to return to first principles. Shortly after I started investing, the dot-com collapse gave me a reality check like no other. I’d been flying high, and all of a sudden, my profits crumbled around me.
The most important lessons are often the most painful to learn. The memory of that experience has helped me keep my head on straight during even the harshest bear markets of the last two decades.
The markets are rough right now. I don’t know anyone who isn’t feeling it, myself included. Fortunately, if you have been reading my newsletters with any regularity, you already know that markets have always gone down, and they always will. I know that doesn’t make it any easier. But at least it’s not a complete shock.
As I and the community of investors we have created on the RiskSmith Discord channel have weathered the storm together, something keeps coming back to me – my interview with Jack Schwager, the author of Market Wizards, a series of books in which Schwager interviews the greatest investors of all time.
Since the interview was published on January 22, 2021, it has been viewed over 1,000 times. In it we discuss excellent strategies for investors at any time, but particularly during times like these. I’ve summarized a few of my favorite moments here.
Even with all of my years of investing, this interview really made an impression on me. There are moments in our talk that stay with me and are comforting as we move through another volatile cycle in the markets.
Early in our conversation, Schwager says that one of the differences between the greatest investors and everyone else is that they learn from their mistakes. I love this! It’s a reminder that everyone makes mistakes – even billionaire hedge fund managers.
What separates the greats is that they know they are going to make mistakes, they plan for it, and they learn from it. They keep a journal of some sort. In this way they learn what works, too. How often do we lose because we stopped trusting what works?
He shares this story:
There’s another trader who … takes large positions and will normally get out quickly if he’s wrong. One time, things turned so quick he hesitated, and there was a big loss. He said, I can’t get out of this loss. And he came back, and he came back. He only lost a small amount and got out, but he recognized afterwards that not getting out immediately and waiting for that bounce was actually a mistake, because there was no guarantee there was going to be a bounce. He was just purely lucky.
What’s impressive to me is that he didn’t stick with the story that his purely lucky moment was actually immense skill and acumen. He acknowledged that he could not have known for sure whether the market would have bounced back and that doubling down the way he did – not his typical strategy – was a mistake he didn’t want to make again.
When the markets are rocky, we start to get uncomfortable and afraid. When humans are uncomfortable and afraid, they make mistakes.
First, we must be vigilant and watch out for sudden flashes of “inspiration” that involve throwing out the window everything we’ve done up until now. Next, we need to admit that we probably will make mistakes, so we can be ready to ward off justification and instead reflect on and learn from them.
Another thing he discovered that all the greatest investors have is methodology, risk management (something I talk about all of the time), and the discipline to stick with your plan. Schwager says:
…You have to have a methodology that has some sort of an edge and a risk management method. Discipline comes in exercising the methodology and in the risk management. … Theoretically you can come up with a good methodology and good risk management, but if you’re not going to apply it – or you’re tempted to deviate – it’s not going to work.
So, what methodology do you use to succeed? That’s another thing I loved about Schwager’s findings. There’s no right answer. Only the answer that works for you:
Novices come into this business and they’re always looking for, what’s the market secret. They think there’s some sort of answer to the markets. There is no single answer. [In my books] … you’ll find people who are purely fundamental, and cynical about technical, and you’ll find people who are purely technical, and cynical about fundamental, and you’ll say, how can they both be extremely successful? It’s not the type of methodology. It’s [different] for each person.
And this is not something you figure out overnight. He goes on to explain:
You’re not going to necessarily know what your methodology is right off the bat. I know in my own life I’ve gone through different phases. It was a while before I decided [what I was] really most comfortable with. It’s a matter of trial and error.
One of my favorite moments in the conversations – when Schwager really blew my mind – was in our discussion of risk management:
So, this is kind of the ironic thing. You’ve had entire books written on risk management. You have hedge funds, which have multiple quants for risk management. But bottom line, the essence of risk management, I could put on one page and probably get 90% of the way there with one sentence. The one sentence from Bruce Kovner: Know where you will get out before you get in.
There you have it, folks. 90% of risk management – something ALL the greatest investors use – is knowing when to get out before you get in.
Don’t just run out and buy Bitcoin because a famous quarterback in a Super Bowl commercial said you should. Take a deep breath and find out whether it is right for you. I wrote a Risk Rituals in April of 2021 on how to do this.
These are some of the moments that I have been thinking about over the last month. There is so much more to this conversation. I encourage you to listen to the entire thing. I hope it helps you as much as it has helped me.