Investing Discipline is Total Bulls-t

Boris Schlossberg

As an investor, how do you know if you are disciplined or stubborn?
If you go broke you are stubborn.
But if you survive and make money you are disciplined.
That’s laughably stupid if you think about it for longer than a minute.

Yet every single day you are bombarded with the conventional pablum that all you need to do is be “disciplined”, buy an index fund and keep buying more on a regular basis and 30 years later you will be rich. The underlying assumption is that the upward drift in stocks will continue infinitely. But the future is almost never just a slightly different version of the past.

Today, America is quickly losing economic power to China. It is destroying the only competitive advantage it has by banning immigrant labor which is responsible for almost all the intellectual contribution to the country’s economy. And it’s getting old. Everywhere you look the United States is a country of fat, old people in wheelchairs sucking up all the available tax dollars of Social Security and Medicare benefits, while the young struggle to live two to a room as they attempt to pay off their student loan obligations from which they can only escape through death.

So yes -- there is every possibility that the American Empire is following the path of Rome and that the wonderful 200 year plus run of progress and innovation that translated into a ever rising upward drift of equity prices could come to an end. And of course now that we find ourselves at the apex of equity valuation, not one person is thinking about the end of Pax Americana, just like the Romans submerged in their orgy of sex and violence of the Colosseum couldn’t possibly imagine that their way of life would be smashed to smithereens by hordes of primitive barbarians.

But I am getting too dark and frankly a bit off point. I have no idea when the US growth party will end, but it sure feels like it could be soon. More importantly, if it does end there will be literally nothing you can do to help yourself if you follow the conventional investing wisdom of the day. Discipline will lead to ruin as you just keep buying an ever falling asset.

The laughably false distinction between discipline and stubbornness (there is no way to judge which is which until you get the final result) was made very vivid this week by the tragic travails of David Einhorn -- a one time a hedge fund God, a Master of the Universe, the King of Value and the present day owner of Greenlight Capital who is suffering the humiliation of seeing his fund lose 20% this year. Again. Einhorn, who for the past ten years has been busy losing all the money that he made in the ten years prior, wrote a letter to his investors noting that, “Right now the market is telling us we are wrong, wrong, wrong about nearly everything….And yet, looking forward from today we think this portfolio makes a lot of sense… We have been accused of being stubborn, but one person’s stubbornness is another person’s discipline.”

To which the inimitable Matt Levine of Bloomberg, the best writer in finance today, responded, ”Yes! Correct! Let me make that a bit more explicit: If you have a plan, and you do the plan, and it makes money, people are like “good job being disciplined in sticking to your brilliant plan.” If you have a plan, and you do the plan, and it loses money, people are like “bad job being stubborn in sticking to your dumb plan.”

I mean! This is wrong! In fact, people regularly distinguish stubbornness from discipline, and evaluate the quality of your plan, without reference to current results; they care about the process by which the plan was arrived at and the quality of your reasoning and the convincingness of your explanation of how the plan will make money in the future. It is not incoherent to say “my strategy is good, and I am right to stick with it, even though so far it has lost money.” It is just kind of funny. And of course, in the long run, how would you distinguish stubbornness from discipline other than by results?”

Exactly.

But it doesn’t have to be that way. You don’t have wait until you lose 75% of your money -- whether you are a buy and hold Mom and Pop investor or hedge fund titan to find out if you are “disciplined” or “stubborn”. If you day trade and if you do it right (not correct, but right, meaning that you slice risk into teeny, tiny pieces by making lots of small trades, you will never put yourself into such a no-win situation. You will have near instant feedback on whether you are correct or not and more importantly you will have much greater control over your drawdown. My pal Robbie Booker showed me an account today where he made 12% return while drawing down just 3%. The best part is that he did it by trading 1000 unit size on a 10,000 dollar account.

That’s right he traded 1/10th leverage and STILL beat the S&P! But that’s not unusual. I have seen many traders in my chat room achieve 20% returns with 3% drawdowns all because they traded small and controlled risk on every trade.

That’s the beauty of day trading. The discipline is in the size and in the stop. You don’t need to come up with excuses. You don’t need to wait years to be proven right or wrong. Your results are there every day and you have much better control of your financial destiny.

Success in Investing and Trading Depends on the Exact Same Thing

Boris Schlossberg

I came across an interesting item in the news this week. Fidelity -- he massive mutual fund giant -- did a survey of the best performing customer accounts. Guess which accounts made the most money? The ones where the customers literally forgot that they had an account open.

