Immelt Vs. Welch

http://www.investors.com/NewsAndAnalysis/Article/581295/201108121608/A-Tale-Of-Two-Chiefs-GEs-Immelt-Vs-Welch.htm

By GARY M. STERN, FOR INVESTOR'S BUSINESS DAILY
Posted 08/12/2011 04:08 PM ET

Winning was everything to Jack Welch. The CEO of General Electric (GE) from 1981 to 2001 described his main mission in his best-selling "Winning" as making GE "the most competitive enterprise in the world by being No. 1 and 2 in every market." Businesses that weren't No. 1 or 2 were fixed, sold or discarded.

Being the dominant business in many markets boosted GE's financial performance. Under Welch, GE's revenue rose from $26.8 billion in 1981 to $130 billion in 2001. Its market cap skyrocketed from $12 billion to $280 billion. Welch was a winner.

Under successor Jeffrey Immelt, GE's faced tougher times, slashing its dividend and seeing its share price falter. How does Immelt's management style differ from Welch's? And is GE ripe to regain its mojo?

Immelt, Welch's successor since 2001, has faced a tougher road boosting GE's revenue and share price. When Immelt assumed the mantle, GE's stock sold for $40 a share. But earlier this year, its stock hovered under $20, about half of what it was under Welch.

Immelt's modified some of Welch's precepts about making every business a leader, says Daniel Holland, an equities analyst at Morningstar in Chicago, who covers GE. Immelt has strengthened its business in energy, health care and aerospace markets but avoided selling off many less-than-stellar businesses.

Different Managing Styles

Holland describes Immelt's management style as "more collaborative" than Welch's. GE's senior managers describe Immelt as "more approachable at working out issues and getting everyone involved" to find solutions, Holland says. Welch solved problems by obtaining data and making executive decisions.

Welch created a Darwinian culture where the strong thrived and the weakest performers fell by the wayside. He urged managers to separate employees into the top 20, middle 70 and bottom 10, identify and cultivate staff who had the skills to become leaders, and ax the bottom 10%.

But GE paid a price for slashing the bottom rung of performers. When GE cut 10% of its senior execs, many "valuable assets were walking out the door," Holland said. Immelt has been more tolerant, giving senior execs time to develop, halting the talent drain.

One reason GE stock nose-dived under Immelt was its lofty valuation of 60 times earnings couldn't be sustained. Since most industrial conglomerates are valued at 15 to 20 times earnings, GE returned to earth by 2011, trading until the recent market tumult at about 15 times earnings.

Under Welch, GE Capital was a money dynamo, generating about 40% of revenue. By overly relying on GE Capital, it "began to look more like a financial than an industrial firm," Holland said. Moreover, its commercial real-estate portfolio plunged during the financial crisis.

Immelt's New Recipe

Immelt developed a more balanced approach. In 2010 GE's profit depended on five major businesses: GE Technology Infrastructure, providing 39% of profit; GE Energy Infrastructure 35%; NBC Universal 12%; GE Capital 12%; and GE Consumer & Industrial 2%. Immelt sold off GE Plastics to Saudi Basic Industries for $11.6 billion in 2007. He also sold the troubled subprime mortgage business in 2007, cutting GE's losses.

GE's portfolio of diversified businesses should sustain steady profits and be less susceptible to downturns. Holland said, "Energy infrastructure forms the backbone of the firm's growth." That strategy should produce continued profits as the U.S. downplays reliance on coal and turns to natural gas, wind turbines and solar. Energy products take advantage of GE's strengths: global scale, service and highly engineered products.

Ill-Timed Coronation

Immelt was jinxed from the minute he was named to replace Welch on Sept. 7, 2001. Four days later, 9/11 happened, the stock market dipped and GE's insurance business lost $600 million in a day, notes David Magee, author of "Jeff Immelt and the New GE Way." Immelt has endured 9/11, a deep recession and still managed to turn around GE's business mix.

Change and evolution are the cornerstones of Immelt's management style. Immelt's most strategic decision at GE was "remaking the business," Magee said. Immelt inherited businesses like appliances and plastics, which were fading, and GE Capital, which was on the downswing.

Immelt invested heavily in R&D, acquired a wind business from Enron for a minimal amount, which turned into a multibillion-dollar business, and began to transform GE.

Magee faults Immelt for not saying five years ago that GE wasn't going to rebound quickly and needed a major overhaul. Nonetheless, Magee gives Immelt credit for redirecting "mature businesses that were worn out and changing GE into a 21st century company."

GE is showing signs of bouncing back. Until this month's stock market tumble, GE's share price had spiked 26% over the last year vs. a 23% rise in the Dow Jones industrial average. To keep the momentum going, Immelt must show "increased revenue and organic growth," Magee said.

Holland expects GE to produce "single-digit revenue growth over the next four years in GE's industrial business and improved results in health care, transportation and GE Capital." If those businesses prosper, Immelt could take a page out of Welch's playbook and start a new winning streak for GE.

Philip Carret, A Pioneer Of Fund Gains

By JAMES DETAR, INVESTOR'S BUSINESS DAILY
Posted 02:01 PM ET
http://www.investors.com/NewsAndAnalysis/Article/580997/201108101401/Philip-Carret-A-Pioneer-Of-Fund-Gains.aspx

It's probably not easy to impress the megawealthy Warren Buffett.

Philip Carret was an exception.

Buffett looked to Carret as a role model, comparing his fellow investor and longtime friend to one of baseball's all-time greats.

He called him "the Lou Gehrig of investing" and said Carret had the "best long-term investment record of anyone I know."

Carret created the Pioneer Fund, one of the first stock mutual funds, in 1928 with $25,000 from friends and family. Today the global firm, called Pioneer Investments, manages a number of funds that total $250 billion in assets.

The Pioneer Fund, itself with $6 billion in assets, recently reached a rich milestone. It's had a cumulative return of 1,000,000% from its founding through Dec. 31. A dollar invested in 1928 would be worth more than $1 million today.

Carret (1896-1998) was born in Lynn, Mass., and was the only child of a lawyer father and social-worker mother. Although his Harvard-trained dad had a good income, Carret recalled his parents weren't very adept at managing money.

In "A Money Mind at 90"— a book he wrote at 90 years old — he said when he was 16 he saw that "If I were ever to gain wealth, it would have to be by my own efforts."

Head Game

Carret believed that a person could learn to manage money well while developing a "money mind."

Although his parents didn't seem to possess much of this quality, he saw it in his grandfather Joseph, who Carret jokingly said found his fortune in "the thriving little metropolis of New York City."

Twenty years after Joseph began working, he had put aside enough capital to buy a sugar plantation in Cuba. He spent the rest of his life there. In good years, Carret wrote, the plantation yielded $25,000, "a princely sum at the time."

Carret thought science might be his path to wealth. So, he took the entrance exam to Harvard, was admitted at 16 and earned a bachelor's degree in chemistry.

An avid reader, he excelled at Harvard. He was socially shy, but he made some good friends while there. As for social clubs, he turned one down when it asked him to do something he found anathema — "that I ditch my Jewish roommate. To reach a decision took no time at all. Until we graduated, David and I roomed together in harmony and friendship."

After college he joined the Army Signal Corps — a forerunner to the Air Force — and learned to fly a Sopwith Camel.

With World War I raging in Europe, the Army sent him to France; the war ended in 1918 before he saw combat.

Leaving the service, he got a job as a reporter for Barron's weekly business newspaper. And in 1924 he began investing money for family and friends who saw that he had a knack for finding winning stocks.

