Day Trade Like Warren Buffett

Boris Schlossberg

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OK. Guilty of click bait as charged. Buffett would never day trade in his life. His holding time is years rather minutes, but that doesn’t mean that we can’t learn valuable lessons from him about trading. There are a few core principles that Buffett holds which we as day traders can adopt for our own purposes.

1. Don’t Lose Money.

How important is this rule? Buffett once quipped that this was his rule #1. When asked what his rules #2 was he said, “See rule #1”. Everybody talks about not losing money, but I think it’s important to understand just why this is the single most important factor in trading success. Losing money is not just psychologically unpleasant, but more importantly, it is mathematically very challenging. It’s the two-steps-back-one-step-forward problem. If you take two steps back, making one step forward isn’t going to cut it. Even two steps forward won’t help you much. You need to make three consecutive steps forward to move beyond the two-steps-back losses.
That’s why the single most underappreciated move in trading is the scratch.

A few days ago I listened to a great interview with Virtu President Doug XX. Virtu is one of the leading high-frequency trading firms in the world, and almost everyone thinks that they make all their money by front running orders -- yet if that were true they would be gone long ago as other faster competitors would beat them to the punch. Virtu’s actual skill is in market marking, and specifically in scratching out trades. They only win about 51-53% of their trades, but unlike amateur traders, they don’t lose on the rest, they simply scratch out at even on most of them. That’s the great secret to winning at the day trading game.

Buffett for his part also knows the value of keeping your drawdown to the minimum. During the 2000 -- 2002 cycle when the S&P was down -11% and -21% respectively Buffett was down just a few percentage points making the recovery in 2003 much easier for him.

2. Let it Come to You.

Buffett is well known for not overpaying for assets. In fact, his favorite dictum is -- Be Fearful When Others Are Greedy and Greedy When Others Are Fearful. The underlying philosophy of this approach is that risk on balance is always lowest when markets dislocate to the downside and always highest when they ramp to the upside. Now there are plenty of individual examples of when this strategy fails. Momentum moves could decimate even the stingiest bid and leave even the most aggressive offer biting the dust. But this is an actuarial argument. Just because some smokers live to 100 years of age and some marathon runners die of heart attacks at 45 does not mean you change your premiums to accommodate the exceptions. If anything exceptions in insurance as well as in investing prove the rule -- don’t f-ing chase price! You may succeed once but you will fail ten times and end up losing in the end.

3. Stick to what you know

Are you good at making 10 pip trades? Do you excel at reactive rather than predictive trading? Do you feel much more comfortable trading with trend than against it? Each trader has personal strengths and weaknesses. Unlike real life where we are taught to constantly “improve” ourselves trading will actually only make you much worse if you go against your natural strengths. Buffett has been adamant about not investing in technology because he did not understand it -- and when he broke his own rules by buying IBM -- he demonstrated just how bad of a tech investor he is. Now he may have missed Google and Microsoft and Amazon, but his performance still remains much better than the vast majority of active managers (though not much better than the S&P). The point being is that by sticking to his formula of buying “old business” companies he still managed to perform very well and found plenty of profit opportunities away from tech. The greatest thing about the market is that it is not a monolithic entity -- there are literally thousands of niche strategies that can be profitable. The key is to find the ones that work best with your personality.

Warren Buffett Does Not Trade Trend

Boris Schlossberg

The other day I came across an article about Warren Buffett’s office. The writer catalogued in full detail all of the knick knacks that Buffett has in what was described as “the domain of a mid-level executive in a generic corporation.” I knew that Buffett was frugal, but the fact that one of the world’s richest men still watches television on cathode ray TV really surprised me.

Yet what really caught my eye about the article was that Buffett had a picture of Ted Williams in his office. I wrote about trading like Ted Williams several years ago and it appears that Buffett is a fan of the baseball great for the very same reason that I am. As Buffett tells the writer the picture of Williams is there to remind him to “wait for the right pitch”.

If you really think about what Buffett is saying, it means that you must let price come to you. It means effectively that Buffett never trades trend. As a value investor he is always buying when everyone is selling and selling when everyone is buying. He, of course, is not alone. Almost all great investors do this including Seth Klarman whose book sits on Buffett’s desk.

