Nothing can stop the man with the right mental attitude from achieving his goal; nothing on earth can help the man with the wrong mental attitude. – Thomas Jefferson
No amount of experimentation can ever prove me right; a single experiment can prove me wrong. – Albert Einstein
Here are some of the most important lessons every trader and investor should know by heart. I used to have this list taped to one of my monitors when I first got to Wall Street back in 1996. Even the best investors and traders forget to heed these lessons at times, and I am no exception to that. More on that below.
1. Use objective analysis and never let emotions drive your decisions.
2. Make the hardest trade, because it is usually the right one.
3. Cut your losses.
4. It’s easier to make up a lost opportunity than it is to make up lost capital.
5. Don’t try to time a turn (ie, don’t try to pick the top or the bottom).
I’ve made every single one of those mistakes with our Morgan Stanley short.
1. I feel visceral anger about the ongoing trillion dollar welfare subsidies and protection and lack of prosecutions in the Too Big Too Fail banks. I’ve been adamantly bullish and positioning us to profit from this ongoing bubble-blowing bull market, but I wanted to have some hedges in the portfolio to offset some of that long exposure. My primary reasoning behind my short positioning for Morgan Stanley (and JP Morgan too) was that bank profits had reached an unsustainable level as measured against the broader economy and GDP. Those levels have continued to rise, and I was wrong to try to pick a magical top level where they would peak. I should have let them peak first and then look to enter some short positions in these TBTF banks.
2 and 3. I should have cut my losses when the stock went straight up against us back when we first put it on the sheets. It would have been very hard to cover this MS short when it immediately went against me 30%, then 50%, and now 100% plus. But the right trade was the hard one and it probably still is.
4. Though we have many stocks up huge to offset the loss on this Morgan Stanley short, it has cost me performance and capital. Capital preservation should have been more in focus for me on this position.
5. In the same way that I’d been wrong with my fundamental analysis about bank earnings as a percentage of GDP being at unsustainably high levels, I have been expecting that the stock would suddenly turn and crash. I should have waited for the stock to start turning south and/or for those earnings levels to start turning south before entering this position.
All this to say that I am making a sacrifice to the trading gods today by covering my Morgan Stanley short and saying mea culpa to all of you for this poor trade. I will be looking to re-enter this and more TBTF bank shorts at some point again. But I am going to force myself to follow these rules now, even as I look and feel like an idiot for throwing in the towel here.
I was wrong. I am moving on.
Ironically, those are two sentences that all successful traders and investors are able to say often.