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Posted 11/10/2003
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Learn from your mistakes -- without going broke
Mr. Market doesnt give scholarships. Making mistakes in investing is how you learn. The trick is learning to limit the costs of your mistakes.
By Bill Fleckenstein
In the investing business, it's very easy to misjudge things and then find yourself in a situation where something you expected to happen didn't happen or happened in a way different from what you expected. That is, you were wrong.
Being wrong in this business comes with the territory. The real trick in the investment business is making sure that your mistakes don't kill you.
Unfortunately, my experience has been that the way you learn is by making mistakes. It's the tuition you pay to Mr. Market, if you will. I have made every mistake imaginable, some more than once. But thanks to having done so, I make fewer of them now than I used to.
Readers of my daily Market Rap column know that I stand behind my motto: "Often wrong, never in doubt." I have a lot of conviction, but I make plenty of mistakes. So, when you factor what I think into what you think, you should factor in the possibility that I might be wrong, and then consider how you will deal with that.
Finding the way to control the risks
I often am asked how I decide whether to be short a stock or own puts, or how I pick a stock to short in the first place. Often, I make my decision based on how best to control my risk. I rarely ever short a stock unless I think I have a specific catalyst that would drive the share price lower. Then, if I can find an inexpensive way to use put options, I do. Usually I can't, and I short the stock. If I am going into an earnings announcement or something like that, I find it much safer to own puts rather than to short the stock, but that is often not possible. To repeat, the idea is to find ways of controlling your risk so that, if youre wrong, you don't get killed. Your winners tend to take care of themselves.
Walking a fine line on whether to sell
Let's take a second to talk about winners. One mistake that Ive made in the past is, I get long a stock, and it turns out to be a big winner. At some point in the cycle of rising, it goes up faster than I anticipate or can understand. So, I sell it or begin selling too aggressively, and the next thing I know, Ive been left behind.
I think some people are going to do that with gold stocks. Theyll say that gold stocks have gone up too fast or theyre overvalued, or whatever. You might do that successfully once or twice, but it's very easy to wind up having lost your position. (Of course, there is a difference between a core position and a trading position that I use in something like gold.)
But some people might now find themselves with too big a position in the metals; in that case, selling some to spare yourself angst is a wise decision. In managing a portfolio, you face a constant battle of controlling your risk while not wanting to cut off your winners too soon -- and while battling your own emotional baggage.
Investing is a complicated subject even when done right. None of us has all the answers, and we all make mistakes.
Despite my being constructive last spring, the present surge in the market has been bigger and better than I imagined. But I really couldnt care less that the market is going up and I didn't catch it. The risk/reward has been all wrong, in my opinion (even though it has worked).
Its as if youve been playing poker and continually drawn to an inside straight. Odds say you lose, but if you do it and win, youll have made money even if the risk/reward was poor. And thats been the story with the stock market.
Down the road, I'll have an opportunity to buy stocks at reasonable prices, and everyone else will, too. You shouldn't have a lot of angst if a stock or a market with poor risk/reward characteristics went up "without you."
I feel very strongly, as I have stated frequently, that this is a rally in a bear market and that the economic strength is transitory. Folks who want to be rational will find a juncture down the road to get long stocks, with a lot less risk.
Its OK to sit on cash
In the meantime, while it's no fun holding cash that pays scant interest, you should take some solace in that you've got pretty good company. As an Oct. 27 Barron's interview with Warren Buffett recounted, it's what one of the world's greatest investors is doing. Hes sitting on $24 billion. Cash is not trash. People work so hard to earn it. But once they have it in their portfolios, they act as if it's going to give them a communicable disease. Its not a disease to be gotten rid of as soon as possible. It does need to be cared for. I hope this little discussion of the fundamental and psychological variables inherent in the investment business is useful.
Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column on his Fleckensteincapital.com site. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of MSN Money.
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