Now you can make all the jokes you like about this, but the Fidelity study confirms once again that the key to successful investing is simply time. We know that the single most successful investing strategy ever devised is dollar cost averaging into a low cost diversified portfolio of equities. As long as stocks continue to have positive drift -- that strategy will beat 99% of hedge funds out there.

The reason this is true is that in investing you are simply playing the law of large numbers with time. If you hold an asset for 1 minute you chance of making money is approximately 48% (due to transaction costs) if you hold it for 10,000,000 minutes (about 20 years) you chance is 95% or better. The law of large numbers is the single most powerful force in making money.

Now the irony of the matter is that the exact same principle applies to trading. All of us have this ridiculous fantasy of sitting on beach, sipping a cool drink and leisurely making one or two killer trades from a smart phone that rake in thousands of dollars. If this is your idea of trading -- you will never make money. The “suave rico” approach to capital markets is a fantasy that you must wipe out from your mind,.

The fact of the matter is that if you want to succeed in trading you have to trade a lot. Most retail traders make two fatal mistakes that doom them to failure. They trade with leverage and they give up after three losing trades.

Want to know how many trades you need to make in a year to have a reasonable chance of success as speculator rather than an investor?

100?
Nope
200?
Nope
500?
No.

If you want to have a reasonable chance of making money you need to make between 500-1000 trades a year in order to mitigate all the typical challenges of trading in speculative markets (slippage, gaps, news bombs etc.) The bottom line is that if you trade you will be wrong a lot. Sometimes your strategy could have 5, 6, 7 stops outs in a row.

We have a killer new strategy at BK that is really making bank in this high volatility market, but I am not naive enough to project this run into perpetuity. I have studied the backtests and I know that the drawdowns will come. The difference however, between losing and winning in trading is to allow that law of large numbers to work for you.

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So in essence, successful investing and successful trading are one and the same thing. In investing you accumulate as many minutes of exposure to the market as possible. In trading you do as many trades as possible and let the law of large numbers lead you to profit.

The Difference Between Trading and Investing

Boris Schlossberg

Contrary to popular belief you do not need to understand high level statistics or even be able to read a balance sheet in order to be a successful investor. Investing isn’t about numbers -- it’s about narrative. How else would you explain a company like Amazon -- a hybrid of Walmart and Federal Express -- which is very good at selling dollar bills for 90 cents. Yet despite never making a dime Amazon’s stock has made its founder Jeff Bezos so rich that he can drop 250M on a vanity publishing project like the Washington Post.

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Apple on the other hand makes more money than the Medici but has seen its stock tumble by 40%. What is the difference? Its certainly not the numbers. Erase both names off the letterhead and set the pair of books in front of an investor and I am sure you would be shocked at what each business will be valued at in a private transaction. The difference is narrative. The Amazon story is all about how they will own the world of commerce, while the Apple story is that after the passing of Steve Jobs they have nothing new to offer to the world.

So narrative, not numbers drives investments -- which is why some of the best analysts on Wall Street come from liberal arts backgrounds with degrees in such disciplines like Comparative Literature rather than accounting and finance. Any moron can build an Excel model whose investment worth is usually less than zero, but few can imagine the future. (see Tesla auto).

As human beings we love narrative. Storytelling is as old as the cave and deeply woven into our DNA. But as traders narrative can be our worst enemy. As traders we operate on a time frame where narrative can change in a heartbeat. Unlike investors who have the luxury of time on their hands to discover if their narrative thesis plays out as imagined, we -- with our levered accounts and day trading focus -- enjoy no such privilege.

Investing may be all about narrative, but trading is all about levels. Trading by its very definition is
the art of profiting from short term movements in price. Value means nothing. Narrative means nothing. Only price matters. And price is ultimately a function of levels. Are they broken? Are they supported? How much do we risk to find out the answer? Those are the only questions that should matter to us traders.

Don’t get me wrong. As a trader you should know your narrative. You should be keenly aware of all the macro and micro themes running through the market, if for nothing else than to know when to stand down. But as traders we cannot make the following mistake. We cannot enter into a trade based upon a price level trigger and then remain in it because we are convinced of its narrative truth.

Yet we all fall into that trap.

In one of the greatest movie lines of all times in The Big Chill Jeff Goldblum challenges Kevin Kline to find anything in life more powerful than rationalization.

Michael: I don’t know anyone who could get through the day without two or three juicy rationalizations. They’re more important than sex.

Sam: Ah, come on. Nothing’s more important than sex.

Michael: Oh yeah? Ever gone a week without a rationalization?

Narrative is what we use to rationalize our losing positions and as traders we simply can’t afford that luxury or we will go bankrupt.

The difference between traders and investors is that we trade levels, not narrative and we constantly have to remember that fact.