Source: Pring-Turner Capital Group, Walnut Creek, California.
Success comes at the margin through hard work and patience; it builds incrementally through the compounding process. Your expectations as a client going into a money-management relationship are probably more crucial to the success of the project than those of your manager. Most people err on the optimistic side, believing that high returns can be earned with very little risk; they also prefer stable returns over unpredictable ones. This immediately sets up a conflict because high returns are predominately a function of risk, and the higher the risk, the greater the volatility and hence the unpredictability. Stability comes with a cost and that cost is a lower rate of return. One way of getting around this problem is to give your manager time, because the passage of time is the mortal enemy of volatility and the friend of superior risk-adjusted rates of return.
Matching Your Needs with the Management Philosophy
The first requirement when selecting a manager is to tell him your investment objectives and, as best you can, your ability to tolerate risk and volatility. He can then judge whether his philosophy is consistent with your objectives and character. For example, you may tell him that you want to retire in 10 years on an annual income of $50,000. At an 8% rate of interest, this would require a capital amount of $400,000 at retirement. Your current capital is $100,000. Achieving that objective will require a gain of $300,000. Since the average annual total return from stocks since 1926 has been around 9%, it will mean that the manager has to take above average risks to achieve that objective. If you also let him know that you are afraid to take big risks, your objectives are clearly unrealistic and will need to be modified. Consequently, the starting point for the discussion should be your ability to tolerate risk rather than your investment objectives. The level of risk tolerance puts a cap on a realistic expected total return. Once you establish your tolerance level, the appropriate return commensurate with that risk can be calculated from historical data. It is then possible to set a more realistic investment objective.
If your objectives are consistent with the investment philosophy of the money manager, it is important to fully accept the broad concepts. If you say you agree with his philosophy and sign a contract with him even though you do not fully accept his investment outlook, conflicts are sure to arise. For example, if the manager has a conservative approach and regards the maintenance of principal as the guiding light of his philosophy, you will become frustrated at this safety-first strategy if riskier smallgrowth stocks begin to take off. You will read about the great gains being achieved by this market sector and will be disappointed in not being able to participate. The manager cannot be faulted for this, because it is alien to his investment universe. This type of conflict is a recipe for trouble. Only by fully buying the philosophy and making a commitment to stay the course will you allow the relationship a chance of success.
Even though a manager hates to turn away prospective clients, it is in his long-run interest to indicate that you should look to someone else if your philosophies and risk-tolerance levels are different from his. An unhappy client will leave sooner or later anyway and difficult clients drain managers of the energy and emotion that they need to devote to the market and their other clients. By succumbing to the temptation of taking on a large client that does not fit the client profile, the manager will jeopardize the performance of all his other accounts.
Part III
STAYING ONE
STEP AHEAD
11
What Makes a Great
Trader or Investor?
He who knows much about others may be learned, but he who understands himself is more intelligent. He who controls others may be more powerful, but he who has mastered himself is mightier still.
-Lao-tsu
Just as there is no Holy Grailthat is, no easy path to quick wealth-there is no secret or formula that history's great traders and investors have called on to propel them to their great achievements. Each success story is unique. Some of their stories are just that: tales, myths, or legends.
The famous quip by former New York Yankee catcher Yogi Berra-"It's not over till it's over"-is just as relevant to careers in the financial world as it is to those in the world of sports. Jesse Livermore, for example, was a legend in his time, but he died bankrupt. He certainly could be classed as a successful trader in his heyday; indeed, he made and lost several fortunes, yet both died a broken man. Is this how we ought to judge success? Is this what we want for ourselves? I hope not.
The problem is that many of us use money as a vehicle to work out our basic internal needs, but in fact money cannot offer us such solace.
It can offer a short-term antidote, but it can never alleviate insecurity, loneliness, or other forms of mental dependency. If you are unsure what is stopping you from becoming wealthy, you will remain a victim of money. If you do not know what you want from money, it is unlikely that you will be able to achieve your financial goals. To follow in the footsteps of the truly great traders and investors, you will have to change your habits and attitudes. Otherwise, you will remain at the starting gate.
The quotation by the Chinese philosopher Lao-tse that begins this chapter summarizes the secrets of the market wizards. They understand themselves and in doing so have mastered their emotions. Not being perfect, they make mistakes like the rest of us. The difference is that their mistakes are less costly because they have learned to recognize low-risk ideas and quickly bail out of them if they do not turn out as expected.
Successful traders and investors possess confidence and a strong sense of self-esteem. They have feelings of personal worth. A truly successful trader or investor does not crave recognition in a wide sense; many, in fact, shun publicity.
