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Real-World vs. Theoretical Investing: Understand the Difference (Part 1 of 2)
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“The Brady 6” is one of my favorite sports documentaries. The documentary profiles the fascinating and unlikely story of the NFL’s most decorated quarterback (and greatest player) of all time, Tom Brady and the six quarterbacks picked before him (who went on to have no success in the league).
Tom Brady was not always the greatest football player of all-time and highly touted. In fact, Brady started as a backup quarterback on a high school football team with zero wins and later was a “bench warmer” for much of his time at the University of Michigan. Eventually, Brady applied for the 2000 NFL draft, though he was regarded as a lower-end prospect. Luckily for Brady, he was selected, though he was one of the last picks in the draft (6th round, 199th pick). The rest is history, as they say. Brady would go on to have one the most decorated NFL careers and would win seven Super Bowls (the most ever).
Having “The Intangibles”
Tom Brady had one of the worst combines in history. His scouting report said, “Lacks mobility and ability to avoid the rush. Lacks a really strong arm. Can’t drive the ball down the field and does not throw a really tight spiral. System-type player who can get exposed if he must ad-lib and do things on his own.” So, if Brady lacked the talent of other players, how did he become so successful? It turns out that “being a system player” has its advantages.
Rather than having overwhelming talent or ability, Brady succeeded by knowing the game inside and out and throwing the ball where there was a high probability it would be caught by a wide receiver. He also had the “intangibles,” AKA the qualities or characteristics of a player that are not easily quantifiable or measured by statistics (leadership, work ethic, mental toughness).
The Demise of Long-Term Capital Management
Long-term Capital Management (LTCM) was a highly touted hedge fund founded by multiple Nobel Prize winners in the early 1990s. Despite their Ivy League resumes, awards, and billions in assets under management, the highly leveraged hedge fund blew up in 1998 and had to be bailed out by the Federal Reserve Bank of New York for more than $3 billion to avoid systemic risk on Wall Street. Like with Brady, real-life execution is far more important than degrees, awards, or attributes.
Below are the Key Differences Between Real Life Trading and Theoretical Trading:
It’s Not About What You Make, It’s About What You Can Keep
Markets are random enough that one can make money even by randomly selecting a stock symbol and purchasing the stock. However, Wall Street is littered with the graves of “boom and bust investors.” LTCM averaged compound annual returns of 40% before blowing up. The LTCM debacle is evidence that it’s not about what you can make in the market but rather what you can keep.
Risk Happens Fast
When asked about risk management, the late, great Charlie Munger famously said to avoid “liquor, ladies, and leverage.”
LTCM proved that one “Black Swan” (the Russian Financial Crisis in the case of LTCM) event can break a portfolio with outsized risk exposure to the market. Leverage extenuates risk. Savvy investors think about risk first and use leverage sparingly (if at all).
The lesson: “There are old traders, and there are bold traders, but there are very few old, bold traders.”~ Ed Seykota
Markets Discount the Future
Many academics obsess over economic data, failing to understand the nature of markets. By definition, economic data is stale information. Wall Street is a future discounting device. The proof is in the pudding. For example, Bitcoin bottomed within days after news broke that crypto exchange FTX was rife with fraud. Another example is the equity bottom of late 2023. The day inflation hit 40-year highs; U.S. equities bottomed.
Image Source: TradingView
Two lessons should be noted for investors:
1. Wall Street trades based on future expectations, not stale data.
2. Stocks tend to bottom on poor news.
Valuation is NOT a Timing Device
Many academics and amateur investors use valuation as a timing device. However, in real-world markets, valuations stretch (and high-valuation stocks outperform), and in a bear market, the opposite occurs. For example, many investors complained that Nvidia ((NVDA - Free Report) ) had a high valuation into 2023. These investors failed to understand that the market anticipated the future and that the company would “grow into its earnings.”
Image Source: Zacks Investment Research
Stanley Druckenmiller, arguably the best investor of his generation, said it best:
“Earnings don’t move the overall market; it’s the Federal Reserve Board… focus on the central banks and focus on the movement of liquidity. Most people in the market are looking for earnings and conventional measures. It’s liquidity that moves markets. I never use valuation to time the market. I use liquidity considerations and technical analysis for timing.”
Price and Volume is Truth, Not Opinions
Unprofitable investors tend to hyperfocus on complex strategies or macroeconomics. That said, successful investors understand that price in itself is news.Price and volume illustrate actual supply and demand not opinions. For this reason, technical information such as price and volume should be the primary focus of investors. After all, only price pays.
Be sure to check Zacks.com for part 2 later this afternoon!
