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Howard Marks, the famed investor who runs more that 100 Billion at Oaktree Capital, tells a story of a phone call that changed his life. He had a conversation with Michael Milken who was just starting out as the king of junk bonds at the time. Milken told him that, “If you buy AAA or AA bonds they only have direction. If you buy single B bonds, and they survive, all the surprise will be on the upside.”
Out of that brief encounter Marks took away the lesson that all investments are about price. As he tells Business Insider, “There’s no such thing as a good investment idea, until you’ve discussed price.
Investing well is not a matter of buying good things, it’s about buying things well. And people have to understand the difference. And if you don’t understand the difference you are in big trouble.”
Mark’s observation made me think about the great stock market crash of 1987. I am embarrassed to admit that I am old enough to remember it. And ironically enough I was at Drexel Burnham Lambert, the very firm that Milken made infamous, when the crash occurred.
What very few people realize is that the 1987 crash was also the day of one of the greatest stock market rallies of all time. At around noon, after a vicious sell-off in the morning, stock staged a massive rally that brought the indices almost to breakeven. All in all, the move from the bottom to its apex was more that 200 Dow points or greater than 10% gain in matter or hours. Trader who bought the bottom and exited midday made a fortune. Of course, equities then faded into the afternoon and ended up down more than 500 points on the day or more than a 22% drop – still the biggest one-day decline in US stock market history. But if you were a trader, there was almost as much money to be made from the long side as there was from the short side. All of which leads me to conclude that in trading just as in investing price entry is everything.
So as traders, we should banish the concept of oversold or overbought. We should stop worrying if we are aligned with trend or not. The only real question to ask whenever you make a trade is – did I get a good entry or not? The answer to that query will determine your chance of success far more than any strategy you use.