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Was Benjamin Graham Skillful or Lucky?

  
  Education
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Last weekend’s Intelligent Investor column looked at the extreme difficulties of disentangling skill from luck when you are evaluating investment performance. It’s the topic of an excellent new book by Michael Mauboussin and a subject of endless fascination – and frustration – to investors.

We tend to think of the greatest investors – say, Peter Lynch, George Soros, John Templeton, Warren Buffett, Benjamin Graham – as being mostly or entirely skillful.

Graham, of course, was the founder of security analysis as a profession, Buffett’s professor and first boss, and the author of the classic book The Intelligent Investor. He is universally regarded as one of the best investors of the 20th century.

But Graham, who outperformed the stock market by an annual average of at least 2.5 percentage points for more than two decades, coyly admitted that much of his remarkable track record may have been due to luck.

In the Postscript chapter of The Intelligent Investor, Graham described “two partners” of an investment firm who put roughly 20% of the assets they managed into a single stock – a highly unusual departure for the conservative managers, who normally diversified widely and seldom invested more than 5% or so in any one holding. (more…)

3 Biases That Affect Your Trading

  
  Education
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1) Gambler’s fallacy bias

People tend to believe that after a string of losses, a win is going to come next. Take for example that you are playing a game of coin tossing with a capital of $1000. You lost 3 bets in a row on heads and cost you $100 each bet. What will you bet next and how much would you stake?

It is likely you will continue to bet on heads and with a higher stake, say $300. You do not ‘believe’ that it can be tails consistently. People fail to realize coin tossing is random and past results do not affect future outcomes.

Traders must treat each trade independently and not be affected by past results. It is important that your trading system tells you how much to stake your capital which is also known as position sizing, so that the risk-reward ratio will be optimal.

2) Limit profits and enlarge losses bias

People tend to limit their profits and give more room to losses. Nobody likes the feeling of losing. Most investors tend to hold on to losses and hope their investments will turn around soon, and they will be happy if their holdings break even. However, chances are that they will amount to greater losses. On the other hand, if they are winning, most investors tend to take profits early as they fear their profits will be wiped out soon. Thereafter, they regretted that they didn’t hold a little longer (sounds familiar?).

One of the most important principle in trading is contrary to what most investors do – Traders have to LIMIT LOSSES and let PROFITS RUN. Losses are part and parcel of trading and hence, it is crucial to protect the capital from depleting too much – live to fight another day is the mantra for all traders. Large profits are thus required to cover the small losses – so do not limit profit runs.

3) I am right bias

Humans are egoistic in nature and we want to prove that we are right. High accuracy is not important in trading but making more money when you are right is. Remember what George Soros said, “It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.”

Warren Buffetts Next Door

  
  Education
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The book The Warren Buffetts Next Door: The World’s Greatest Investors You’ve Never Heard Of and What You Can Learn From Them by Matthew Schifrin is an interesting compilation of true stories about ‘average Joes’ who have made huge amounts of money in the stock market. Some use technical analysis, some use fundamental analysis, and some use gut feelings.

This book gives hope to every investor and trader. Each chapter covers a different person, describing what their occupation is, how old they are, their investment strategy, what broker they use, and what their favorite web sites and chat rooms are. Also, their best and worst picks, along with the long term track record. My favorite one is the Stock Angler in Chapter 9. The guy has a full time job, trades during the hour or two before he leaves for work, and has been able to achieve a 33% average annualized return since January 2003.

Every trader that is profiled provides an example of on of their successful trades, and shows how the decision was made to make the trade. I really like the last chapter which lists all the major investment websites which he calls Investor Incubators. You should read The Warren Buffetts Next Door for proof that you don’t have to be Warren Buffett, George Soros, T. Boone Pickens, or Carl Icahn to be a successful stock trader.

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