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Real-World vs. Theoretical Investing: Understand the Difference (Part 1 of 2)
“The Brady 6” is one of my favorite sports documentaries. The documentary profiles the fascinating and unlikely story of the NFL’s most decorated quarterback (and greatest player) of all time, Tom Brady and the six quarterbacks picked before him (who went on to have no success in the league).
Tom Brady was not always the greatest football player of all-time and highly touted. In fact, Brady started as a backup quarterback on a high school football team with zero wins and later was a “bench warmer” for much of his time at the University of Michigan. Eventually, Brady applied for the 2000 NFL draft, though he was regarded as a lower-end prospect. Luckily for Brady, he was selected, though he was one of the last picks in the draft (6th round, 199th pick). The rest is history, as they say. Brady would go on to have one the most decorated NFL careers and would win seven Super Bowls (the most ever).
Having “The Intangibles”
Tom Brady had one of the worst combines in history. His scouting report said, “Lacks mobility and ability to avoid the rush. Lacks a really strong arm. Can’t drive the ball down the field and does not throw a really tight spiral. System-type player who can get exposed if he must ad-lib and do things on his own.” So, if Brady lacked the talent of other players, how did he become so successful? It turns out that “being a system player” has its advantages.
Rather than having overwhelming talent or ability, Brady succeeded by knowing the game inside and out and throwing the ball where there was a high probability it would be caught by a wide receiver. He also had the “intangibles,” AKA the qualities or characteristics of a player that are not easily quantifiable or measured by statistics (leadership, work ethic, mental toughness).
The Demise of Long-Term Capital Management
Long-term Capital Management (LTCM) was a highly touted hedge fund founded by multiple Nobel Prize winners in the early 1990s. Despite their Ivy League resumes, awards, and billions in assets under management, the highly leveraged hedge fund blew up in 1998 and had to be bailed out by the Federal Reserve Bank of New York for more than $3 billion to avoid systemic risk on Wall Street. Like with Brady, real-life execution is far more important than degrees, awards, or attributes.
Below are the Key Differences Between Real Life Trading and Theoretical Trading:
It’s Not About What You Make, It’s About What You Can Keep
Markets are random enough that one can make money even by randomly selecting a stock symbol and purchasing the stock. However, Wall Street is littered with the graves of “boom and bust investors.” LTCM averaged compound annual returns of 40% before blowing up. The LTCM debacle is evidence that it’s not about what you can make in the market but rather what you can keep.
Risk Happens Fast
When asked about risk management, the late, great Charlie Munger famously said to avoid “liquor, ladies, and leverage.”
LTCM proved that one “Black Swan” (the Russian Financial Crisis in the case of LTCM) event can break a portfolio with outsized risk exposure to the market. Leverage extenuates risk. Savvy investors think about risk first and use leverage sparingly (if at all).
The lesson: “There are old traders, and there are bold traders, but there are very few old, bold traders.” ~ Ed Seykota
Markets Discount the Future
Many academics obsess over economic data, failing to understand the nature of markets. By definition, economic data is stale information. Wall Street is a future discounting device. The proof is in the pudding. For example, Bitcoin bottomed within days after news broke that crypto exchange FTX was rife with fraud. Another example is the equity bottom of late 2023. The day inflation hit 40-year highs; U.S. equities bottomed.
Image Source: TradingView
Two lessons should be noted for investors:
1. Wall Street trades based on future expectations, not stale data.
2. Stocks tend to bottom on poor news.
Valuation is NOT a Timing Device
Many academics and amateur investors use valuation as a timing device. However, in real-world markets, valuations stretch (and high-valuation stocks outperform), and in a bear market, the opposite occurs. For example, many investors complained that Nvidia ((NVDA - Free Report) ) had a high valuation into 2023. These investors failed to understand that the market anticipated the future and that the company would “grow into its earnings.”
Image Source: Zacks Investment Research
Stanley Druckenmiller, arguably the best investor of his generation, said it best:
“Earnings don’t move the overall market; it’s the Federal Reserve Board… focus on the central banks and focus on the movement of liquidity. Most people in the market are looking for earnings and conventional measures. It’s liquidity that moves markets. I never use valuation to time the market. I use liquidity considerations and technical analysis for timing.”
Price and Volume is Truth, Not Opinions
Unprofitable investors tend to hyperfocus on complex strategies or macroeconomics. That said, successful investors understand that price in itself is news. Price and volume illustrate actual supply and demand not opinions. For this reason, technical information such as price and volume should be the primary focus of investors. After all, only price pays.
Be sure to check Zacks.com for part 2 later this afternoon!