He learned how to pick and hold stocks by reading about and studying the market, says Pioneer Fund manager John Carey, who took the reins from Carret 25 years ago.

"Phil read a great deal. He read history and political works and economic works. He kept up with the news," Carey told IBD. "If you went to his office, you would see piles of reading material."

One thing Carret learned early in his reading was how to advance by doing the straightforward.

"He read a book called 'Obvious Adams,' about an advertising agent who made his living advertising the obvious," said Carey. "For example, the agent was hired by a brown sugar company to promote its product. He went to stores and found brown sugar didn't come in a brown box. He told the company to switch to brown boxes, and their sales doubled in a year and then tripled the next year."

Bliss

Carret wrote that a cornerstone of his success was his lifelong partnership with his wife, Betty: "In the most important aspect of my life — marriage and family — I was exceptionally fortunate. Almost from the day I met Betty — in November 1920 — until the day of her death 65 years later, we enjoyed a supremely happy relationship."

He also drew strength from his friendship with the Rev. Norman Vincent Peale, author of "The Power of Positive Thinking."

That best-seller "encapsulates Phil Carret's approach to investing," Carey said. "He was always open and looking for opportunity.

"Phil once said, 'There's never been a great fortune built in the U.S. by a bet on catastrophe.' He was thinking about Thomas Edison and J.D. Rockefeller and people who built enterprises and employed people, making goods that were useful to people."

Carret himself inspired many other people. Among them was Jack Kenney, former CEO of Western Reserve Life Assurance, now part of Aegon.

Kenney worked alongside Carret in the 1960s and '70s. They paired stock funds and insurance policies to create hybrid investments.

"He had what I would call the greatest integrity of any person I've met," Kenney said. "He inspired me. I started my own mutual fund in '85 and tried to emulate the way he managed money."

Carret's investing strategy involved buying high-quality, underpriced stocks and holding them for the long term.

Carret's love of learning helped him acquire a deep understanding of markets, said Kenney: "He was an amazing individual. Often we at Western Life would look at a stock and we didn't think much of it, but he did. In most cases it turned out to be a winner."

In 1963, Carret sold Pioneer and founded Carret & Co. (now Brean Murray, Carret & Co.), an investment portfolio manager. In 1988, he sold his stake in Carret & Co., but continued to work there three days a week without salary. He also remained on Pioneer's board until his 100th birthday in 1996. In the preface to "Money Mind" he said, "If I've contributed even an infinitesimal bit to the welfare of society, my life has not been in vain."

Carret began celebrating his 100th birthday when he was 90. By the time he reached the century mark, he'd had several birthday parties to mark the occasion.

For his 100th, he appeared on TV's "Today" show.

According to Kenney, Carret told the show's host: "I attribute my longevity to three things. No. 1, I eat my meat very rare. Two, I drink my bourbon very strong. Three, if I get the urge to exercise, I lie down."

Carret died two years later, soon before his 102nd birthday.

Thriving Long Term in the Stock Market

http://community.marketsmith.com/telligent/b/blogs/archive/2011/08/04/7371.aspx

Much of the recent commentary from experienced Wall Street professionals more or less promotes buying into stock market dips as the right investing approach for handling the current market. My problem with this approach is that, by definition, an investor is buying into a downtrend. Any purchase larger than a small add to a solidly profitable, existing position carries with it high risk. Best case, the investor buying on a dip will make a few extra percentage points on those stocks that snap back. But sometimes stocks don’t bounce back right away—or at all. Sometimes, a dip becomes a drop. And where a drop ultimately ends up is anyone’s guess.

The real issue is: what level of risk are investors taking by buying into a downtrend? Unfortunately, the allure of buying their favorite stock cheaper makes many investors gloss over risk assessment. The stock market is inherently a risky venture. We are risking capital to make money. That very fact should keep risk assessment front and center, but strangely enough when the market is at its riskiest, few assess their true risk.

There are countless rationalizations for downplaying risk. But this one should cut through them all. No one, including the investment legends of the last century, can consistently call market bottoms and tops. Nor can they consistently predict at which point a stock will stop going down. In the 1998-1999 stock market, analysts were continually upgrading their price targets on stocks and recommending investors buy them on the dips. We all know the bubble’s outcome. The old adage “try to catch a falling knife” comes to mind: Nortel Networks topped at 86 in July 2000, a year later it was around $8.00 per share; it went bankrupt in 2009. Nokia topped at 62.50 in June 2000, a year later it was hovering in the mid 20s and is currently around $5 per share. These were both great companies that had outstanding fundamentals. An interesting but little-known fact: When a great, winning stock finally tops, the number of stockholders typically increases as it drops all the way back down.

Yes, this market will eventually go back into an uptrend, next week, next month, or next year. Who knows? But ask yourself: what is my risk-reward ratio in buying and owning stocks right now—so late in the cycle, not to mention all the volatility—versus owning stocks in a clear uptrend?

There are correct times to enter a position and many more incorrect times to enter one. This is why investors should consult a stock chart before making an investment decision. A chart is factual and removes all outside chatter. It also gives investors context and a perspective from which to better gauge the risk of entry at that particular time. We want to buy right, not cheap. We also want to sell right. Charts help investors do both, more consistently.

But you’re still thinking, “I don’t want to miss the upturn, so I’ll hold my best stocks now and endure the pain.” This was the prevailing thought among most investors in 2000-2002 and in the first part of 2008. I don’t think this correction, should it continue, will be nearly as devastating as those two downtrends, but we are in a downtrend now. And no one is smart enough to know how long it will last or how low the market will go. What we do know by consulting stock charts of the major indexes is that the market is not acting right. And fighting a downtrend can be costly.

As of this writing, I am watching the dozen best, strongest leaders resist this downtrend. They all have phenomenal earnings and sales. Their stories are compelling. However, when the tide is dropping all boats sink. Even that beautiful yacht for sale that everyone wants to own.

In a topping process, the very best stocks do hold up to the last. Unfortunately, that shred of hope—coupled with the market’s cunning ability to appear just good enough to invest in—keeps us interested and owning stocks. Many investors get so focused on the profit side they forget that defense always comes first when dealing with a market that, in the end, always tops all stocks.

As in life, patience (with a good dose of perspective) helps keep difficult situations from turning into despairing ones. Right now, patience is an investor’s best friend.

Watch the Thing Itself

[The following is from p.1-2 of The Successful Investor - What 80 Million People Need to Know to Invest Profitably and Avoid Big Losses by William O'Neil (2004)]

What did the brokers, strategists, and economists do wrong? They relied purely on their own opinions of what the market would do. They also relied too much on their interpretation of the dozens of business and economic indicators they favor.

This approach rarely if ever works because the economy does not lead the market, the market leads the economy. That why wiser souls years ago included the S&P 500 index, a proxy for the general market, as one of the "leading" economic indicators released by the government each month and not a "coincidental" or "lagging" indicator. In short, the experts on Wall Street, by using the economy as a predictor of the stock market'rather than vice versa, had it all backward.

Another group of experts, called market technicians, follows 50 to 100 technical indicators such as advance-decline lines, sentiment gauges, and overbought-oversold measures. But in 45 years, I can't recall a technician picking both a market top and the eventual market bottom. At best, they're usually right one time and wrong the next. The reason is that the vast array of technical indicators they follow are secondary and far less accurate than the general market averages.

There's an important lesson here. To be highly accurate in any pursuit, you must carefully observe and analyze the object itself. If you want to know about tigers, watch tigers--not the weather, not the vegetation, not the other animals on the mountain.

