A critical distinction of all great investing books is that every time you re-read them, you find insights that you somehow missed the previous times. Recently I had the opportunity to re-read some of the chapters in Hedge Fund Market Wizards. The section about equity traders is my favorite one, so I delved into it again. In this post, I am featuring some interesting observations from Jack Schwager’s conversation with Joe Vidich:

1. Position sizing is a great way to manage risk

The larger the position, the greater the danger that trading decisions will be driven by fear rather than by judgment and experience.

If you are diversified enough, then no single trade is particularly painful. The critical risk controls are being diversified and cutting your exposure when you don’t understand what the markets are doing and why you are wrong.

It is really important to manage your emotional attachment to losses and gains. You want to limit your size in any position so that fear does not become the prevailing instinct guiding your judgment. Everyone will have a different level. It also depends on what kind of stock it is. A 10 percent position might be perfectly okay for a large-cap stock, while a 3 percent position in a highflying mid-cap stock, which has frequent 30 percent swings, might be far too risky.

2. Charts are extremely important.

One of the best patterns is when a stock goes sideways for a long time in a narrow range and then has a sudden, sharp up move on large volume. That type of price action is a wake-up call that something is probably going on, and you need to look at it. Also, sometimes whatever is going on with that stock will also have implications for other stocks in the same sector. It can be an important clue.

3. Being flexible is a must.

To be successful in the markets, you have to be willing to change your opinion. Most people are not willing to change their opinion. You have to be humble about your ideas.

4. There are two types of sentiment.

There is the popular sentiment, as it might be expressed in the media, and then there is the sentiment that is expressed by the market. When Joe talks about sentiment, he is referring to how the market responds to external events. What is the news? What is the price action? That is what generates his view of the markets. A stock being down after a good earnings report would be an example of negative sentiment. That is how Joe thinks about sentiment.

If everyone is bearish because that’s what CNBC says, that is public sentiment, but if the stock gaps higher after a conference call, that’s the market sentiment. What matters is the market sentiment, not public sentiment. I try to drown out public sentiment, except if public sentiment is so heavily one-sided

5. Vidich doesn’t believe in using hard stops. He prefers to scale out and scale in positions.

I scale out, and I also scale in. The idea is don’t try to be 100 percent right.

That way you will never be completely wrong, and you can reassess the situation if the market goes lower. It is all about keeping the portfolio from weighing you down.

6. Don’t try to short strength in story stocks.

As an equity trader, I learned the short-selling lessons relatively early. There is no high for a concept stock. It is always better to be long before they have already moved a lot than to try to figure out where to go short.

7. The difference between bull and bear markets.

Do you know what happens in a bull market? Prices open up lower and then go up for the rest of the day. In a bear market, they open up higher and go down for the rest of the day. When you get to the end of a bull market, prices start opening up higher. Prices behave that way because in the first half hour it is only the fools that are trading [pause] or people who are very smart.

8. Vidich has a top-down approach to the market.

Vidich combines longer-term investments with short-term trading that provides supplemental returns.

Even though long-term investment themes and position trades are core to Vidich’s investment approach, he is an extremely active trader. The turnover for the fund is approximately 20X.

9. At the heart of his market approach is the deeply ingrained belief that reaction to news is more important than the news itself.

Vidich’s timing in entering and exiting these positions is heavily influenced by what he calls his assessment of sentiment—price action relative to events. Vidich or his analysts listen to about 300 conference calls every quarter. The market action following these conference calls can provide Vidich with important clues. For example, if a company reports generally bullish news in its conference call, and the next day the market is up, but the stock is down, Vidich would view this price action as a bearish indicator.

On the question: “Now that you have switched from net long to net short, what would get you long again?”, Vidich says:

Buying. If all of a sudden stocks stopped going down on bad news that would be a positive sign.