Risk Literacy: Trading the Great Correction of 2015

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Chapter One

Going Full Sherlock

"Something I learned long ago. It is not necessary to know what a person is afraid of.

It is enough to know the person is afraid."

— Lawrence Block, The Sins of the Fathers

No one watches a hawk with empty talons. The first time an officer goes into combat he is just like an investor, they both know there will be losses. No one will place themselves into either position unless they think they will succeed, eventually. They drastically wish to reduce risk. No one wants to be wiped out or fought to a standstill. All risk is about context, tolerance, focus, experience, and opportunity. Most people avoid opportunities to lose money. The perception of risk comes from experience and the pattern recognition of perceived, repeated context. There is a genuine difference between being right and becoming rich. On the other side of that formula lies a chasm between becoming rich and attaining wealth. Most of the people who are reading this book are on the wrong side of both benchmarks and wish to change their location. Fear is the reason both for moving forward and standing still. Risk literacy always helps. This book cannot prevent your financial failure, however it might contain the wrinkled treasure map that can show you an unexpected way forward.

As you sit at your own computer, facing the trading data of the day, you have many questions. Perhaps you are looking for an inside tip, or a secret algorithm to enhance your next trade. You are not a beginner and never discuss your trades or strategies. You would rather tell me the exact details of your last bout of lovemaking than tell me about the last investment trade you made. Most of the people who invest, and especially the commentators on TV, are the same way. Rarely do people tell you what they actually did. It’s either too embarrassing, or you made money and definitely DON’T want people to know that. This book is the exception to that.

Among other things, this book contains a log of my trades during the third quarter of 2015. You should refer to the chart at the beginning of this book to put this period into perspective. People rarely act until they are genuinely motivated to do so. When that happens their judgment is frequently compromised. Action at a point in time is what investing is about. One minute you are studying a situation and all of its possibilities. Then a short time later you own it and the only possibility you want to consider is that your investment will now go up immediately. Sometimes people lack discipline and focus. This frequently also precludes that essential step called Planning. The emotional jumble of fear and greed frequently dilute clear thinking and logic. We are ALL surrounded by people giving stock market advice but no one EVER tells us what they did with that advice.

No one publicly wants people to see and examine their bad trades. People usually only talk about their most successful trades. Sometimes a market will make an unexpected move and almost completely wipe out a position you thought was solid. Who wants people to see that? Well it might help other people not to make the same mistake. That has a value, but that is not a reason to actually lose money. This book openly is going to show you my trading for 90 days. How much I took out, or how much I lost. Eventually many of the readers of this book might benefit from it. I always try to help new investors when I can.

Frequently people who have made it to the other side do not give actionable advice or they have forgotten how they got where they are now. Fear and greed are easy emotions to forget, and with good reason. Heuristic decision making is not a precise, conscious pattern for most people. Most people use overly complicated models that end up paralyzing them. In lieu of that, people run with their gut instinct. Scientific method proves that both methods are wrong and irreproducible. There can be a streamlined choice that is usually successful half of the time. Attempting to make it simple is what this book is about. The old adage, You can be successful because of luck, skill or timing, but never confuse one with the other, certainly applies. The process of taking risk — how it was used and how it turned out — is a difficult topic. But there is a simple first step. You have to go full Sherlock before any real, expected success can occur. You have to be willing to reproduce behavior that was successful for you and adapt it to changing circumstances – with integrity. The prime factor is that you have to change — internally — but with deliberate personal focus. One must commit.

Do you think that the hero of everyone, that paragon of logic and deductive analysis, emerged fully formed in his Victorian world to solve crimes, without putting in the time? Hardly. Without a doubt he suffered for more than a few years and finally accepted that his unique mind would become the tool that eventually, everyone would respect. He realised that he had to have precise process discipline if he was to amount to anything. It was only then that he began the journey and put in the real time required. The delta did not change for Sherlock until he began to travel the right road, with conviction. Then the multiplier of his actions kicked in exponentially. Once he had his task in hand, everything he did after that added to the person that he was constantly in the process of becoming. He realized that once his discipline was clear it must ever remain that way, only clearer. Holmes knew that the biggest weakness of his discipline was his own personality. To exercise discipline you must see how your emotional perception can be, far and away, the biggest flaw in your well-thought-out process. Getting inside of that concept is where we are going. Actually I’m going there and you are tagging along. Later in this book I’ll occasionally throw you a few gems of moneymaking wisdom. You expect that. You also get to fillet me alive as I struggle with these concepts.

You are reading this to see if you can find a magic bullet or two from my thoughts that might help you to avoid some consequences that may have just become visible – on the horizon of your life. There must be a way to continue your path of living without actually changing what you do, or getting advice that you actually take, right? This book is not about a stock market financial meltdown. It is about your’s. Have you ever defined how risk impacts and controls your life? Did you know that avoiding risk is actually taking one? Have you been successful in your investments? Sex is so much easier to understand and has far less, real risk.

Let’s talk about stocks.

If you want to actually become good at making investments you have to become a person who contains all of your skill sets, but who also has the ability to focus those skills on a precise and disciplined approach to successful investing. First you have to understand how you, uniquely, process risk. Those last two sentences define every single investor who has ever had any success in investments. You won’t understand them until you become them. The likelihood that you have done that is remote. Successful investors are focused on researching investments. They already have set of heuristics they own, that work.

You don’t gamble, but you will buy a lottery ticket. Why? It is a very small compartment and the risk is fully understood and managed. You are fully literate on this risk, have already accepted the loss of the dollar and know the odds are not only not in your favor, but are almost impossibly stacked against you. You hand over your money, look at the numbers and put the ticket in your pocket.

