Yes I do. I had zero trades.
How long did this go on?
I probably didn’t have a single account or trade for eight months.
You cold-called for eight months without a single sale! That sounds brutal. Was this your low point?
No, this wasn’t the low point [he laughs]. The low point happened shortly afterward. Regardless of my lack of success in selling, I knew there was a big difference between trading and selling. Eventually, after watching the markets, I decided I had to start trading again. Although I didn’t have any money, I realized that I could take out a home-equity loan and do whatever I wanted with the money. I said to myself, “I can liquefy my house and invest it.”
I can see it coming…
I started selling stocks that I thought were up too high—powerhouse stocks like Liz Claiborne and the Gap—and buying stocks that I thought were down too low. In effect, I was shorting good companies and buying bad companies.
How much of a home-equity loan did you take out?
I had placed a down payment of $75,000 on the house, and I took out a loan of $50,000 against it. Within three weeks of taking out the loan, I had lost 75 percent of the money.
How did your wife react to this turn of events?
She had no idea.
She didn’t know that you took out a home-equity loan?
She knew about the loan, but she didn’t know what I did with the money.
What did you tell her you were going to do with the money?
I did tell her that I was going to invest it, but I told her that I was going to invest it in a conservative dividend play that would give us a greater return than the rate we had to pay on the home-equity loan. That was my intention. But once I had the money I thought, “I’m not going to put this into some boring dividend play to make a few dollars on the spread between the dividend income and my loan rate.”
When you are at a brokerage firm, there is always something exciting going on. There is always some stock doubling or tripling. You can’t avoid the frenzy. I was listening to the stories being pitched all around me. The salesmen could make any story sound great.
So apparently you had failed to learn your lesson about not listening to tips and rumors. You made the same mistake all over again.
Absolutely. I couldn’t bring myself to tell my wife that I had lost almost all the money. I had trouble sleeping the entire month. I made up all these excuses why I was looking so sickly. I told my wife that I had the flu. She was worried, but she had no idea what the truth was. One day a buddy who worked beside me gave me a tip to buy Commodore Computer. “I think this story is really going to work,” he said. “We’re hearing that their latest game is going to be a high-flier.” I was so desperate that I told myself, “I’m going to do it.” I took everything that was left in my account, leveraged it at 200 percent, and bought the stock.
That was the low point in my life. The $75,000 I had put into my house was my entire savings. The thought that because of some gambling I could lose everything that I had built up in ten years of saving really scared me. It was the black abyss.
The stock went from $10 to $17, and I got out. After I liquidated, the stock reached as high as the low twenties, but it eventually went back down to zero when the company went bankrupt. That single trade was enough to almost make me whole again.
You actually were salvaged by pure luck, by a tip that could have been a disaster because the stock eventually ended up going to zero. You just happened to catch it during the right time window.
It was just luck. To this day, I look back at pivotal points in my life, and I don’t know whether they were due to luck or intelligence, but I never care about the difference. It’s funny how things work out. I always tell people that luck is a very important factor in this business. Maybe you have to put yourself in the position to be lucky, but I think we all get our fair share of luck—both good and bad. We just have to take it as it comes.
That Commodore trade saved me. You might think my attitude would have been: “That tip worked, so I’m going to listen to other tips.” But at the time, I recognized the luck involved. I realized that I was being bailed out by the stock market gods. I did learn my lesson. From that point on, I traded so much better.
Did you say, “Thank God, I won’t sin again”?
Exactly. Even though everything worked out, the stress was incredible. Therefore, when I made it back, it was a godsend. Then I just started to chip away at it. Of course, I still had a lot to learn, but at least I had that experience behind me. I think it’s important to get that low and see the abyss.
How did that help you?
The shock of the experience gave me clarity. I understood that stocks don’t go up and stay up because of stories, tips, or people’s opinions; they go up for specific reasons. I was determined to find those reasons, shut out the world, and then act on my own knowledge. I started to do that, and over time, my record got better and better.
This was really the first time in your life that you were trading stocks with any success. What types of things were working?
The theme I noticed back then that has persisted through bull and bear markets is: Good companies, on balance, continue to go up. Grandmothers in Kansas City know that.
And how do you find these good companies?
I look for companies that have been blessed by the market. They may be blessed because of a long string of quarters they’ve made [quarters in which the company’s reported earnings reached or exceeded expectations], or for some other reason. You can identify these stocks by how they act. For some reason, the market goes to some stocks, and it doesn’t go to others, no matter how many brokers tell their clients to buy these other stocks because they are cheap.
In effect, you actually reversed what you had been doing before: Instead of buying bargains and selling stocks that had gone up a lot, you were buying the expensive stocks.
That theme has continued to this day. The hardest thing to do is to buy a high-flying stock or to sell a stock that has gone down a lot, but I always find that the hardest thing to do is the right thing to do. It’s a difficult lesson to learn; I’m still learning it now.
