Let me start this post with a minor criticism of Mr. Schwager.
He begins this interview by schooling Steinhardt on what he perceives to be the difference between a trader and an investor. I thought this a bit strange and annoying; aren't we reading this book to hear what the traders think about shit? Sometimes I feel Schwager inserts himself into the interview too much, as if he wants to impress upon the reader (or the person he's interviewing) how much he knows.
There was a time when I thought I would get into journalism. I remember reading a book by a reporter (the name escapes me) who said basically, "Look, if you're doing a story about a kid who rides a red tricycle, whatever you do, don't get on the red tricycle yourself and wave to the camera at the end of the report."
Perhaps if the subtitle of this book was "Conversations with Top Traders" and not "Interviews with Top Traders" I wouldn't notice it as much. It's a minor criticism, but it crops up now and again throughout the book and always bugs me. I guess I find the best parts of Market Wizards are when the interviewee is allowed to give nice long responses full of little trading anecdotes and aphorisms.
Anyway, the point is that I didn't get much from the whole first portion of the interview because I was distracted by Schwager, but by the end I came away thinking it was quite good.
Steinhardt is different from the other traders we've read about thus far. Take the following quote from him about risk for example: "My attitude has always been that to make money in the markets, you have to be willing to get in the way of danger." While there have been a few traders who didn't even want to talk about trading disasters and "war stories," Steinhardt seemed to revel in these, which I found refreshing. Why? Because it's just natural to talk about these things...
Overall, I got the feeling that while Steinhardt might be a bit of a dick, (Schwager mentions his firm has high turnover and that he plays bad practical jokes on people) he had a real "feel" for the markets and that most of his trading was intuitive, locked up in his own psychology, and based on his own personal feelings about a situation. Instinct and art were much more a factor in his trading than science, and he would probably be a very difficult guy to sit next to and learn from...
He was one of the first hedge fund managers and they get into a long interesting discussion about the benefits of hedge funds versus mutual funds. I won't get into it here but I came away thinking that the investing populace as a whole would be about 1000 times better off if there was more of a balance between mutual funds and hedge funds. They're just so much more flexible... mutual funds seem horribly dated to me and I can't imagine after the trainwreck of the last two years that someone won't attempt to put together a hedge fund for the "small guy."
As a hedge fund manager, Steinhardt talks often about his "exposure" to the market; or what percentage of his capital is tied to the long side of the market, and what percentage is tied to the short side. This was interesting because I realized that many traders in the RO (particularly D and B) are obsessed with their "exposure" and I guess they're trading like hedge fund managers...
Steinhardt says his main trading principle is "variant perception" which is a fancy way of saying that he's a contrarian. But he highlights a very interesting subtlety about being a theoretical contrarian and having to deal with being a contrarian at a practical level...
In order to win as a contrarian, you need the right timing and you have to put on a position in the appropriate size. If you do it too small, it's not meaningful; if you do it too big, you can get wiped out of your timing is slightly off. The process requires courage, commitment, and an understanding of your own psychology.
This sums up what you need to think about next time you start shorting a stock that is spiking "too much" in one direction or the other... most important is commitment. If you're going down that road, be prepared for the pain and stick to your position, otherwise you might find yourself getting tied to the emotional aspect of it all and blow out at bad prices. I can't tell you how often I've done just that.
And like many of the other traders interviewed by Schwager, Steinhardt talks about the importance of learning from your mistakes.
There is a very good investor I speak to frequently who said, 'All I bring to the party is twenty-eight years of mistakes.' I really believe he is right. When you make a mistake, there is some subconscious phenomenon that makes it less likely for you to make that same mistake again. One of the advantages of trading the way I do-being a long-term investor, short-term trader, individual stock selector, market timer, sector analyst-is that I have made so many decisions and mistakes that it has made me wise beyond by years as an investor.
This post is rather long already. Knowing that many of my readers (at least the Anonymous ones) are blessed with very small attention spans, I will simply end this post with two more Steinhardt quotes.
Steinhardt's advice to a layman:
Recognize that this is a very competitive business, and that when you decide to buy or sell a stock, you are compteing with people who have devoted a good portion of their lives to this same endeavor. In many instances, these professionals are on the opposite side of your trades and, on balance, they are going to beat you.
Steinhardt's elements of good trading:
Good trading is a peculiar balance between the conviction to follow your ideas and the flexibility to recognize when you have made a mistake. You need to believe in something, but at the same time, you are going to be wrong a considerable number of times. The balance between confidence and humility is best learned through extensive experience and mistakes. There should be a respect for the person on the other side of the trade. Always ask yourself: Why does he want to sell? What does he know that I don't? Finally, you have to be intellectually honest with yourself and others. In my judgement, all great traders are seekers of truth.Next week we discuss a trader who definitely influenced me (though not my politics), William O'Neill, founder of IBD.