Investing Lessons from the Gold Collapse

The other day legendary financial blogger and current Bloomberg View columnist, Barry Ritholtz, put together a great piece on the 40 percent collapse in gold prices called “10 reasons gold bugs lost their shirts.” What I love about the piece is not what he says specifically about gold, but some of the universal investing truths Barry extrapolates from bullions’ rise and fall.

Here are a few in particular that spoke to me.

Beware of the narrative: Story telling is a massive part of the human experience, but in investing, this can become a hindrance. Barry notes that storytelling plays a crucial role in the Wall Street sales process, but I would argue that all investors build their own narratives in their minds, subconsciously or not, and we become attached to these narratives—which as we learned from gold, can be spectacularly wrong.

As a blogger, I know this is something I must contend with as I often write about the markets I am looking to trade and I must be careful not to become too emotionally invested in the pieces I craft. For example, I wrote an extremely bearish note about gold the other week…and I have been wrong ever since I hit the publish button. Should gold keep rising, I will need to admit my narrative was incorrect and reconsider my bias that gold has at least one more down leg in the near term. It hurts to admit being wrong, but I’d rather be wrong than sacrifice my bankroll.

Gold does not have many industrial applications but it looks good as a toilet seat...

Gold does not have many industrial applications but it looks good as a toilet seat…

Ignore history at your peril: I’ve touched on this theme is the past during my discussion about “this time it’s different.” As gold bugs chose to ignore the fact that gold is just like any other commodity market in that it is not a “safe haven” but a highly leveraged, zero-sum game that trends both up and down.

Barry points out not just one or two, but nine gold run-ups and selloffs in the last century. It happens nearly once a decade.

Ignoring history, or in the gold bugs’ case, selective history that fits neatly into one’s narrative leads nowhere but to financial ruin.

Barry Ritholtz: 10 Reasons Gold Bugs Lost Their Shirts

Previously on Rip City Trader…

What My Serengeti Safari Taught Me About Risk Management

Links Special Edition: Top Trading Tips


What My Serengeti Safari Taught Me about Risk Management

Last week I had the opportunity to visit Serengeti National Park in Tanzania. It was a fantastic trip that yielded a bevy of animal sightings—lions, wildebeest, hippos, elephants and a cheetah hunting down a rabbit among many more. I will never forget this incredible experience, but unfortunately, the one memory that will probably stick the most is a dark one.

Minutes after arriving in the park we passed the first of two terrible game-drive accidents. Although the park is full of dangerous animals, regular car accidents make overland travel on the park’s treacherous roads a potentially more dangerous proposition than trekking across the landscape on foot.

A game drive gone wrong in Serengeti National Park

A game drive gone wrong in Serengeti National Park

Our guide informed us that, thankfully, no one died in the accident, but noticing the dried blood inside the vehicle did little to stop the chill from traveling up my spine. The turned-over SUV looked exactly like the one I was sitting in when I took the photo above.

Lucky for us, we had an experienced driver who has spent countless hours driving the dirt and gravel roads of the Serengeti year in and year out. We didn’t have any problems despite the intermittent showers that quickly turned roads to mud pits.

The common issue in most Serengeti car accidents is excess speed. Game drivers talk constantly on the radio and stop to chat with other drivers who pass by to get a read on where the action is, such as a lions eating a fresh kill down the road or a Leopard gorging on a gazelle in a nearby tree. These moments can be fleeting and drivers feel compelled to put the pedal to the middle to catch the action—and a fat tip.

It is human nature to put the thrill of short term excitement ahead of one’s long-term survival. Unfortunately, taking unnecessary risks on the plains of the Serengeti, or on a trade that makes you giddy with excitement, can lead to terrible consequences.

During the trip I spent my downtime reading the classic from Jack D. Schwager, Market Wizards: Interviews with Top Traders. The legends interviewed discussed their own unique trading styles and philosophies, but they all maintained one trait in common: strict risk management. Every single one has experienced the horror of risking too much on one trade and going nearly broke. Most believe traders should never risk more than one to five percent of total capital on any single trade idea. Personally, I prefer five percent, and can think of countless times where I felt tempted to increase that threshold only to save myself from a large drawdown by simply not acting on this impulse.

Next time you feel compelled to up the ante on a trade idea you just KNOW will work, take a step back. On the plains of Serengeti I would much rather drive safely to a fresh lion kill than risk it all for a quick glimpse. There are thousands of lions in the park and I’d rather finish the safari at the exit gate than in a nearby hospital.

My trading account was once on life support from excess risk and I’ll never let that happen again.

A visitor to our campsite

A visitor to our campsite

My Top 10 Favorite Quotes from Reminiscences of a Stock Operator

A fascinating aspect of trading is how history seems to repeat itself. Although globalization and technology have transformed traditional floor trading, the underlying emotions of fear and greed continue to drive price action. Trading remains largely a human endeavor and as long as humans run financial markets, booms, busts and panics will continue.