Years ago, when Lou Brock set his mind to breaking baseball stolen base record, he had all the big-league pitchers photographed with high-speed film from the seats behind first base. Then he studied the film to learn what part of each pitcher's body moved first when he threw to first base. The pitcher was the object Brock was trying to beat, so it was the pitchers themselves he studied in great detail.

In the 2003 Super Bowl, the Tampa Bay Buccaneers were able to intercept five Oakland Raider passes by first studying and then concentrating on the eye movements and body language of Oakland's quarterback. They "read" where he was going to throw.

Christopher Columbus didn't accept the conventional wisdom about the earth being flat because he himself had observed ships at sea disappearing over the horizon in a way that told him otherwise. The government uses wiretaps, spy planes, unmanned drones, and satellite photos to observe and analyze the objects that could threaten our security. That's how we discovered Soviet missiles in Cuba.

It's the same with the stock market. To know which way it's going, you must observe and analyze the major general market indexes daily. Don't ever, ever ask anyone: 'What do you think the market's going to do?" Learn to accurately read what the market is actually doing daily as it is doing it.

The Big Stock Principle

[The following is from page 80 of Trade Like and O'Neil Disciple by Gil Morales and Chris Kacher.]

My experience with Lumisys served as the genesis for what eventually became my Big Stock Principle, a basic underlying principle of O’Neil methodologies that slowly dawned on me over the next couple of years. The essence of the Big Stock Principle is that in any economic and market cycle certain companies appear on the scene that represent the leading edge of what is happening in the economy with respect to the new industries, new economic developments, and other themes that serve as essential drivers for the economy at any given point in time. In turn, because of their status as key companies representing the niches of growth, whether broad or narrow, in any given economic cycle, institutions have no choice but to own these stocks, and once they do they tend to be a staple of institutional portfolios through many market cycles, even when they aren’t bona fide leaders. In the 1970s these were stocks like Pic N Save and Tandy Corp., in the 1980s they were stocks like Intel Corp. (INTC) and Microsoft (MSFT), in the 1990s America Online (AOL) and Cisco Systems (CSCO), in the 2000s names like Amazon.com (AMZN), Apple, Inc. (AAPL), Google, Inc. (GOOG), Baidu.com (BIDU), and Research in Motion (RIMM), to name just a few from each cycle out of many, many more. These are the stocks to own in any bull market cycle as they represent the areas to which institutional research will direct money flows, and in the process create huge upside price moves. As well, because of the broad, committed institutional sponsorship in these stocks you have a sort of insurance policy when these stocks sell off since there are usually logical pullback areas where institutions will naturally come in to support their positions.

One of the key characteristics of “big stocks” is that they don’t trade 120,000 shares a day on average, they trade several million. Unless there is a cartel of grandmothers out there who instead of buying two shares each of Microsoft and AT&T are buying large blocks of leading stocks, it is institutional money that drives the market, and it is in this river of money flow where you want to set yourself right into the middle. And the only way you can do that is by striving to own the “big stocks” in any market cycle. My horrendous experience in Lumisys ledme on the path to discovering for myself this “big stock” principle as I realized thinly-traded stocks cannot possibly be big stocks. [...]

I also found that the Big Stock Principle is also at work in short-selling, since the best short-sale targets in a bear market are precisely those stocks that were the big leaders in the immediately preceding bull market phase. Institutions that have loaded up on big leaders will in turn create a wave of selling that continues to wash over the stock in a sustained downtrend during a bear market, and we will have more to say about short-selling when we get to Chapter 8.

Style over Stocks

[The following is from p.164-167 of The Guru Investors by John Reese and Jack M Forehand.]

As we noted earlier, Fisher’s investing approach has evolved in many ways since the original publication of Super Stocks. In the 1990s, for example, he began to focus more and more on the importance of investment style. Investors, he said, need to focus on style and to rotate their investment holdings to match the popular style of the time.

One interesting example of what Fisher meant by “style” involves his study of stock returns between January 1976 and June 1995. In this study, he broke stocks down into six styles: big-cap value, midcap value, small-cap value, big-cap growth, midcap growth, and small-cap growth. What he found was that these styles went in and out of favor periodically. From January 1976 to September 1978, for example, small cap value was the leading style, producing an annualized return of 42.69 percent. This beat the loser, big growth, by 37.84 percent. The spread of the best four styles over the worst two was big — 23.25 percent — and the four best styles outperformed the S & P 500 by 23.41 percent.

The bottom line for the entire period studied (January 1976 to June 1995) was:

The annualized return for the best four styles at a given time 17.79%

Annualized market return (Wilshire 5000) 14.64%

Premium of best four styles over the market 3.15%

For Fisher, this was evidence that style selection was a crucial part of achieving excess returns in the market. If you could figure out when certain styles were going to be in favor, you could pick from a wide swath of stocks in that style and do well. To decide which style to pick, he would use certain economic indicators, such as the yield curve (which measures the relationship between shorter- and longer-term interest rates) and how the U.S. gross domestic product (GDP) compared to overseas GDP. Back then, he advocated focusing on what he believed the best four styles at a given time were, and avoiding the worst two. Focusing your investments only on what you believe is the best style at a given time could net you even better returns, but you risked losing a bunch if you picked the wrong style.

As Fisher focused more and more on style, he scrapped the PSR strategy he had detailed in Super Stocks. The reason? He believed that once the masses learned about it, the ratio had become priced into the market. Essentially, more people were focusing on low-PSR stocks, driving their prices higher and limiting the gains you could get from buying them. (We’ll address this and its impact on our model in a bit.)

Today, Fisher remains focused very much on style, so much so that he says only about 10 percent of his strategy involves actual stock selection. He writes in “The Only Three Questions That Count” that about 70 percent of it involves assessing various economic, political, and sentiment drivers to determine asset allocation — that is, how to divvy up investment dollars among stocks, bonds, and cash. Another 20 percent is “sub-asset allocation,” which involves deciding which countries, which sectors, which types of market capitalizations, and which styles (value or growth) to invest in. Only after he’s determined how much of his portfolio to put in stocks and which categories of stocks he’s interested in does he start looking at individual stocks. From there, he says, he goes category by category (one category might be “U.S. small-cap value industrials”, for example), and picks a few stocks from each.

How does he pick those stocks? Part of it is fundamentals (in one example he mentions in “Three Questions,” he even notes that a stock he liked was selling at a low price for its revenues — essentially meaning its PSR was low). But a big part of it is non-quantitative, as is the way he decides his asset allocation and sub-asset allocation. One of the key points in “Three Questions” is that, according to Fisher, “You can’t make market bets and win long term unless you know something others don’t.” It’s the same concept behind his reason for ditching his low - PSR approach: Once the masses are aware of an investment 166 the growth legends strategy, it gets priced into the market. That’s why one of the three questions the book’s title refers to is “What Can You Fathom That Others Find Unfathomable?”

One example Fisher gives of something he can fathom but most investors can’t is the “presidential term cycle.” Part of this phenomenon is that, historically, stock returns are much better in the third and fourth year of a president’s term than they are in the first two years. Fisher surmises that investors are more hesitant in the first part of the term because that’s when big changes can occur as the president begins to put his or her agenda into action. In particular, one thing that can occur is the redistribution of wealth through tax and other legislative changes, something that makes Wall Street very cautious. By the third and fourth years, however, the president has settled in and controversial legislation is unlikely because he or she is trying to get reelected or is simply tired and hanging on as their term winds down. Investors have more of an idea what they can expect, so they’re more likely to be bullish, the theory goes.