Yet think about the idiotic cult of trend that pervades all retail trading. From the moment you are newbie to the very last penny that you lose from your account you are told by every paper trading guru that you “must trade with trend”. Now there is no doubt that some -- few -- traders can trade with trend successfully, but the vast majority of traders lose all their money following that useless advice.

Why?

Because trading trend puts you at a disadvantage from the moment go. You are chasing price, you are following the crowd and that strategy only works if the wave continues to swell. But hurricanes are rare and most of the time the wave crests and you just crash into the rocky bottom of unforgiving ocean wondering what you did wrong.

Currency markets -- and for that matter all capital markets -- are just like the ocean. On a day to day basis prices crest and fall and rise again. That’s why in my day trading room we trade counter-trend almost all the time. Trading counter trend by no means guarantees success. In fact, if you do what most retail traders do, which is -- add to the position and trade without a stop -- you will most certainly go bankrupt. But counter trend trading with a robust entry model and an intelligent trade management system is a much better way to day trade. It puts odds in your favor.

Just ask Warren Buffett.

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Warren Buffett – Daytrader

Boris Schlossberg

At first glance there seems to nothing common between Warren Buffett and the chaotic frenzy of the day-trading world that I inhabit. But on closer inspection I realized that there are some striking similarities between the way Mr. Buffett approaches investing and the way I look at trading every day. Both of us try to stay away from risk as much as possible.

The Gordon-Gekko-I-am-Master-of-the-Universe stereotype of Wall Street is actually not how true wealth is built.“Have a hunch, bet a bunch” is not the the cornerstone of success of the great investors.

If you listen carefully to what Buffett says you realize that wealth is built by giving yourself a much bigger “margin for error” than most people think is necessary. In his latest letter to the shareholders, Buffett talks about the insurance business. He states that it is not enough to just understand the risks involved in the transaction and to price that risk correctly. To be truly successful in business you need to be able to walk away if the buyer of the policy isn’t willing to pay your price.

This I think is the core secret for all trading and investing success. Simply put, Mr. Buffett’s advice boils down to just two simple ideas -- know the full cost of your risk and don’t chase price. When you look at the way Mr. Buffett invests it has very little to do with picking a great stock ( although he certainly tries to do his homework) and much more to do with picking a decent stock at a good price.

As investors and traders we all have our narratives for where the market will go. But if we are honest with ourselves we’ll admit that no matter how much research we do, the accuracy of our forecasts is largely taken out of our hands. The world is too complex, developments happen faster or slower than we think and of course human beings are rarely rational and their behaviour is often bewilderingly unpredictable.

Even if you are right you can be wrong.

A few months back you may have seen The Big Short. Christian Bale portrays Mike Burry who as one of the heroes of the film walks away with billions in profits by betting on the subprime crisis. Yet what is lost on almost everyone in the audience is the fact that Mr. Burry only won his bet by literally taking his investors money hostage. Although he was absolutely right in his investment thesis, the markets refused to move his way for a very long time. Meanwhile he was forced to pay premiums to keep his bets alive, which led to near term losses and calls by his investors to abandon the strategy. Had Mr. Burry not had the clause in his contract that allowed him to lock his investors money -- in short had he not had the “margin of error” to consider the absolute worst scenario -- his bets would have ended worthless and he would have been just another woudda-coudda-shoudda chump on Wall Street instead of becoming a celebrity investor.

What Mr. Buffett teaches is that we can only control two things -- the amount of risk we take on and the price we are willing to pay. One is intimately tied to the other.

Mr. Buffett and I could not be more different. As a long term investor he trades time for money while as a short term trader I try to time my money and flip it over as fast as possible. But I’d to think that we both have a healthy respect for risk and more importantly the discipline to never chase price which hopefully puts me on the same road to financial success albeit via a different path.

How To Day Trade Like Warren Buffett

Boris Schlossberg

In his seminal book Stocks for the Long Run Wharton School professor makes a fascinating point. He makes a longitudinal study of two well known companies -- Exxon and IBM and comes to very surprising conclusion.

Based on Siegel’s study of the two stocks from 1950 to 2012, IBM outdistanced Exxon in every growth category — sales, earnings, dividends, and cash flow. Big Blue’s earnings growth exceeded Big Oil’s by more than three percentage points per year. IBM was the classic growth stock, Exxon was the classic value play.