What tells you—to use your word—that a stock is “blessed”?
It’s a combination of things. The fundamentals of the stock are only about 25 percent of it.
What is the remaining 75 percent?
Another 25 percent is technical.
What are you looking at on the technical side?
I like stocks that show relative linearity in their trend. I don’t want stocks that are swinging all over the place.
That’s 50 percent, and you have already gone through fundamental and technical. What’s left?
Another 25 percent is watching how a stock responds to different information: macroeconomic events, its own news flow. I also pay attention to how a stock reacts to going to round numbers: $20, $30, etcetera. I try to get a feel whether a company has that special shine to it.
What kind of response are you looking for?
I want to see a stock move higher on good news, such as a favorable earnings report or the announcement of a new product, and not give much ground on negative news. If the stock responds poorly to negative news then it hasn’t been blessed.
That’s 75 percent. What’s left?
The last 25 percent is my gut feeling for the direction of the market as a whole, which is based on my sense of how the market is responding to macroeconomic news and other events. It’s almost like looking at the entire market as if it were an individual stock.
How long do you typically hold a stock once you buy it?
I don’t day trade, but I only hold a stock for an average of about a few weeks. Also, when I buy a stock, even if it’s a core position of a few hundred thousand shares, I might be in and out of it twice in the same day and six times in the same week, trying to get a feel about whether I’m doing the right thing. If I’m not comfortable with the way the stoc
k is trading, I get out. That’s one thing I love about running a hedge fund. I don’t have to worry about my customers seeing the schizophrenia in my trading. I used to work for a company where the customers received a confirmation statement for every trade that I did. They would go nuts. They would call up and say, “Are you crazy? What are you doing? I thought you were supposed to be doing real research.”
What prompts you to get out of a stock?
I get out either because the stock looks as though it’s rolling over, and I am in danger of losing what I have made, or because the stock has made too much money in too short a period of time.
Would you then look to buy back the stock on a correction?
Yes.
Does that work, or do you often end up missing the rest of the move?
I often end up missing the rest of the move because the stocks I am buying are good companies, and they usually continue to go up.
Have you considered changing your trading approach so that you hold stocks longer?
I have changed gradually over the years, but to this day, I still fall prey to the mistake of getting out too early.
When you get out of a stock, do you sometimes buy it back at a higher price?
Sure, all the time.
So you are at least able to bite the bullet and admit that you made a mistake by getting out, and then get back in at a higher price. You don’t say, “I can’t get buy it now; I sold it $10 lower.”
I may have done that in earlier years, but now buying back a stock at a higher price doesn’t bother me at all. To me, the successful stock is not one that I bought at 10 and held to a 100, but one where I picked up 7 points here, 5 here, another 8 here, and caught a major part of the move.
But it sounds as if it would be easier to just buy one of these blessed stocks and hold it.
Sometimes, but it really depends on market conditions. For example, right now valuations are so high that I don’t have any core positions that I intend to hold on to.
That brings me to a question I was going to ask: In this type of market, where the leading stocks have already seen such extraordinary price run-ups, do you still use the same approach? If not, how do you adjust your methodology?
To be honest, I’m having a hard time adjusting. My philosophy is to float like a jellyfish and let the market push me where it wants to go. I don’t draw a line in the sand and say this is my strategy and I’m going to wait for the market to come to me. I try to figure out what strategies are working in the market. One year it might be momentum, another year it might be value.
So you adopt your strategy to match your perception of the market environment.
Exactly, I try to anticipate what the market is going to pay for.
How do you know when there is a sea change?
I’ll look at everything and listen to as many people as I can, from cabdrivers to stock analysts. Then I sit back and try to see what idea rises to the top. Sometimes the opportunities are so obvious that you almost can’t lose when they come around; the only problem is that they don’t come around that often. The key is not to lose money in the times in between.
Give me an example of an opportunity that was that obvious.
Last year [1998] it was very clear to me—I don’t like saying stuff like this because it makes it sound as though I have a crystal ball—that the market had a very good chance of rolling over in a serious way during August.
What made you so sure?
I constantly evaluate market sentiment—Is the market hopeful? Is it fearful?—and wait for the price action to confirm my assessment. Throughout last winter and spring, the situation was very confounding. There were lots of reports about potential problems in Asia, but the market ignored everything. Therefore, the only way to make money was to be long, even in the face of this potential trouble.
So I decided to get really long in July. The leaders were performing great, and the market was roaring. At one point, I was up 15 percent for the month. Then all of a sudden, in a matter of days, I lost everything and actually found myself down 3 percent for the month. The market took the money away so quickly that just by looking at my own portfolio, which was filled with market leaders, not stocks with poor fundamentals, I knew something had to be wrong.