Fisher is also a big proponent of looking at global economic indicators — not just those that reflect conditions in the United States. He uses the global yield curve (the spread between shorter - and longer - term interest rates) as a way to discern whether to focus on growth or value stocks, for example. “Simply put, the global yield curve tells you when to switch from value to growth and back,” he writes. “After it has gone completely flat, you head into a period of growth stock dominance. After it gets very steep, you switch into value stock dominance. After it flattens, it’s time to tilt to growth again.” Fisher focuses on the global yield curve rather than the U.S. yield curve because, “If one country’s yield curve inverts while the global yield curve remains positive, there are still opportunities for businesses, institutions, private clients, and so on to continue doing business globally.”

Fisher also considers factors such as the global gross domestic product and global inflation. This global focus, particularly the global yield curve information, is another example of how Fisher takes advantage of knowing something that most other investors don’t know. (Be aware that Fisher doesn’t base his approach on just one thing that he can fathom but others can’t — “Never assume you have found the one silver bullet,” he writes.)

The presidential cycle, global yield curve, and other atypical factors Fisher uses today to guide his investment approach are quite interesting, but, to Fisher, they’ re not carved in stone. “The advantages I showed you will all fade away one day” as they become known and priced into the market, he writes. That’s why it’s critical, he says, to continue to try to fathom what other find unfathomable. “Winning at investing requires constant innovation and constant testing,” he says. Put another way, you have to be willing to go against the Wall Street grain to win in the stock market. That same rebelliousness that led Fisher to focus on the PSR years ago is still there; it’s just in a different form today — and it could be in a different form tomorrow, next month, or next year, depending on what happens in the investing world.

Not to Convince, But to be Convinced

http://www.marketoracle.co.uk/Article26819.html
By Victor Chan Wai-To

The most valuable mantra in investing goes by: “Not to convince, but to be convinced.” A good investor does not take unnecessary chances and then convince himself that everything would be alright. Rather, he would wait until the right opportunity comes by and convinces him that it is the choice to make. In other words, a winning investor always abides in stillness until a high-probability signal dawns on him.

Let the Winner Proves Itself

For example, a momentum investor refrains from buying a fundamentally sound stock until its price has broken out to a new high. The reason is that, whenever the price reaches the higher end of the range, short-term investors would anxiously sell for a quick profit, while the long-term investors would begin accumulating those shares just being sold. The price would finally succeed in breaking into a new high when there are no more sellers to push the price back down, i.e. all stocks are transferred from bears to bulls, which means that there is no more resistance against the price to go up, and this is the safest time when you can put your capital at risk.

If you buy a stock long before the breakout occurs, chances are it may remain going sideways or even plunge down later, because your analysis of the stock may not be correct after all, and you forgo better opportunities by sticking your capital with a loser. It is against human nature to give up a bargain, but it would be risky to buy under an unconfirmed situation. This is especially true if the current market is in a correction mode, which gives us more reason to wait for a properly formed breakout. This is why instead of trying to predict the future, we patiently allow the stock to prove itself, and buy at the proper time as indicated by a change in price and volume.

ASSUME = ASS U and ME

Therefore, instead of assuming what will happen, you should simply wait for the market to confirm what you are assuming. One of my favorite jokes on the English language is that, “The word ‘ASSUME’ spells ‘ASS U and ME.’” Most financial analysts make the mistake of assuming that they know a lot about the market, and make predictions that are wrong for 50% of the time. It is ego play instead of investing, and unfortunately the smarter the individual is, the more prone he is to fall into this trap. This explains why so many bright people, including those really knowledgeable professionals like Julian Robertson and Victor Niederhoffer, were blown up in the financial market simply by not admitting they were wrong when the market told them the truth.

A great investor does not assume that he can always be right in the market, and instead he knows the only one who is always right is the market itself. As legendary stock operator Jesse Livermore pointed out that the aim of the game is not about being right, but about how much you can make when you are right. Therefore the difference between the stock “expert” and the true winner lies in that, while the “expert” always has to appear confident, pour out myriad of theories of fundamental analysis and make calls on the market, the profitable investor, on the other hand, believes that he could never be smarter than the market, and let only the market, instead of anyone else, to tell him whether he is right or wrong.

The Lure of Omniscience

As Sherlock Holmes said, “It is a capital mistake to theorize before one has data. Insensibly one begins to twist facts to suit theories, instead of theories to suit facts.” All these troubles begin with the human urge to demonstrate omniscience by predicting events before they occur. It is almost like you would need to have an IQ of 200, the knowledge of a PhD, and some enormous insider information to make you successful in the market. As a result, you can see a lot of amateur investors spending a lot of money on expensive seminars to learn some obviously pointless methods like astrology, simply because it is too alluring to know how to predict the future. They do not realize that investing success is as simple as patience and humbleness.

The 80/20 Rule in Investing

To cure this, one must understand that the 80/20 rule applies in investing that, for most of the time, you simply do nothing. As Livermore warned, “No man can always have adequate reasons for buying and selling.” In other words, there are times when the correct trade is sitting in cash. Many otherwise profitable investors give back profits by overtrading, and they would surely benefit from the discipline of momentum investing by only buying on strength as proven by a breakout.

Livermore believed that timing was everything to a speculator, so that it is never about if a stock is going to move, but when. Although it seems quite obvious, many investors simply do not bother, as they would buy the stocks they want anyway, and wait for the move to play out, and hope that everything would be alright. The market may eventually move in the desired direction, but it may also not. It is simply not sensible to be exposed in the market before a confirmation, just to hope that it would turn out fine.

Summary

A good investor does not buy a stock and convinces himself it is correct. Rather, he waits for an opportunity to prove itself to him. The reason is that the market has its own cycles of profitable and barren periods, and the former is way less often than the latter. By not imposing one’s own logic and ego onto the market, he will be able to see the market as it is, and hence keeping the powder dry until the best opportunity presents itself. Unfortunately, conquering one’s own ego is the most difficult task in the world, especially for those who consider themselves more knowledgeable than average. Still, it is only after an investor has acquired this habit to “be convinced but not to convince”, he is able to make money.

The Truth of the Funds

[From: Richard L. Peterson (2007). Inside the Investor's Brain: The Power of Mind Over Money (p.77-78). Hoboken: John Wiley & Sons Inc.]

Sometimes at social events, if I mention my occupation as "investment psychology," people are curious. Often, their questions are market related ("Where do you see the market in 12 months?"), and sometimes they are personal ("Why is my spouse so hopeless with a budget?").

In early 2006, when Jodie heard my profession at a dinner, she asked me defensively, "Did someone send you to talk to me?"

"Uh, no," I answered.

"Are you sure?" She said, eyeing me sideways.

"Er, yeah." I was perplexed.

"Come over here. I need to talk to you." She motioned me to a quiet corner of the room.

"Um, okay," I said.

After some pleasant conversation, Jodie opened up. She told me that she'd been having nightmares about poor old people living under bridges. In many dreams she herself was destitute. When she saw commercials on TV about happy older couples in retirement, tears would come to her eyes. This had been happening for about a year, and she didn't really understand it, but she thought she might have a clue.

"What clue is that?" I asked.

"Well, I used to work at a major investment bank as a broker in the late 1990s. We were responsible for getting retirees to buy recommended investments in their private accounts. When I started in mid-1998, everyone wanted to buy Internet stocks. We'd call clients, offer a few shares in an IPO [initial public offering,] and recommend some other stocks as well. They'd usually follow our advice without questioning, and they'd be better off for it. In late 1999, we started offering these Internet mutual funds, and we would charge two points on the buy, in addition to our regular commissions."

