While the questions I've been asked range from "What do you think of XYZ stock?" and "Where do you think the market is heading?" to "Do you need a wedding planner?" (that one was in response to my latest Cabot Wealth Advisory), one thing that I'm almost never asked about is ... what it takes to be a great investor.
Said another way, everyone is focused on today's stock, or tomorrow's headlines. I can literally count on one hand the number of calls or emails I've answered in nearly eight years that concern building a successful system that will generate above-average profits for years.
And the funny thing is, that system--while it involves many rules and tools for finding, buying and selling the best stocks at the right times-- eally begins with the individual. People are usually their own worst enemies when it comes to winning the investment battle.
All of this leads me to a recent Sunday afternoon when, unfortunately, I've had more time to kill on weekends now that the NFL season is over. (My fiancee says I'm like a big ol' dog, wandering around looking for things to do on Sunday for a few weeks after the season ends.) So, with the market still in a downtrend, I'm re-reading a couple of good investment books to reinforce moneymaking habits. I guess in that sense, these days are almost like the offseason for an investor, as now is the time to study up and re-establish positive traits.
Anyway, I stumbled upon "New Market Wizards," the second in a three-book series by Jack Schwager, in which he interviews numerous top traders and investors, looking for insights. (All are highly recommended, and each is available cheaply in paperback.) This book, originally published in the early 1990s, contained an interview with William Eckhardt, who was actually a mathematician. I'm not sure whether I ever read this interview before -- hearing some quant talk about a black-box system doesn't interest me -- but after reading it last weekend, I quickly got my idea for this week's Cabot Wealth Advisory. Simply put, it's the best investing interview I've ever read.
Personal Side of Investing Equation
In the interview, Mr. Eckhardt hit on many points that I want to summarize here. Sure, none of these ideas will tell you what stock to buy or sell this week, but the more they make you focus on the personal side of the investing equation, and the more you're in tune with your own tendencies, the more money you'll end up making.
Most of the following are interrelated with one another, but all are good to think about:
1. Too many people think about what the market is going to do. But the trick isn't forecasting what's going to happen; the trick is to think about many market possibilities ... and have a plan of action in case it does happen. Specifically, you should focus on a few unpleasant possibilities (the market falls out of bed, or your stock gets hit on earnings), and decide ahead of time what you're going to do.
2. Investing is tough psychologically because you must train yourself to think exactly opposite of how you normally think. For instance, when you have a profit in a stock, the idea of a big pullback isn't comforting ... but you must prepare yourself for that to happen. And when you're down on a stock, it makes you feel good to believe a rebound is coming -- but usually it's best to cut the loss and admit you're wrong.
3. As I wrote above, you shouldn't put too much emphasis on the present. The reason investors want to take profits yet avoid cutting losses is because doing so makes them feel smart today; cashing in a winner obviously makes you feel good, and refusing to cut a loss means you still have hope that position will turn into a winner. But that tactic is the exact opposite of what successful growth-stock investors do.
4. The best investors usually go into the market with lots of fear -- each loss hurts, so they do what they can to avoid them. A reckless, aggressive, cocky investor may hit a few homeruns, but it's only a matter of time before he gets on a losing streak and craps out. Said another way, the investors who prosper don't let a bad trade lead to another bad trade, which leads to another bad trade ... and so on.
5. Realize this: Good investing systems go against normal tendencies. Studies show that people will choose a sure gain, rather than an investment lottery that has a higher expected outcome. And they'll shun a sure-but-small loss for an even worse lottery, as they want a chance of coming out ahead. Again, in the market, you should be doing the exact opposite.
6. Human nature does not operate to maximize profit -- it pushes you to maximize the chance of having a profit (i.e., boosting your win rate). But, ironically, your win rate is not overly important; most great investors are successful on half of their trades or less. But the size of their winners dwarfs the size of their losers, which is how they make money.
7. In many ways, large profits are more dangerous to your future trading than large losses. Most losing streaks get started after investors have booked a big profit or two ... leading them to lose their risk discipline and act more like gamblers than investors.
8. The market acts like an evil tutor that is trying to teach you to trade poorly. How? It spends most of its time in a trading range, which teaches you to buy weakness and sell strength. (Wrong.) Most small- and mid-sized profits tend to vanish, which teaches you to cash in your winners quickly. (Wrong.) It lulls you into looking for high success-rate techniques and systems, which, in the long run, are often failures or mediocre performers.
There were some other points, and other great interviews in the book. But it's good to spend a few minutes thinking about the above points during the current investing "offseason," reinforcing proper traits and realizing how easy it is to get pulled off track.
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Cabot Top Ten Report Record
With the help of fellow Cabot editor Paul Goodwin, I've been trying to put together some sort of track record for my Cabot Top Ten Report. Recently, some data has come together that has surprised even myself.
Here's a summary:
From the start of 2007 through Thanksgiving, Cabot Top Ten Report made more than 450 recommendations, and I'm glad to say that in the month after recommendation, the average stock advanced 3.4%. I know what you're thinking: What am I going to do with a 3.4% profit? But that's just over one month; compounded, earnings that return for twelve months a year would result in a 49% gain!
Over three months, the average recommendation gained 7.4%, resulting in a compounded annual gain of 33%. All this happened during a time when the S&P 500 and Nasdaq made zero progress.
Of course, nobody is going to buy all the Top Ten recommendations, nor should they -- the publication is a great source of new ideas, not a strict portfolio. However, this data does reinforce (there's that word again) my belief that I've stated many times: If you're fishing the pond of Top Ten stocks, there will be plenty of good catches.
I bring this up not to brag (OK ... maybe a little), but as a prelude to my stock idea this week. It's Cleveland-Cliffs (CLF), an iron ore producer that's benefiting from voracious demand from emerging markets. My OptiMo stock-screening system found the stock a few weeks back. Here's what I wrote about the stock in Cabot Top Ten Report last week, when I named it as my favorite of the week:
"With the developing world leading a global hunger for steel, Cleveland-Cliffs' six iron-ore mines in Michigan, Minnesota and Eastern Canada -- plus its controlling interest in an Australian iron ore mining company and a smaller one in Brazil -- just keep getting more valuable. The company supplies iron ore pellets to integrated mines in the U.S. and Australia. It also produces large amounts of the metallurgical coal that's used to make coke from its mines in West Virginia and Alabama. And finally, Cleveland-Cliffs has an agreement with a Japanese steel company to produce a new form of nearly pure iron nuggets from taconite that could really boost the bottom line. Tie this package together with a 0.6% dividend and a sprinkling of speculation that it's a takeover target, and Cleveland-Cliffs looks a little less like a stodgy commodity company."
I'm impressed with the stock's tremendous volume patterns - it broke out to new highs above 105 two weeks ago on huge volume, and has already topped 125. Too extended to buy? Probably. But there have been many big-volume buying days of late, and I'm guessing any retreat likely won't last too long. With the commodity boom in full force, I think CLF has a chance to be a good winner.
All the best,
Editors Note: Michael Cintolo is Cabot's Vice President of Investments, as well as editor of Cabot Top Ten Report. That publication, as mentioned above, has a great history of bringing subscribers the very strongest stocks in the market, stocks that are under strong accumulation by the biggest and best institutional investors in the marketplace. If you'd like to always know what's working in the market, you can sign up at a charter rate here.