As Kathleen Gurney put it in the March 1988 issue of Personal Investor, "The money masters are in control; they know themselves and their money styles. They are aware of who they are, where they have been and where they are going. Their money sense of themselves is both positive and secure." Gurney adds that it is this self-assurance that makes them secure that their decisions are the correct ones.
In Money Masters, John Train reiterates the view that there is no one secret to success in the market. He believes that basically two investment attitudes mark successful investors: Either they can study with focused care and imagination what is under their microscope at the moment, or they see their work as "an exercise in cautious futurology-peering into the fog a little farther than the crowd." In addition, Train rebuts the argument that these individuals are lucky. It is true that being in the right place at the right time can result in some spectacular success stories. However, to maintain a position at the top for a long time can only be achieved with hard work, lots of study, and a consistent performance.
Working hard and working smart are different things. In his book, Peak Performers, Dr. Charles Garfield sets out his conclusions from interviews with more than 300 successful individuals in business, sports, arts, and education. He found great differences between a workaholic, who is addicted to activity, and a peak performer, who is committed to results. In the book, he lists six basic attributes common to individuals who achieve peak performance. Since these characteristics are common to all forms of successful activity, including trading, they are worth repeating:
1. A Commitment to a Mission. This ultimate source of success was common to all respondents. In deciding their missions, peak performers have first to decide what they really care about and what they want to accomplish. The motivation for their mission is not expertise but a personal choice based on preference.
2. Results in Real Time. Peak performers establish realistic, measurable goals and act in a deliberate manner in order to achieve them.
3. Self-Management through Self-Mastery. Each peak performer was able to demonstrate an ability for self-observation. This involved both the ability to grasp the big picture and small details. Survey participants were also able to utilize the technique of menta
l rehearsal in which the most desired outcome of an event and the most effective way of achieving it are first orchestrated mentally.
4. Team Building and Team Playing. This characteristic is but prevalent in traders and investors who often act alone. But it is an important trait as well in larger organizations where it is necessary to delegate investment functions. Team builders are able to delegate to empower, stretching the abilities of others and encouraging educated risk taking.
5. Course Correction. This refers to the ability to initiate change and to learn from past mistakes.
6. Change Management. Peak performers have the ability to anticipate and deal with rapid, external changes caused by new technology or other factors and to construct alternative outcomes.
Summarizing his conclusions, Garfield states that what motivates an individual to fulfill his talents is a strong commitment to values. "These values-the old fashioned and very real qualities that make up a person's and organization's character-are the leverage point for the whole internal impulse to excel, to put a mission on its course."
Dr. K. Van Tharp, a research psychologist, has spent considerable time studying the psychology of high achievers and has had extensive exposure to successful traders. He has tested many of them to determine whether there is a correlation between their success and specific personality traits.
Tharp's work covered three basic areas: psychology, management discipline, and decision making. The researcher discovered that successful traders in their psychological makeup showed a well-rounded personal life, a positive attitude, a motivation to make money, a lack of internal conflict, and a willingness to take responsibility for results. Risk control and patience were key factors in the area of management discipline, Tharp found. Finally, sound decision making requires a good understanding of technical factors and the market, an ability to make unbiased choices, and independent thinking derived from competence.
Tharp's research also uncovered the characteristics common to losing traders. They appear to be highly stressed, a trait that impairs their ability to make sound decisions. They also tend to be pessimists, to have personality conflicts, and to blame others when things go wrong. Furthermore, losers tend to be crowd followers, are easily discouraged, and rarely establish a set of rules to follow. The psychologist emphasizes that a losing trader need not exhibit all these characteristics. One or two of them will suffice.
Generally speaking, Tharp's work confirms many of the ideas put forth by the other experts described in this chapter. Like Tharp, they conclude that successful traders and investors hold most if not all the following beliefs:
♦ Money itself is not important.
♦ Trading or investing is a game, hobby, or "love" above all else.
♦ Profits are a fringe benefit.
♦ Losing money is an accepted aspect of playing the market.
♦ Mental rehearsal helps in anticipating all possible outcomes.
♦ A high level of self-confidence enables them to convince themselves that they have "won" the game before it has begun.
There is, of course, a big difference between justifiable and unjustifiable confidence. Justifiable confidence comes from a coherent set of beliefs, usually encapsulated in a methodology or trading approach that has been soundly tested. Well-founded confidence springs from a commitment to do well. This means that you are certain that you are doing the right thing and are prepared to make some sacrifices to accomplish your goals.
The Opposite Side: Why Do "Stars" Self-Destruct?
We can better appreciate what motivates successful traders and investors by looking at the other side of the coin and examining why "stars" tend to self-destruct. Perhaps two classic examples of this tendency are the entertainers, Elvis Presley and Marilyn Monroe. Both enjoyed unprecedented international fame, substantial wealth, and the adoration of millions of fans. Tragically, both ended their lives with an overdose of drugs.