"Wow, that's huge," I muttered.

"Yeah, my boss told us that we'd be fired if we couldn't sell the fund to 80 percent of our client accounts. It was my job to persuade dozens of mostly older retirees to buy shares in the Internet fund. Some of them wanted to put all their money in it, and I let them."

"What happened?"

"I left in early 2001, when clients were calling me wondering why their accounts were shrinking. I told them to hold on, that things would recover..." She paused. "I feel so rotten now. People really trusted me." Jodie took a sip of her drink and her eyes inspected the faces in the room, as if looking for someone else to talk to.

It didn't seem like a fitting end for her story. "Then what?" I persisted.

"I got my real estate license, and now I'm a real estate agent."

"No, I mean what happened with the clients and the funds?"

"I don't know, I imagine the department was shut down. I think some of the clients told me that he was going to have to postpone retirement 10 years based on what I'd sold him." She studied her shoes.

And now for the bad news

[This article was published here: http://kn.theiet.org/magazine/issues/0901/bad-news-0901.cfm. You will be amazed how great was the insight of the author.]

At the First European Futurists Conference in Lucerne two years ago, John Casti shocked delegates by predicting a major global recession in 2008. Here he explains why the prevailing mood means the worst is yet to come for engineering and technology.

This year should see the completion of the world’s new tallest building, Burj Dubai in the United Arab Emirates. Societies often feel compelled to show how good they feel about the future by erecting the world’s tallest building. Construction begins on these behemoths as the social mood starts accelerating upward.

But skyscrapers don’t appear overnight, and by the time construction is actually completed several years later, the positive mood has given way to a deeply pessimistic one. The troubles of property developers in Dubai are not at all surprising, at least to those who understand this ‘skyscraper curse’. Bad things tend to happen in countries when they start trying to express their confidence by erecting the world’s tallest buildings.

This curse leads one to wonder about the future of Saudi Arabia, which in late 2008 announced its intention to outdo Dubai by building a skyscraper in Jeddah vastly taller than Burj Dubai. And this is not to mention the fortunes of that darling of evangelists of globalisation everywhere, India, where an architect in Delhi announced plans to build the world’s tallest building, making the statement: “It is about status. It is about glorification. It is high time that people started realising that we too are a great nation.”

Breakthrough barometer

From 1966 through late 1968, as public sentiment skyrocketed with the increasing stock market, technological wonder ran rampant. Futurists with visions of colonies on the Moon, the sea floor and Mars were routinely quoted in the business press. Public fascination with such forecasts was reflected by famed futurist Herman Kahn in his book ‘The Year 2000’, which anticipated the conversion of sea water to drinking water and the use of artificial moons.

One project that caught the imagination of reporters was Probe, a think tank of 27 top scientists established by TRW Inc. The team used existing technologies to forecast more than 335 wonders. Not a single one came true. And six years later, the Dow was down 45 per cent with many of the most popular technology companies having gone bankrupt.

A similar story can be told about the Internet boom in the late 1990s. My belief is that we will see the same pattern unfold from the mini-boom of 2003-2007: Euphoria denied!

To test this hypothesis, have a look at Fig 1 (page 36) showing major technological developments over the period 1920-2001 plotted against the Dow-Jones Industrial Average in that same period. Do you notice anything unusual about this chart?

What’s interesting are the three periods marked in red. During these periods, very few “breakthrough” technologies were introduced compared with the rest of the chart. And what are these times of low technological breakthrough? Exactly when the financial markets are either in freefall, like the late 1920s early 1930s, or going sideways with bursts of decline, as in the early 1970s mid-1980s.

Given what we see in the world today and can reasonably project to the world of the next decade, it’s not too difficult to make the call that life-changing technologies are going to be thin on the ground during this period.

Patent problems

It doesn’t take an undiscovered genius to know that advances in technology go hand-in-hand with innovation. Without new products, or at least new ideas for how to use existing technology, we’d still be riding on horses and communicating by smoke signals.

While it’s difficult to measure ‘innovation’ directly, a good surrogate is simply to look at how many patents are granted, since patents necessarily involve something new and different. To get a feel for the way social mood impacts innovation, consider the diagram showing patents versus the Dow Jones Industrial Average (DJIA) for the 20th century (Fig 2).

We put this figure together bearing in mind that the social mood is always a leading indicator of social events and implying that we must shift the blue curve to the left by a few years to properly compare the two processes. You will therefore have little trouble forecasting the future of innovation. You will also notice that these stories of skyscrapers, technology and patents have all been set against movements in financial market indexes. Here’s why.

Mood swings

On March 19, 2003 US forces rained “shock and awe” down upon the hapless residents of Baghdad, thereby initiating the Iraq War. While there is and will be much to say about this affair, it is enough here to note only that it illustrates perfectly the role played by the “mood” of a population in creating a social climate, a kind of Zeitgeist, within which actions, behaviours and events of all types unfold. And the nature and texture of those events are dramatically impacted by whether that mood is optimistic or pessimistic.
The concept of the mood of a population as setting the tone for collective social events of all types, ranging from tastes in popular culture to shifts in political ideologies to the rise and fall of civilisations, is the root cause of my pessimism about what we are likely to see in the coming years and decades. Put simply, the social mood represents how the population feels about the future – on all timescales.

And, as with the Iraq War, the potential represented by the population’s sense of the future, its mood, is realised in vastly different types of events, depending on whether the mood is waxing positive or waning negative on the timescale appropriate for the type of event in question. But to make the notion of the mood of a population useful for either explanation or prediction, we need an effective way to measure it.

Sociometers

Some years back, financial analyst Robert Prechter coined the term ‘socionomics’ for the way the social mood leads to social actions. He then proposed using the financial market averages as a way of measuring the mood. He called this measure a ‘sociometer’, as it serves much the same purpose for measuring social mood that a thermometer for measuring the overall motion of a collection of molecules.

The underlying argument is that a market average like the DJIA reflects bets that people make about the future on all timescales from seconds to decades. The financial markets collect all these bets and process them into a single number: a change of price. That price change then serves as a very effective measure of how people feel about the future. If they are positive, they tend to buy and prices increase; if they’re pessimistic, the tendency is to sell and prices go down. And the stronger the collective sentiment, the larger the bets.

But just as a thermometer doesn’t measure what every single molecule is doing, the financial market averages do not represent the feelings of every single person in a population either. However, experience shows that an index like the DJIA serves as a much better characterisation of the social mood than other types of measures of mood, such as opinion surveys, annual births, and the like. Moreover, accurate financial data is easy to find in every daily newspaper, and is available over quite long periods of time.

To illustrate this idea, consider the years 1930-2000. These seven decades divide into two completely different periods on a decade-to-decade basis: a 20-year span of negative global social mood from 1930-1950, followed by 50 years of increasingly positive mood that ended in early 2000.
During the pessimistic period, we saw events like the rise of dictatorships in Nazi Germany and the Soviet Union, the Holocaust, and the Great Depression, while in the post-war period the Berlin Wall came crashing down, apartheid ended in South Africa, and the European Union was formed. Note the qualitative difference in character between these events. Entirely different types of events tended to occur during the period of negative social mood than those taking place when the world, in general, was more optimistic about the future.

This difference is the crux of our argument for a rather more pessimistic view of what to expect over the coming decades. The global social mood started rolling over from positive to negative in about the year 2000.

