There’s nothing like an unprecedented level of volatility to focus the attention of the investing public on the activities of traders. During calm times, most value investors are happy to make their long-term plans and deploy capital for lengthy periods of time, and are OK with waiting patiently for the market to recognize the intrinsic value of their underpriced investments. However, it is hard for even the most stoic value investor to sit still and buy stocks cheaply when prices are falling as fast as they have recently. Volatility may produce many bargains, but it is still a hard thing to stomach.
Traders, on the other hand, live for volatility. The more volatility there is in a market, the more short-term mispricings there are to be exploited. Value investors could arguably learn a lot from traders. Yes, the time frames involved are typically very different, but the core principles - finding mispriced securities, managing risk and controlling emotional responses - are common to both traders and value investors.
Jack Schwager’s excellent book, "Hedge Fund Market Wizards," explores some principles that successful traders can operate by. Here’s how I think they can be applied to value investing.
Wait for high-conviction trades
Many of the fund managers interviewed by Schwager listed this as a top priority. Boredom has been the death of many a trader (or investor). In fact, most people will do anything to escape boredom. I recently read about a psychological study in which participants were left in a waiting room with nothing to amuse them except a device that delivered an electric shock if a button was pressed. Here’s the kicker: left to themselves for just 15 minutes, more than half of the participants chose to shock themselves, rather than be left alone with their thoughts. They preferred pain to boredom.
This phenomenon may explain why so many investors throw money away on half-baked ideas they don’t really believe in. The thought of doing nothing is so unpalatable that they would rather do anything else. Successful investors are able to control this part of their psyche. Over the last several years, Warren Buffett (Trades, Portfolio) has amassed a $120 billion cash pile at his Berkshire Hathaway (BRK.A, BRK.B) precisely because he did not see a good enough opportunity to deploy it (although I would wager that he is now rubbing his hands together).
The road to success is paved with mistakes
It is often said that good investors need to be good students of history, and I certainly believe that. However, there really is no substitute to getting a solid beating by the markets. Most, if not all, successful investors went through periods of hardship, and all made their own share of mistakes. Buffett considers the acquisition of the original Berkshire Hathaway textile mill to be one of his greatest blunders.
There’s no shame in making a mistake once. The real shame is failing to learn from it, or worse, to be too proud to admit it. Many people are more concerned with looking infallible than making money. I would posit that these people will not make good investors. So make sure you reflect on your own textile mill acquisitions. Doing so will make you much better at this game.
Disclosure: The author owns no stocks mentioned.
Read more here:
- Bill Ackman Sees Opportunity in the Beaten-Down Hospitality Sector
- Howard Marks: How to Learn From History
- Jim Simons: Will Computers Kill Fundamental Investors?
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