Before we get too far we have to dig into the surface of four concepts. Gambling is fun and has amused people for centuries. Chance and randomness affect the outcome and some kind of a reward or loss is involved. Speculation is a temporary dislocation in a previously stable market that if correctly bought can result in inordinate, and immediate gains. This can happen in all kinds of markets — stock, real estate, commodity, currency and a great many others. Trading occurs when a slight shift in advantage happens in a structured market that allowed a market participant to risk money should that dislocation create favorable leverage. Investing is acquiring an asset of value at greatly reduced and very favorable price and holding on to it for a long dated period of time. Each of these four actions has a different risk and each of them should impact your perception of risk differently. The problem is they don’t, because most people have only one reaction to risk. They perceive risk only as danger and they cannot see the opportunity. Worse, sometimes they fall in love with the emotional state of being at risk. Their fear causes them to exit from risk eventually, over a duration of time. That is why most people are not successful in the stock markets. The first thing they should invest in is understanding their own perception of risk and how to compartmentalize it successfully.

Before we get into some of these categories of risk let’s talk about consequences. Most people hate even the word ‘consequence. Essentially a consequence is an effect, as in cause and effect. You let go of a brick you are holding and the effect of this letting go is the brick falls. If it falls and it lands on your bare foot and breaks your toe that is an unexpected consequence. If it broke the skin and you get an infestation of flesh eating bacteria that is an unintended consequence. If you lose your leg that is a bizarre, open ended, consequence that may never happen again in recorded history. And so it goes with risk and risk literacy. Reasonable risk that is contained may or may not have consequences. These consequences may be contained and fully understood at their worst case" scenario level. Depending on your management and literacy of risk they may be greatly diminished by taking a few steps. Failing to understand the true nature and size of a consequence of risk is the lesson that can only be learned from understanding input actions and many possible outcomes. Academic risk is entirely different from actual experiential risk. When dealing with human behavior or nature and any number of other variables, compartmentalizing risk and studying it is important before exposing yourself to the potential consequences. Getting clear on the differences between taking a risk and experiencing the effect of consequences is the essential nature of risk literacy. It is also fundamental to investing. You must balance time, position size, cash position percent and a hedge.

So let’s look occasionally at gambling, speculation, trading and investing.

If you are looking for some clever self-help advice that will gently nurture you to a safe resting place, where you can remain safe from any risk-free, actual life experiences, then you are reading the wrong book. This book is about producing money from the resources you have and getting that money to work for you. Try to not only avoid financial disaster, but get ahead. It is also about becoming more literate about risk. I will experience losses; you will experience losses. You have to put money, not to work, but to war. The color of blood is green, the scent you smell is your own fear. That excitement you feel is your own lust – your greed. These are surmountable obstacles along the path. They can be recognized and flagged. Some of your money might die, but you won’t. If you are going to extract income from capital over time and the capital is going to survive and grow you have to become deliberate about consequences.

When I was eighteen years old I had a job making flow meters that were lined with teflon. I was sent by my foreman to the back of the factory with a three-quarter-inch threaded rod about four feet long. I was told to put it over a steel form and use the hydraulic press to form it into a hook. Alone I positioned the rod and held it steady as I activated the press. The rod began to bend and then suddenly it bent almost straight up and pushed almost flat against the side of the press. My hand was trapped up against the press by the threaded rod and being pulled downward toward a series of decreasing sizes of steps. I could not reach the off switch as my hand was trapped against steel. I felt my skin go clammy and the blood began to drain out of my extremities. I had probably turned white as a sheet. I froze and watched my hand being pulled down. I could see all four fingers being crushed off of my hand, in my mind’s eye. Then I realized that if I squeezed each finger down into the steps of the hydraulic piston my hand’s fingers might be saved. I forced each finger through a very narrow gap and moved the whole hand down, step by step. The press moved unrelentingly down. Eventually my fingers were all spread apart and moved farther down and I moved through each gap in the steps to eventual freedom. The threaded rod had crushed into the skin of each finger and left its bleeding mark but had not cracked any of the bones.

I went to the restroom, ran cold water on my fingers and put tight band aids over each finger. I was in shock and it took fifteen minutes for me to come out of it. I went back to the assembly area and my foreman asked where I had been. I told him. Together we rebandaged my fingers. Now that is an example of fear. For many people their reaction to losing any money in the stock market is just as severe, or more. I am not one of them. You might be.

This book may also become a personal journal of the continued creation my own investing model. Very simply, this book is about what I actually did – written as I was doing it. I altered my risk profiles over a period of time and learned how to cull and create stock market rule patterns. You can see my thought process and the outcome of what I did, as well as the consequences and how I respond to them. It is also about risk literacy and teaching you how to define how the impact that your perception of risk, is affecting your life. When AIDS was just appearing – my, how behaviors changed! Perception changed when people realized that being a player could actually kill you. Oddly, AIDS can still kill you. Behaviors have gradually reverted back. Risk is still evident and unimpaired. Risk patterns shift based on heuristics and opportunity.

I have been investing since the early seventies and always wanted to write this book. It took me over two years to decide what period of time I would write this book about. I wanted a difficult period, that might have volatility, and perhaps a few events that were surprising. Most of the time the market is going up, or down gradually. The stock market can be pretty boring. I also wanted to risk embarrassment, and real financial loss, by reporting on a period that would challenge me. Self disclosure is a benchmark of genuine honesty. I finally choose the period of July through September in 2015. Let’s hope this isn’t too boring and I don’t lose a