My contention is that it will accelerate in the downward direction for at least a decade or more before we hit the bottom. As a result, the types of events we can expect will be of a decidedly different nature than what has been the case over the last 50 years. The examples of skyscrapers and patents illustrate the overall situation we face today. Here is yet one more to hammer home the point.

The decline of globalisation

Unlike skyscrapers, which are an inherently local phenomenon, physically confined to a particular geographical space, the once trendy idea of globalisation – the view of the world as of one gigantic marketplace perfectly structured to solve the ills of humankind, unfettered by the inconveniences of restrictions on the flow of capital, labour, materials or ideas – is another collective social phenomenon that is in the process of coming undone.

Since the driving forces behind globalisation are, to a substantial degree, American corporations, we look at the DJIA from 1970 as an indicator of the overall worldwide mood, since the New York Stock Exchange is still about the closest thing we have to a global financial market.

Every single milestone in the path to globalisation – from the launching of the basic idea at Davos in 1975 to the formation of the World Trade Organization in 1996 to China’s joining of the WTO in 2000 – took place at a peak in social mood.

Since 1975, the global social mood has been rosy. In such times, the types of events we expect to see are ones that can be labeled ‘unifying’, ‘joining’, and ‘expanding’. Sadly, the picture shows that this global mood is rolling to begin a decades-long decline that is likely to lead to just the opposite types of social events.

Globalisation will be replaced by localisation, unification will be replaced by fragmentation, and openness to strangers will be replaced by xenophobic behaviours. Distant early-warning signals of these types of behaviours are apparent in the pages of your favourite newspaper or on the Internet.

The juggernaut of history

When I recently presented this rather downbeat vision at an international symposium on ‘the future’, a member of the audience accused me of drafting a ‘doomsday’ scenario. It is far from any kind of doomsday, as it’s easy to imagine futures vastly worse than this.

Humanity survived the 1930s and it will survive the 2030s. The situation is desperate but not serious. And part of minimising the pain of an unpleasant future is being prepared for it.

So whether you’re managing a family, a company, or a country, if you don’t plan for the future you’ll be squashed by it. A rerun of the 1930s may not be the future you want. But the juggernaut of history doesn’t care.

And how is the flow rolling for innovation and technology? The outlook for the next several years is for a period of polishing existing apples to a brighter shine, not one for the introduction of major, life-changing technologies like practical fusion power.

John Casti is a research scholar at the International Institute for Applied Systems Analysis in Laxenburg, Austria, and co-founder of The Kenos Circle, a Vienna-based society for the exploration of the future

The Red Dress Story

Investing in the stock market is really no different from running your own business. Investing is a business and should be operated as such.

Assume you own a small store selling women’s clothing. You've bought and stocked women’s dresses in three colors: yellow, green and red. The red dresses are quickly sell out, half of the green ones sell, and the yellow ones have not sold at all. What do you do about it?

Do you go to your buyer and say, “The red dresses are all sold out. The yellow ones don’t seem to have any demand, but I still think they’re good. Besides, yellow is my favorite color, so let’s buy some more of them anyway,”? Certainly not!

The clever merchandiser who survives in the retail business eyes this predicament objectively and says, “We sure made a mistake. We’d better eliminate the yellow dresses. Mark them down 10%. Let's have a sale. If they don’t sell at that price, mark them down 20%. Get our money out of those ‘old dogs’ no one wants, and put it in more of the hot-moving red dresses that are in demand.” This is common sense in a retail business. Do you do this with your investments? Why not?

Everyone makes buying errors. The buyers for department stores are pros, but even they make mistakes. If you do slip up, recognize it, sell, and go on to the next thing. You don’t have to be correct on all your investment decisions to make a good net profit.

Now you know the real secret to reducing your risk ans selecting the best stocks: Stop counting your turkeys and get rid of your yellow dresses!

--- William O'Neil (2002). How to Make Money in Stocks (3rd Edition, p.96).

The Most Important Rule for Buying and Selling

http://www.selfgrowth.com/articles/the-most-important-rule-for-buying-and-selling
By Victor Chan Wai-To

What is the most important trick for buying and selling stocks? If you can only learn one, then let it be this: only buy a stock when the evidence of strength presents itself, and sell only upon the symptoms of weakness, and in other times, just stay quiet.

The Wheat Campaign

The following story of Jesse Livermore, one of the greatest traders ever, illustrates the point. One day, when Livermore was having lunch with his friends, one of them asked Livermore about a recent trade he made in the wheat market, so Livermore entertained them with his story and said:

“I just felt the demand for wheat in America was underestimated and the price was going to rise. I waited for what I call my pivotal point and stepped in and bought five million bushels of wheat, about seven million dollars worth.

“I watched the market closely after the purchase. It lagged. It was a dull market, but it never declined below where I bought it. Then one morning the market started upward, and after a few days the rise consolidated, forming another of my pivotal points. It lay around in there for a little while, and then one day it popped out on the upside with heavy volume.”

Livermore took it as a good signal and put in an order for another five million bushels. The price kept getting higher and higher and Livermore was very happy, because it was evident that the market was very bullish at that time. The trend roared strong and the price rose steadily for several months in Livermore’s favor. He finally booked a profit of $2,500,000 when the price was 25 cents above his average.

It looked like that it was a successful trade, but instead Livermore commented on his decision, “This was a bad mistake.” His friends were puzzled.

“How the hell could it be a bad mistake to make a profit of two and a half million dollars?” asked one of his friends.

Livermore explained that his mistake was that the wheat futures market had shown no signs of weakness when he sold it. “Simple. Why was I afraid of losing the track’s money? When I sold, I was simply acting out of fear. I was in too big a hurry to convert a paper profit into a cash profit. I had no other reason for selling out that wheat, except that I was afraid to lose the profit I had made,” said Livermore, who realized he had made a great mistake of not having the courage to play the deal out to the end until he got a real definitive sell signal.

“So?”

“I reentered the market and went back at an average price 25 cents higher than where I had sold out my original position. It rose another 30 cents, and then it gave a danger signal, a real strong danger signal. I sold out near the high of $2.06 a bushel. About a week later, it sold at $1.77 a bushel.”

Livermore finished the story with the conclusion that the reason he sold the first time was simply a lack of courage, whereas the second time was different. “The next time I sold the wheat it was different; I could see definite symptoms of weakness. It gave the clues, the hints, the telltale signs of topping out. The tape always gives plenty of warning time for the savvy speculator to heed,” said Livermore.

Think Right and Sit Tight

You must have to courage to play along until the signs of weakness appear. This is the most important lesson that a trader can learn which, many years later, was emphasized by the great trader again in his biography with this famous quote:

“After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight! It is no trick at all to be right on the market. You always find lots of early bulls in bull markets and early bears in bear markets. I’ve known many men who were right at exactly the right time, and began buying and selling stocks when prices were at the very level which should show the greatest profit. And their experience invariably matched mine – that is, they made no real money out of it. Men who can both be right and sit tight are uncommon. I found it one of the hardest things to learn. But it is only after a stock operator has firmly grasped this that he can make big money. It is literally true that millions come easier to a trader after he knows how to trade than hundreds did in the days of his ignorance.”

It is a very important piece of the puzzle, but even seemingly easy at first glance, anyone who has ever tried to put it into practice would find it extremely difficult. Just as the first time Livermore sold in the above story, the discipline of a trader is usually overtaken by his fear of losing when his trade is in profit. It demonstrates a strange human behavior that a trader is very impatient with a profitable trade but almost always falls in love with a losing trade. As a result, a trader usually just loses control, acts on his impulsive feeling and forgets this important rule altogether.