What did you do at the time? You said you had started out the month heavily long. Did you cover your entire position? Did you go net short?
I was 130 percent long. What I typically do when I believe there’s a major bearish event occurring in the market is to sell everything and then just watch. That’s what I did then.
Did you go short?
Yes, about two weeks later. I thought that the Asian crisis that precipitated the break would have a second leg to it. Usually you don’t just hear about a problem and then have it end. We also started seeing headlines about potential problems in Russia. Although we had seen these types of news reports before, the difference this time around was that prices were responding. I felt convinced that the situation would continue. Russia was not going to get fixed the next day, neither would Thailand or Korea, and prices were reflecting these fears. During the second week of August, I went 130 percent net short, and the scenario played out. To me it was very obvious.
When did you cover your short position?
I covered my shorts during the second week of October. I have a number of rules taped to my quote machine. One of these is: Buy on extreme weakness and sell on extreme strength. The only way to identify extremes is to get a feel for the sentiment, whether it is euphoria or pessimism. Then you have to act on it quickly, because there are often abrupt peaks and bottoms. By the second week of October, I felt that I had to take advantage of the opportunity of the market’s extreme weakness to cover all my shorts. I covered the entire position in one day and actually went net long 25 percent.
Was there anything significant about that day in particular that prompted you to reverse your position?
That day, stocks like Dell went down from 50 to 40, and before the end of the day they were going up 2 or 3 points at a clip.
So you were buying these stocks at much higher prices than they were trading at earlier the same morning.
Absolutely. Actually one of the things I like to see when I’m trying to buy stocks is that they become very difficult to buy. I put an order in to buy Dell at 42, and I got a fill back at 45. I love that.
Do you just put your buy orders in at the market, or do you try to get filled at a particular price?
I always buy and sell at the market. I never mess around trying to get the best fill. I’m a broker’s dream.
You said you went long about 25 percent. When did you increase that long position?
Whenever I start to go back in on the long side, I like to wait and see that the market rebound continues the next day and that there is no further bearish news. If there is additional bearish news and the market doesn’t go down, then I really go nuts.
Did that happen then?
It didn’t happen the next day, but it happened later in the week. There was more news about the collapse of Long Term Capital. [The multibillion-dollar hedge fund was overleveraged in the bond market and suffered enormous losses, leading to fears of repercussions to the entire financial system. See David Shaw interview.] The market just shrugged it off. That gave me greater confidence to just plow in on the long side. I had a chance to buy all these market leaders while they were down sharply from their peaks, which I love to do.
Did the all-or-nothing trade that recouped most of the money you had lost from your home-equity loan mark the beginning of your successful trading career? Did you stay true to your vow to give up your trading transgressions?
For the most part. I immediately started trafficking in quality growth names. I bought the stocks that went up more than the market when the market was going up. I figured those were the horses to bet on. I forced myself to buy these stocks on down days. I found these stocks would often go up five points in a week, whereas I would have
been lucky to get five points in a year in the low-quality stocks I had previously been buying.
The only time I really got into trouble was when I fell prey to a great sales pitch. The most dangerous thing on the Street is the ability to communicate. I worked with some great salesmen. They would say, “Stuart, you have to look at this.” And sometimes in a weak moment, I would rationalize that I’d done well and had some extra money to speculate with. Maybe this trade would work, and if it didn’t, I’d get out quickly. Before I knew it, I would be down 20 or 30 percent on the trade. It’s a lesson that I continually have to learn.
Do you still find yourself vulnerable to listening to tips even now?
Absolutely. At some level, I have a gambling urge, which I decided a long time ago I needed to satisfy, but in a small way. Therefore, I set aside a small amount of money in the fund for doing these speculative trades.
On balance, do you end up winning or losing on these trades?
About breakeven.
How did you go from being a stockbroker to a fund manager? For that matter, did you ever make a sale?
Eventually I started to do okay as a stockbroker because I learned how to sell.
How do you sell?
You need to find out what the customer wants and package your sales pitch—not the product—accordingly.
What did the customer want?
Instant gratification, excitement, sizzle, the comfort of knowing that lots of other people were buying the same stock, and a million reasons why the stock would go up.
So you tried to make the stock sound as good as possible without any qualifications?
Absolutely. That’s what all stockbrokers do.
Weren’t you troubled by making something uncertain sound certain?
Sure, but it wasn’t exactly lying, because I had no idea whether the stock would go up or not. It was, however, a huge embellishment. After a while, I just couldn’t hack it anymore.
How did you get out of it?
After I started doing well in my own account, I began recommending some of my own ideas, not just the stocks that were part of the company line. I was bailed out by one of my accounts who liked my style and offered me a job to manage money for them. That was really what wanted to do. If I hadn’t landed that job, I would have had to quit because I was once again at the point of waking up in the morning and feeling I can’t do this anymore.
Stock Market Wizards Page 3