My favorite trading axiom is “This time it’s different.” It is often used during market bubbles by perma-bulls who let greed get ahead of rational thinking. There is even a whole book about it, describing how in specific markets through history people convinced themselves that the normal levels of valuation no longer applied. The U.S. housing bubble that popped in 2007-2008 is a perfect example. Those who said and believed housing prices “never go down” essentially thought the housing boom really was different. We all know how that turned out.

Markets, trading methodologies and products may change, but timeless investing advice does not. That’s why my favorite trading book remains Reminiscences of a Stock Operator by Edwin Lefevre with Jessie Livermore—it is chocked full of great advice for any investor. First appearing as a series of articles in the Sunday Evening Post during the 1920s, the book is largely a biographical account of Livermore’s professional life. He is remembered as one of the world’s greatest traders who won and lost tremendous fortunes before tragically taking his own life in 1940.

Although Jessie’s life ended too early, his words of wisdom live on for discovery. The book is filled with obscure references and colorful characters long forgotten by the general public, but the key themes of the text remain as relevant as ever. Therefore, I’ve pulled out my favorite quotes, below, though I highly recommend reading the entire text.

There is nothing new in Wall Street. There can’t be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again.

The desire for constant action irrespective of underlying conditions is responsible for many losses in Wall Street even among professionals.

I never lose my temper over the stock market. I never argue the tape. Getting sore at the market doesn’t get you anywhere.

They say you can never go poor taking profits. No, you don’t. But neither do you grow rich taking a four-point profit in a bull market. Where I should have made twenty thousand I made two thousand. That was what my conservatism did for me.

Remember that stocks are never too high for you to begin buying or too low to begin selling.

A man may see straight and clearly and yet become impatient or doubtful when the market takes its time about doing as he figured it must do. That is why so many men in Wall Street…nevertheless lose money. The market does not beat them. They beat themselves, because though they have brains they cannot sit tight.

After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It always was the sitting. Got that? My sitting tight!

Losing money is the least of my troubles. A loss never bothers me after I take it…But being wrong—not taking the loss—that is what does the damage to the pocketbook and to the soul.

Prices, like everything else, move along the line of least resistance. They will do whatever comes easiest.

The speculator’s chief enemies are always boring from within. It is inseparable from human nature to hope and to fear. In speculation when the market goes against you hope that every day will be the last day—and you lose more than you should had you not listened to hope—the same ally that is so potent a success-bringer to empire builders and pioneers, big and little. And when the market goes your way you become fearful that the next day will take away your profit, and you get out—too soon. Fear keeps you from making as much money as you ought to. The successful trader has to fight these two deep-seated instincts…Instead of hoping he must fear; instead of fearing he must hope.

What Traders Can Learn from the $3 Billion Snapchat Offer from Facebook

Let’s say you own a small company with about a dozen employees. You make absolutely no revenue and then one day Mark Zuckerberg walks through your door offering to buy you out for $3 billion, what do you do?

The obvious answer is you take the money. And yet…there are those who won’t. Call it hubris, call it greed, call it whatever…this is exactly what happened this week when the WSJ reported that Snapchat, which “specializes in ephemeral mobile messages,” rebuffed a purchase offer from Facebook that would have made the group incomprehensively wealthy.

I’m not going to pretend to know the conversations between Snapchat and Facebook, or riff on the motivations of the parties allegedly involved. I can only comment from personal experiences, and my trading experience tells me it is much better to take the meat of a major trend in the market then to try and pick market tops and bottoms. Thinking about today’s market hysteria around social networking platforms, we are in the midst of a great bull market for all things social. Facebook is taking care of business and Twitter’s IPO got off to a hot start last week.

Many luminaries in the technology-finance industrial complex completely agree with the power move from Snapchat CEO Evan Spiegel. Many cite the fact that Instagram, which sold last year for a mere $1 billion to Facebook, could now be worth $15 billion. WHAT A DISASTER!!! Please…

The situation is analogous to Mark Cuban’s billion-dollar deal with Yahoo! more than a decade ago. From Business Insider:

Mark Cuban once sold a company to Yahoo for stock. He sold the stock as soon as he was able. Then the stock went up some more. The next time he was on CNBC, an anchor asked him:  “Don’t you feel dumb that you cashed out your Yahoo (YHOO) stock at $200 and now it’s trading at over $230?”

Cuban’s answer: “Well, it’s hard to feel dumb when you’re flying around in your G-5.”

Don’t Get Too Greedy

Whether you are trying to sell your company, your tickets to the Super Bowl or closing out the trade of a lifetime, it is better to take a good deal when you have it than to hope for more gains. Sure, you may miss out on some profits, but at least you will actually get to keep most of the winnings before they vanish.

The Cubes sold his company to Yahoo! in April 1999. Today that same Yahoo! stock is worth about a third of its peak value achieved roughly 8 months later. CNBC anchor person, do you still think Mark is dumb?

Read more: Industry People Are Whispering That Kevin Systrom Blew It Selling Instagram For $1 Billion