Yet Exxon proved to be the better stock to buy. “When your lockbox was opened 62 years later,” reports Siegel, “the $1,000 you invested in the oil giant would be worth $1,620,000, more than twice as much as IBM.”

How come? “Valuation,” the author explains. “The price investors paid for IBM was just too high.”
“Those who bought its stock and reinvested the oil company’s dividends accumulated 12.7 times the number of shares they started out with, while investors in IBM accumulated only 3.3 times their original shares.”

Now I‘ve often made the distinction that investors looks at value, while traders look at price but its is really a distinction without a difference because successful investors and traders both share the same process. That process can be summarized in one sentence -- “Let the market come to me.”

Warren Buffett is notorious for buying stocks at a discount and then holding them for many years as their value is realized. The single most important aspect of his style is that he simply never pays up for an asset. In fact he often will buy beaten down ideas if he feels that the core of the business can survive. This provides him with ample room for error as the downside on such a trade is fairly limited but the upside can be many multiples of the initial investment.

Although I am the farthest thing from Warren Buffett -- his ideal holding time is forever, mine is one hour or less -- I actually find myself to be a kindred spirit of his style. In our chat room I am always selling above the market and buying below. If the trade doesn’t come to me -- so be it. Like Mr. Buffett I would rather pass up on the opportunity rather than initiate a trade at an inferior price. To do that consistently you have to be able to walk away. That’s hard to do for many traders because the siren song of the market is very appealing and the excitement of the flow can be overwhelming. Yet I can’t tell you how many times this approach has saved me from a certain loss.

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Buffett’s rule one is “Don’t lose money.” His rule 2 is “See Rule 1”. By letting the market come to him, Mr. Buffett has beaten the averages for many decades in a row. For day traders that’s a lesson to never forget. As professor Siegel has shown in markets as in life the tortoise often beats the hare.

“FOMO=FUP” or How Warren Buffett Taught Me to Take Money From The Market

Boris Schlossberg

Is there a better business in the world than the insurance business? Not if you ask Warren Buffett. While he fools you with his aw shucks friendly grandfather routine, the man actually makes all his real money not on his investment acumen (which is extraordinary of course) but on his ability to lever the massive daily cashflow that he receives from his insurance operations.

The other day in our trading room I blurted out that real traders learn how to take money rather than make money from the market. The more I think about it the more I am convinced that it is probably the smartest thing I said.

Is there a better business in the world than the insurance business? Not if you ask Warren Buffett. While he fools you with his aw shucks friendly grandfather routine, the man actually makes all his real money not on his investment acumen (which is extraordinary of course) but on his ability to lever the massive daily cashflow that he receives from his insurance operations.

The other day in our trading room I blurted out that real traders learn how to take money rather than make money from the market. The more I think about it the more I am convinced that it is probably the smartest thing I said.

Allow me to explain.

Let’s go back to insurance. The insurance business is the only business model based on the idea of taking your money first while making a murky promise of delivering a payout sometime later. In fact, in a perfect scenario the insurance company would love to collect money from you in perpetuity and never pay you out a dime.

I am always amused at the fact that people find interactions with the insurance companies to be so confrontational. Of course they don’t want to pay you! In all other businesses they need to deliver the goods before they get your money. That’s why they are so nice to you. In insurance, they already have your money, so everything else that follows is pure annoyance and cost for them.

But setting the ethics of the business aside, the financial rewards of running an insurance company can be enormous IF you price the risk correctly. And this is where Warren Buffett comes in. If you read anything about Mr. Buffett’s insurance operations he is the farthest thing from being a low cost provider. In short, Mr. Buffett never cuts his premiums to attract more business. Indeed if you follow all his recent market deals be they insurance or not -- the primary principle by which he operates is get paid first, worry about making money on the investment later. Preferred stock anyone?

But back to the insurance business. There are basically two components to making it wildly profitable -- take the money in and make sure you give as little of it back as possible. (Buffett’s Rule #1 of investing -- Don’t lose money. Rule #2 -- see Rule #1) By assiduously focusing on both sides of the equation Buffett has learned how to take money from the market rather than just make it.

What does that mean for us as traders? It means that under no circumstance ever, do you chase business. You let the business come to you, on your terms or no terms at all. Over the past week or so I have been extraordinarily selective in picking out VT levels for us to trade. The net result is that of course we made far fewer trades, but those trades were all winners and we wound up the week up about 1% with no drawdown whatsoever.

