A Conversation with Charles Kirk

Teresa, April 28, 2008 @ 2:08PM ET | Link | RSS | Read via Email | 2 Comments  

Charles Kirk kindly invited me to be his guest for this month’s Q&A. This lengthy interview took us three days of solid work to complete. The complete transcript is at KirkReport.com.

In case you’re been listening to our podcasts, I provided the answer to the Warren Buffett riddle:

Kirk:   Clearly, one of the most important skills an investor can have is knowing what information, research, analysis, and indicators to overlook. Do you have any suggestions or words of wisdom in this regard?

Teresa Lo:   Yes, nothing I have ever come across was satisfactory for what I wanted to do. Some stuff is too general, some too specific. Most of the indicators have no basis in fact, so we can’t expect them to work, or they are an invalid application of analytical tools borrowed from another discipline. Quite often, we don’t even know what they purport to measure. Opinions are not helpful. Forecasting is tricky. The market is a complex system and not easily navigated when viewed in the context of a deterministic, cause and effect mindset.

I want to talk more about the probabilistic mindset, because as you know, many traders swear by Mark Douglas’ book, Trading in the Zone. It is accepted that one must think in probabilities rather than certainties, but my observation is that humans find it exceedingly hard to defy our genetic heritage as hunters. As Spencer Wells put it so eloquently in Journey of Man: A Genetic Odyssey (watch Part 2 and Part 3 on Youtube.com), the quantum leap made by humans 50,000 years ago — the single cognitive advance that allowed our proliferation — was figuring out that a beast out of sight and smell’s range could be found by tracking its footprints. Follow A to B. And that is where the majority of humans are presently situated in their thinking.

The market demands that we make another quantum leap in that there are no certainties in the financial world, only probabilities. Let me give you an example. Most people admire Warren Buffett. He has made money for decades. He seems like a nice old fellow, but underneath it all, he is not a big game hunter. Over time, he has learned how to harness the corporate animal and become a farmer of profits. He thinks outside the box. While the public lambasted Bill Gates during the 1990s, Buffett befriended him and became his bridge partner. In June 2006, Buffett began giving away 85% of his wealth, mostly to the Bill & Melinda Gates Foundation.

Buffett is mentioned twice in Alan Greenspan’s memoirs, once as “my good friend” and the other as “my friend.” Greenie is probably the most maligned central banker in financial history, yet when you read his memoirs, it shows a deep understanding of behavioral economics and reveals his thinking in probabilistic terms. None of this sits well in a world of people who demand to know with certainly how A leads to B, or worse, with the benefit of 20/20 hindsight, they all think they can do better.

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Buffett is quoted on the front cover of Robert Rubin’s memoirs: “It’s a hell of a book. As Secretary of the Treasury, Bob Rubin ranked with the best. This drama-packed account should be read by all who are interested in what happens when politics and economics intersect.” Rubin and Buffett have been friends since the 1960s. They had regular breakfast meetings and after leaving the Clinton administration, Rubin sought out Buffett’s advice.

It seems to me that Buffett would not be friends with, let alone give his billions to, people of doubtful character. He would not play a game that was rigged. What does he see in these people and the capital markets that the vast majority of the public cannot? I think the title of Rubin’s book gives us a hint. He agreed to write the book due to overwhelming feedback to Keeping the Boom From Busting. People wanted to know more about the probabilistic way he had approached the decisions in his career. This book is a real eyeopener to many of the critics, because it turns out that, at the end of the day, Buffett, Gates, Greenspan, Rubin and their proteges are intellectuals and very well-informed professionals doing the best they can… In an Uncertain World. Traders are never given an embarrassment of riches; we only get to make the “least worst” choice in a fluid situation.

Kirk:   Everyone makes mistakes (and some more than their fair share). Looking back over the past few years, can you recall a mistake you’ve made and what you’ve learned from it?