Stick to Your Method

How can a trader tackle this problem? Former US trading champion and market analyst Robert Prechter believed that the only solution is to have the discipline to stick to your method. “To win the game, make sure that you understand why you’re in it. The big moves in markets only come once or twice a year. Those are the ones which will pay you for all the work, fear, sweat and aggravation of the previous eleven months or even eleven years. Don’t miss them for reasons other than those required by your objectively defined method,” he said.

In all, develop your own method for recognizing strengths and weaknesses in a market, and acquire the discipline to stick to the marvelous rule of buying only on strengths and selling only on weaknesses, or else just sit tight and do nothing. If you are able to do this, you will not be very far away from the promised land of speculative wealth.

Trading Wisdom of William Eckhardt

http://www.kirkreport.info/2008/02/trading-wisdom.html

n reading "Profit from The Winner's Curse" by Teresa Lo, she cites an interview with legendary trader William Eckhardt. I remember reading the interview many years ago, but I enjoyed reading through them again. His perspectives about trading are unique and offer wisdom that you won’t find anywhere else.

Here are just a few quotes that I think you’ll enjoy:

• "If a betting game among a certain number of participants is played long enough, eventually one player will have all the money. If there is any skill involved, it will accelerate the process of concentrating all the stakes in a few hands. Something like this happens in the market. There is a persistent overall tendency for equity to flow from the many to the few. In the long run, the majority loses. The implication for the trader is that to win you have to act like the minority. If you bring normal human habits and tendencies to trading, you'll gravitate toward the majority and inevitably lose." - William Eckhardt

• "It's much easier to learn what you should do in trading than to do it. Good systems tend to violate normal human tendencies." - William Eckhardt

• "One common adage on this subject that is completely wrongheaded is: you can't go broke taking profits. That's precisely how many traders do go broke. While amateurs go broke by taking large losses, professionals go broke by taking small profits. The problem in a nutshell is that human nature does not operate to maximize gain but rather to maximize the chance of gain. The desire to maximize the number of winning trades (or minimize the number of losing trades) works against the trader. The success rate of trades is the least important performance statistic and may even be inversely related to performance." - William Eckhardt

• "The people who survive avoid snowball scenarios in which bad trades cause them to become emotionally destabilized and make more bad trades. They are also able to feel the pain of losing. If you don't feel the pain of a loss, then you're in the same position as those unfortunate people who have no pain sensors. If they leave their hand on a hot stove, it will burn off. There is no way to survive in the world without pain. Similarly, in the markets, if the losses don't hurt, your financial survival is tenuous." - William Eckhardt

• "I know of a few multimillionaires who started trading with inherited wealth. In each case, they lost it all because they didn't feel the pain when they were losing. In those formative first few years of trading, they felt they could afford to lose. You're much better off going into the market on a shoestring, feeling that you can't afford to lose. I'd rather bet on somebody starting out with a few thousand dollars than on somebody who came in with millions." - William Eckhardt

• "In many ways, large profits are even more insidious than large losses in terms of emotional destabilization. I think it's important not to be emotionally attached to large profits. I've certainly made some of my worst trades after long periods of winning. When you're on a big winning streak, there's a temptation to think that you're doing something special, which will allow you to continue to propel yourself upward. You start to think that you can afford to make shoddy decisions. You can imagine what happens next. As a general rule, losses make you strong and profits make you weak." - William Eckhardt

• "If you're playing for emotional satisfaction, you're bound to lose, because what feels good is often the wrong thing to do. Richard Dennis used to say, somewhat facetiously, "If it feels good, don't do it." In fact, one rule we taught the Turtles was: When all the criteria are in balance, do the thing you least want to do. You have to decide early on whether you're playing for the fun or for the success. Whether you measure it in money or in some other way, to win at trading you have to be playing for the success." - William Eckhardt

• "Trading is also highly addictive. When behavioral psychologists have compared the relative addictiveness of various reinforcement schedules, they found that intermittent reinforcement - positive and negative dispensed randomly (for example, the rat doesn't know whether it will get pleasure or pain when it hits the bar) - is the most addictive alternative of all, more addictive than positive reinforcement only. Intermittent reinforcement describes the experience of the compulsive gambler as well as the future trader. The difference is that, just perhaps, the trader can make money." However, as with most affective aspects of trading, its addictiveness constantly threatens ruin. Addictiveness is the reason why so many players who make fortunes leave the game broke." - William Eckhardt

• "Don't think about what the market's going to do; you have absolutely no control over that. Think about what you're going to do if it gets there. In particular, you should spend no time at all thinking about those rosy scenarios in which the market goes your way, since in those situations, there's nothing more for you to do. Focus instead on those things you want least to happen and on what your response will be." - William Eckhardt

If you don't think these principles are true, you haven't been trading very long. Print these out and refer to them often.

Lao Zi on Water

(Based on the translations by Tormod Kinnes)

Chapter 8

The highest good is like that of water.

The goodness of water is that it benefits the ten thousand creatures; yet itself hardly ever scrambles –

It seems quite content with the places that all men disdain.
It is this that can make water so near to some Tao.

And if men think the ground the best place for building a house on,
If among thoughts they value those that are profound,
If in friendship they value gentleness;
In words, truth and sincere faithfulness,
In government, order;
In deeds: competence, ability, effectiveness;
In actions: timeliness and being properly timed –

In each case it is because they prefer things that hardly lead to strife, and therefore hardly go much astray or amiss.

Chapter 66

How did the great rivers and seas become the kings of the ravines? By being experts at keeping low.

Therefore to be above the people you have to speak as though you are lower than the people in some ways.

So to be ahead of the people, you have to follow them in your own person. To be foremost or guide well, walk behind.

The wise man keeps himself on top, and the people hardly feels his weight or get crushed by it in time. He guides in this way, and the people do not harm him the least.

He can even walk in front, and people do not wish him harm.

In this dynamic way everything under heaven will be glad to be pushed by him and will not find his guidance irksome. Then the people of the world are glad, the world rejoices and praises him without getting tired of it, in order to uphold him forever.

He accomplishes his aims by overt non-striving. Because he does not compete in the open, no one can compete well with him.

Chapter 78

There is hardly anything more yielding than water, but almost none is better in attacking the resistant and hard,

There are few substitutes for it.

Thus the yielding may conquer the resistant and the soft the hard. This was utilised by none I knew.

Wise sayings,

“Only he who has accepted the dirt of a country can be lord of its soil-shrines: can become heaven-accepted there. Who bears evils of the country can become a king. Who takes into himself the calumny of the world serves to preserve the state.”

Straight words seem crooked.

Reflexivity And Trend Following

http://www.marketoracle.co.uk/Article25941.html
http://www.selfgrowth.com/articles/reflexivity-and-trend-following
By Victor Chan Wai-To

George Soros is unarguably the greatest fund manager ever lived who, upon the request to disclose his secret, attributed his success to a market behavior theory he developed himself, which is now famously known as the theory of reflexivity. The basic assumptions of the theory as well as its implications to the formulation of a successful trading strategy will be discussed in this article.

Reflexivity vs. Traditional Theory.

While market participants are assumed to be rational observers in traditional economics, Soros proposed that participants are irrational, and they interact with the market in a way that firstly, on a cognitive level, the participants study the news and form a bias of the future (e.g. the stock will go up), and then, on a participation level, they collectively act according their bias (i.e. buying the stock) and change the market reality (i.e. the stock price jumped), which in turn provides new facts to reinforce the bias (i.e. the stock will go even higher) until the reinforcement fades or an opposite bias is formed.