In an article in New Dimensions in 1990, Roy Masters comes to grips with this seeming dilemma. He points out that stars with tendencies to self-destruct have attributes that are the exact opposite of those common to successful market operators. The financial wizards have put their acts together and are comfortable with themselves. They know that if they carry psychological baggage their goals will be unattainable, so they make continuous efforts-partly conscious, partly subconscious-to improve themselves by observing themselves.
On the other hand, as Masters points out, the stars are the victims of their own successes. We know that everyone loves to be loved, but, writes the author, "There is something strangely negative and destructive about being unconditionally loved by everyone, being constantly reminded that you are wonderful and can do no wrong." This state, he goes on to warn us, reinforces a person's worst attributes. The very reason these self-destructive stars began to seek this unconditional love and adoration may well have been to avoid confronting their problems. Eventually, they discover that this type of "success" is the ultimate betrayer, for they are still miserable, guilty, or angry. Yet, as Masters puts it, "There is no more promised land to look for." Either the high they experienced no longer satisfies them, or, more tragically, they begin to decline.
In a paragraph near the end of the article, Masters confirms what really makes a successful operator. "Contrary to popular misconception, there is nothing inherently wrong with attaining fame, great wealth, or power. But a great deal of maturity is necessary to deal with and hold on to power and wealth without going crazy. And such maturity is acquired gradually through a certain crucial process." In effect, Masters is stating that these self-destructive stars haven't got their act together, while traders and investors with a long history of success do. Whereas the stars obtain their wealth very quickly with relatively little effort, market wizards earn theirs through hard work over a longer time. Market operators often go broke or are on the verge of giving up before they become established. They pay their dues by learning from their mistakes, while the stars succeed only in temporarily covering up their problems. Under the surface, these problems then intensify in a potentially destructive manner.
The Attributes of Great Traders and Investors
Being a market wizard involves no real secret. The rules and explanations are set out in this book. If you study the operations and methodology of any of the successful names, either historical or current, the same old characteristics come to the fore. We will examine a few case studies later, but first here are a few thoughts on attributes that are common to them all. In a sense, I am repeating some of the principles outlined earlier in this chapter, but they are so important that they deserve highlighting to reinforce the message.
First, every successful market operator is interested in the markets and how they work, not because they promise instant or even distant wealth but because of the fascinating inner workings and the challenges they offer. To quote a Wall Street journal article by commodities specialist Stanley Angrist: "[Successful traders] share a surprisingly large number of attitudes in regards to why they do it. For example, almost all claim that they do not trade for the money, but view the market as a difficult game that is changing constantly. They are by now rich and diversified enough to afford this attitude."
In a published interview with Jesse Livermore, Richard Wyckoff points out that the eminent investor operated in a fashion similar to that of a merchant who, "accurately foreseeing the future demand for certain goods, purchases his line and patiently awaits the time when he may realize a profit." He quotes Livermore: "There is no magic about success. No man can succeed unless he acquires a fundamental knowledge of economics and conditions of every sort."
To us mere mortals, this highlights the point that if we trade purely for the monetary gain, we are placing low odds on our potential for success. In effect, anyone who puts undue emphasis on making money is likely to be consumed by that desire. This strong emotion will override any attempt at maintaining objectivity. It is better in such circumstances to try to overcom
e this natural desire and trade or invest in smaller positions where the money stakes are less. Only when we have begun to appreciate the market as a challenge in its own right will we be in a position to take a more aggressive stance.
A second characteristic is that almost all successful traders and investors are loners. They more or less have to be, because they are constantly called on to take positions opposite to those held by the majority or by the consensus view of the market. To buy low and sell high, they must be able to go against the crowd. Being a loner, of course, is not enough. They also need to be creative and imaginative independent thinkers. There is no point in bucking the crowd just for the sake of being contrary. The investor also needs to rationalize why the crowd might be wrong and what the alternative outcomes are likely to be. These money masters therefore have the ability or the knack to justify their contrariness. This then gives them the confidence to hold on to the position and swim upstream against the current of popular opinion.
Third, all great investors and traders utilize a philosophy or methodology. It was once said that all roads lead to Rome but that none of them start at the same place. When we examine the different trading and investment approaches followed by the money masters, we find that their goals-to accumulate wealthare identical but their paths to that destination are vastly different. It does not matter which approach an investor takes as long as it works and the individual practitioner feels at home with it. Because he is comfortable with his methodology, he is able to work at it and refine it to its highest degree of efficiency. In effect, he has to be utterly dedicated to his chosen craft, for only then can he truly excel.
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