Teresa Lo:   For a long time, I too, thought that trading was the only way to avoid market dislocations. Also, when I got into the business, I fell to Spinoza’s conjecture and started to parrot all the Fed bashing, “Plunge Protection Team” and conspiracy theories that is so prevalent today. What I know now is that people who fail to make money in the market need an excuse for their failure rather than admit they have no method. But as you know, active management is a $100 billion a year industry and people will do anything to deflect the fact that they depend on luck over skill to keep collecting the fees. What I learned is that almost everything I heard about trading and portfolio management in the mainstream was a myth.

Kirk:  Ah, this is why I like reading your blog Teresa. You say what needs to be said! It is so important for all of us to understand this very important point within the context of all of the opinions about the market we must sort through on a daily (if not hourly) basis. Thank you for having the guts to say it.

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  1. Tuesday links: shedding debt « Abnormal Returns on April 29th, 2008 10:13 AM

    […] “(A)lmost everything I heard about trading and portfolio management in the mainstream was a myth.” (InVivoAnalytics.com) […]

  2. Mike (via email) on May 8th, 2008 10:50 AM

    I was lucky in that the first major book I read on investing was also one of the best. Those of us blessed enough to be intellectually curious keep going back to those Market Wizards books because they contain so many lessons. Arguably the most important lessons contained are the actual keys to the kingdom! Some of those interviewed are so bold as to give their exact roadmap to success. The truly insightful cannot avoid adding snark afterwards by stating that it won’t matter anyway. Seriously, anyone who can drive a stick could learn every vital rule for winning a NASCAR race in under an hour. You don’t even have to learn how to make a right turn! But to try to teach them how to win ­ that’s where the proverbial rubber meets the literal road.

    I couldn’t escape the grand Turtle Trader paradox while reading that interview at the Kirk report as well as other interviews both you and he have posted in the past. You and I have both spoken at length about for all the insight and expertise in the world, most people in the end just want you to tell them what to do with their money. Can we get there on our own? With that mindset in place, I have some pointed comments concerning that preparatory list you created from the lessons of your father.

    Lesson #1: Ensure the objective is realistic and worth the potential loss. Pick battles you can win.

    OK, it doesn’t take a long stint in the market to arrive at this insight. Alas, I cannot but imagine the barometer for this first step to be those who fall prey to infomercial schemes or any other marketing ploy utilizing excessive exclamation points.

    Lesson #2: Gather all the information available, even though some of it might be wrong or even be misinformation.

    Here is a jump into rarified air and the most likely reason that the Market Wizards, you, Charles Kirk (did I mention yet that he’s from Minnesota?), and a few scant others can offer the keys to the kingdom without worry whatever. I try to put forth an honest effort on this front, but I really should try harder. I’m much better at objectively assessing information now that I utilize Taleb’s insight concerning imposing narratives. You can’t come with a fresh outlook every day and you certainly can’t expend the energy to remove all preconceived bias. I do try to do the best I can.

    Lession #3: Make a plan with the best information on hand and prepare not one, but a bunch of contingency plans.

    This is why personal growth as well as emphasis on objectivity are critical to success. This is harder to do than sifting through all the information, but objectivity isn’t possible until enough information is gathered to discover something resembling the truth. If it were easy to separate what you want to have happen from what is actually happening then you’d have no reason to constantly remind everyone that it’s never different this time.

    Lesson #4: When Plan A fails, roll out Plan B, Plan C, Plan D, etc., while you are in motion. Do not hesitate or panic. If all else fails, do your best to get as many men out alive as possible.

    If every trader could think clearly during times of stress, then no moves would be in response to emotion and the whole market could actually be modeled and what fun would that be? Also, stops mean never having to say you’re sorry (to yourself).

    Lesson #5: Regroup, rinse and repeat until the objective is achieved. Recognize that there is risk in everything. Things can and do go wrong. People get killed in action.

    Is this a paradox? The conundrum here is that even with all objectivity, insight, and planning in place, a legitimate case can be made to take all manner of trades all the time. So the challenge would seem to be how to find the balance between the keys to the kingdom and your own personality fraught with shortcomings and bias. You can’t get there purely programmatically and you can’t get there through only intuition. I’m pretty sure I can get there, but it most certainly will not be easy. Thankfully the task is not so hard as I will just defer to whatever decisions you make.