Its not glamorous. It’s not sexy. It’s hard to sit on your hands and deny yourself the lower quality trades even as you watch them go to profit. But it undeniably works. We have a saying in the room -- “FOMO=F*up” ( i.e. Fear of Missing Out will kill you in the end).

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I think Mr. Buffett will agree with the spirit if not the tone of that message as his lesson of taking money from the market rather than making money from the market reverberates with all us in the BK trading room.

The One Trick That Lets You Trade Like Warren Buffett

Boris Schlossberg

Remember Jon Corzine? The one time CEO of Goldman and former Jersey Governor? As his last gig in finance he became CEO of a futures broker called MF Global. In 2011, in the midst of the Eurozone sovereign debt crisis, Corzine loaded MF Global trading books with Italian and Spanish bonds yielding 7%-9%.

You know where those bonds trading today? At yields of less than 1.5%.

So how come Corzine isn’t hailed in the media as the bond king extraordinaire that he once was? Why did he resign in disgrace after the MF went bankrupt and has spent the last few years fending off lawsuits?

Contrast his fate with that of Warren Buffett who was also buying distressed assets at the time, including BoA and many other financial stocks. Buffett is revered as an investment genius and is called “the Oracle of Omaha”.

But you know the only difference between Corzine and Buffett? Its not intelligence, it’s not courage, its not skill.

Its just money.

Corzine was overleveraged and ran out of capital before his trades could start to work. Buffett on the other hand never runs out of money and can afford to wait for as long as it takes to let his investments make money for him.

Now we may not own an insurance company to provide us with a ready source of funds any time we need it, and in all honesty no retail trader could ever replicate Buffett’s returns even if he shadowed him stock for stock (a topic for another column), but there is one lesson we can all take from Buffett that could greatly increase our chances of success.

Don’t run out of money.

The rule in trading is that money buys you time and time makes you money. This is true if you are long term investor or day trader like me. If you can wait out the adverse excursion of the market 9 times out of 10 you can turn a profit on your position. We do this all day long in my chat room.

Now of course that is not always true. Of course some ideas are never going to work and whether you trade or invest you will eventually have to let some positions go. But if your size is small enough even a total wipeout of an idea won’t take down your whole account.

Buffett may trade in billions of dollars but relative to his equity size he never overlevers his positions. He can afford to have any one trade idea go to zero and he will still be in business tomorrow.

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That -- not strategy, not analysis, not market knowledge -- is the key to Buffett’s success. Money buys you time which as Warren Buffett knows is the most valuable asset in any market environment.

What Warren Buffett Does That You Don’t

Boris Schlossberg

The longer I live on this planet the more I come to realise that 99% of our misery stems from the 1% of a-holes in our life. In fact the single greatest path to happiness is to simply avoid contact toxic people. Eliminate the rancor and you will be healthier and happier by a wide margin. As the saying goes the best way to avoid a fight is not to have one.

I think the question of our environment is more than just an academic exercise for us traders. Trading at it core is a highly psychological activity. That’s why any disturbance to our psyche -- be it a fight with a loved one, a nasty illness, horrid family news -- almost always results in disastrous trading.

This is a tough lesson to learn, especially for those of us A personality types who have never met a challenge or an argument that that they didn’t like. We love to fight, we love to take the world head on and we love to think that we are “mentally tough” to face any problem. In the real world those attributes can be of great help. In trading such attitude is often a major hindrance.

Just as I learned that you never fight the market if you want to win, I also learned that you never trade angry or hurt. Trading is such a delicate activity and rife with so many bad judgement calls that it requires a clear mind and a calm environment if you ever want the chance to succeed.

Take a look a Warren Buffett. Here is a man who is considered to be one of the greatest investors alive. He could live anywhere he wants and have access to the most up to date information and the most sophisticated software to analyze it. Yet he chooses to live in the middle of nowhere -- in Omaha Nebraska -- in the same modest house that he has lived in since the 1950’s. Why? Because there he is undisturbed. He can read and think in peace and therefore make clear headed, intelligent decisions in the calm and comfort of a familiar environment.

So if you want to trade like Warren Buffet, try to achieve his state of serenity. Create a pleasant environment to trade and most importantly delete anyone who annoys you from your life.