Approaching the summer of 2013 I had a significant short position in the banking sector. During a sudden market panic which triggered the divestment of several long positions, I increased my bank shorts.
Not long after, the market bottomed. So did not least many bank shares. Unfortunately, every day for the coming six months I came up with some kind of new argument for holding on to my shorts for a while longer. Meanwhile a handsome profit shrank to nothing and inverted into a big loss.
Instead of truly questioning my previous research and conclusion regarding European banks, given the new information (of globally synchronized central bank accommodation), I stuck to my view of ever increasing European turmoil. I was both psychologically and mentally too weak to wipe the slate clean, change my vantage point and try to see what the buyers were thinking.
Very rarely there is such a thing as a stupid market reaction, which means you should always be open to investigate in what way a surprising move is actually the right one.
I was too complacent, lazy and proud at the same time. I should have known better, should have known that there is no room for relaxation on the financial markets. I guess I didn’t want to face my own shortcomings, and, what’s worse, didn’t care to make the extra effort.
I lacked zeal.
Proactively and diligently look for weak points
in your own research, arguments, timing and investment decisions
Challenge the premises of your investment opportunities,
and constantly look for threats to your current convictions
Identify and seek to understand the strengths of your antithesis
n my book about 15 years at the best performing hedge fund in Europe over a decade, I list 50 rules of investing.
This post is one in a line of articles detailing and explaining some of my most important insights from that time. Taken together I believe they will make for a useful and inspirational reminder for evolving and consistently improving your investment habits.
Zeal means internalizing the fact that the market devil resides in the minute details
Sometimes it’s a question of going over every footnote in the available financial reports, checking for error, fraud or symptoms of hidden disease and danger. Sometimes it’s a question of understanding other investors and their behavior. Sometimes the “detail” is of a more holistic character, e.g., how your investment stacks up relative to other investments, rather than its absolute merits.
No matter what the issue is or what the specific answer or solution might be, what I mean by investment zeal is not being content with having established a good case. Exhibiting zeal means that your well-researched absolute value investment case is just the beginning. Zeal means looking for holes and omissions, trying to understand what the sellers are thinking, wanting to find out you’re wrong.
Actively strive to disprove your own ideas
and understand and prove your opponent’s
The other day I lost 70% in a single day on an investment in a small Swedish biotech company (Peptonic).
I originally bought some shares in the IPO. The shares increased some 50-60% before crashing by 80% from there to about a third of the IPO price. In short, I then increased my position sixfold close to the low point and divested about half of my position when the price doubled, but kept the other half over the catastrophic study result. All in all, I did little better than break-even, thanks to trading around the position, albeit marginally.
What I did wrong was buying based on liking the underlying science and the people involved, rather than diligently checking the merits of the case, not to mention questioning my own reasons for buying and holding. Sure, I knew the risk of failure was high. I mean, the company had already failed once. In addition, biotech companies fail all the time.
What saved me was dumb luck due to guts and sizing. I took a very small position in the IPO, and a significantly large one after the first crash. My saving grace was divesting half of my enlarged position when the stock exhibited absurd surges. The stock’s strong performance was entirely unwarranted, especially considering the inherent risks of investing in a one-product biotech company that had already manifested serious quality issues.
You do the math
I knew all this but still didn’t want to do the actual math. I even convinced myself there was no math to be made (which in itself should have been enough to 1) not invest from the beginning, 2) get out after the first surge, 3) get out after the first crash, 4) definitely get out after doubling my money on the sixfold position [which I never should have taken to begin with, given my lack of zeal] instead of just selling half.
You’re never done
“You do the math”, is a typical rhetorical quip meaning “just add 2 and 2 and you’ll see what I mean”. It also means you should actually do it, and not just trust they’re right. All too often the math never gets made at all, when
Not only should you do the adding – the math – but check the sources for the “2:s” as well. Getting to 4 still doesn’t mean you’re done. You’re never done. That’s the meaning of zeal. You should ask yourself, and others, what “4” means both from an absolute perspective and as many different relative vantage points as possible.
Don’t be afraid of errors or of being proven wrong by yourself or somebody else. It’s not embarrasing. You should want to find out you’re wrong. The sooner the better – if you’re lucky it’ll be before the market does.
Avoid my most recent mistake, and check and re-check the premises of your investments. Do they hold up to external scrutiny or are they mostly based on chance and complacency?
If you manage to find flaws
in your reasoning
you should be glad
Zeal is the fifth installation in my 12-part series of TAOS – The Art Of Sprezzatura. You can buy the artwork here. If you missed the previous four articles you can find them here: Strategy, Patience, Resilience and Endurance.
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