The theory of reflexivity is applicable more than just in the stock market. One historical example was the US dollar under President Carter and President Reagan, which, in the former case with Carter, depreciated and sparked inflation under a weak-dollar policy, and when the inflation encouraged the dollar to be shorted, the dollar dropped further and raised inflation in a vicious cycle, in steep contrast to the latter case with Reagan who adopted a strong dollar, hammered the inflation, and created a benign cycle for the dollar.

The Three “U’s” of the Market.

Three characteristics of the market could be concluded from the theory of reflexivity, which can be summarized as 3 “U’s”. The first “U” is “Unstable”. Traditional economics assumes that any change in price would be corrected towards an equilibrium, e.g. when the price increases, investors would sell it back to a lower level, but this is not usually true in a bull market in which instead, as suggested by the theory of reflexivity, a rise in stock price increases the bullishness of the investors, and in return their bullishness increases the stock price, so that the price has a tendency to move away from the supposed equilibrium and produces a trend.

The second “U” is “Unfathomable”. This is not to say fundamental analysis to be completely useless, but according to Soros, it has two shortcomings. Firstly, information is imperfect and very often the most important information, without which any decision is bound to be inaccurate, is already digested in the price before it becomes apparent; and secondly, fundamental analysis ignored the interaction between price and fundamentals, e.g. an increase in credit rating of a company may increase the stock price, but an increase in the stock price may also indirectly improve the credit rating, and the latter part of the interaction is usually ignored in traditional fundamental analysis.

The final “U” is “Uncertain”. You can never predict what’s next in the market. Soros once had a habit of rationalizing his decisions to his son, and later his son infamously criticized him, “My father will sit down and give you theories to explain why he does this or that. But I remember seeing it as a kid and thinking Jesus Christ, at least half of this is bullshit. I mean, you know the reason he changes his position on the market or whatever is because his back starts killing him. It has nothing to do with reason. He literally goes into a spasm, and it’s this early warning sign.” Soros was correct to feel uncomfortable about his mistakes in the market, but rationalizing it to someone else would only make it a joke itself.

The Four Principles of Trading.

With the three characteristics of the market elaborated above, we arrive at the following principles of trading:

1. The price has the final say. You may have an opinion on the market, but it is dangerous to marry it to your positions, as famous trader Richard Dennis explained, “You don't get any profits from fundamental analysis; you get profit from buying and selling. So why stick with the appearance when you can go right to the reality of price and analyze it better?”

2. Follow instead of forecast. Legendary trader Paul Tudor Jones once declared that he would never hire fundamental traders who frequently tried to outwit the market and got burned, because by the time the fundamentals become clear, the trend is over. You can never know if the next trade wins or not, so simply follow your rules and see.

3. Preserve your capital. Since the market is impossible to forecast, all great traders agree that you must limit your losses before it gets out of hand, since they have seen a lot of intelligent traders got bruised in a market crash simply because they held on to the losers or even averaged down on the way as the price became “fundamentally” attractive.

4. Let your winners ride. The other side of the coin is not to cut the profit too soon before it can grow large. Jesse Livermore explained, “I've known many men who… began buying or selling stocks when prices were at the very level which should show the greatest profit. And … they made no real money out of it.” Why? They sold too soon.
   

On Trend Following.

One of the best strategies which work according to these principles, and are tested to be profitable empirically, is trend following, which in fact is an important element of the trading strategy of Soros. According to trader Stig Ostgaard, there are three elements in a trend following strategy, which are, firstly, to enter positions based on the perceived trend; secondly, to hold positions going in favor of the trend; and finally, to exit positions going against that trend. A possible fourth element is to perform the above with systematic rules backed up with computer analysis, but this is not absolutely required, since it is certainly possible to follow a trend without computers, for otherwise how was it possible for “ancient” traders like Jesse Livermore to make a killing?

As a matter of fact, it is exactly those traders before the digital age who serve as a proof of the simplicity of trend following. As a famous example, Nicolas Darvas was a professional dancer in the mid 50s who made $2,000,000 in stocks within the short 1957-58 bull market, despite of the handicap that he was on a world ballroom dancing tour and always received his subscription of the Barron’s one week late in an age without the internet or any electronic trading platform! His secret was so uncomplicated that his approach was actually nothing more than a simple breakout system applied in a number of stocks recommended by the Barron’s, with which he exited the losers upon the trigger of a stop, and held on to the winners until the opposite breakout occurred. If he could do it, so can you.

Conclusion.

The methodology of developing of a trading system is beyond the scope of this article, but by now it should be clear to you that you do not have to be very smart or knowledgeble to beat the market, you simply have to be humble and follow the mass. Trend following is one of the easiest ways to take advantage of the unstable behavior of the market because it simply requires you to follow the market instead of making complicated predictions. Surely it is not the only way to skin the cat, but it is a very good way.

Trend following and fundamentals

From: http://www.michaelcovel.com/2009/04/25/david-merkel-defending-a-wrong-view-to-the-bitter-end/#comment-4377

Fundamental investing presupposes that one knows more than the market, that essentially the market for that security is somehow wrong. It is the quintessential ego play, as one is therefore smarter than the market. This incidentally explains why so many “good investors” were blown up by the market: they take positions, the market moves against them, they buy more, their ego will not allow the possibility that they are wrong. This is why the market killed longs like Bill Miller and hedgies like Amaranth or Niederhoffer.

Trend following presupposes that one can never know more than the market, that the market, despite its apparent randomness, is always right. The real irony in trend following is that it is based on fundamental investing at the margin. Securities are priced at the margin by intense supply and demand of that specific security. BUT, it is the sum total of the supply and demand which moves the market, and as information is discovered by more and more investors, a trend is formed.

Therefore the dispute between the fundamentalists and the trend followers lies in the differential between what one believes he knows. The fundamentalists believes that he is smart enough to outthink the market, to somehow know more than the myriad of inputs into the complex system, and to then translate that into an investing decision. The trend follower believes that he could never be smarter than the sum total of “smart investors” pricing the security at the margin… as well as the continual marginal information being priced into the security during the day.

Guys like Merkel are just examples of egos who cannot accept that a concept like trend following can work, as it doesnt take minds like soros or robertson to make money. It is almost like they believe you need to be some avant thinker to make money in the markets. They need to justify their education, their backgrounds etc, in order to satisfy some justifiable performance equation in their mind. They cannot stand the fact that something as seemingly simple as trend following could better their fundamentally-based results. What they continue to misunderstand, and the key to the entire trend following method, is that trend following not only checks its ego at the door, it USES fundamental investing in tota, as its foundation. THAT, i think, is the great and unseen irony in trend following.

A theory of salesmanship

I came from the trading and sales side, where I had made it a point of keeping myself scrupulously insulated from my work. I had had some experience as a salesman before entering the securities business. After finishing college in England I joined as management trainee a firm making handbags, custom jewelry, and fancy goods, and I ended up as a salesman. I developed a theory of salesmanship based on the principle that one must not on any account identify oneself with the merchandise one is selling. Selling is a game where you score when you make a sale. If you allow your ego to be involved, the customer can brush you off and you lose; but if you do not identify yourself with your work you will be able to redouble your efforts when you are rejected, and if you make a sale you come out the winner.

--- George Soros (2003), The Alchemy of Finance, p.41