The Skills It Takes To Be A Great Active Investor
Investing — like life — is all about probabilities. While we don’t know what is going to happen with certainty in the future, we can at least predict a range of possibilities as to what might happen.
The ability to predict these possibilities and assign a range of probabilities to various situations is what separates the successful investors from the unsuccessful.
Now, the verdict is out that a passive strategy beats an active strategy for the average investor over the long haul. Active strategies don’t even come close over a 30 year period.
Passive strategies are great for retirement. Many of my friends have 401k plans through their work and when they ask me what mutual funds to put it in (usually a selection of 10-15 funds), I tell them to put it all in the S&P 500 index fund (if their plan offers it). The reason is that something like 90% of mutual funds underperform the S&P index after all the fees. And then for everything else beyond their 401k I tell them about the ideal passive investment mix and direct them to Wealthfront. You’re just far better off putting your leftover funds into a diversified mix of low cost index ETFs and adding to it on a regular basis (i.e. dollar cost averaging).
However the main problem with passive strategies for the short term is that when (yes, when not if) we get a deeper correction, all those people are going to ride the wave down too. Another 2008 comes along and you’ll see your mix drop by 50%. Whereas some good active managers could still average 10-15% up in those down years.
So I do believe there is a place for active management in addition to your passive retirement mix. And not just for the super rich few that can afford the high multi-million dollar minimum commitments at elite hedge funds like Ray Dalio’s Bridgewater Associates (his flagship fund Pure Alpha has been up an average of 14% a year since 1991). I think there’s a place for active management for the many who have extra cash outside of their 401k and IRA retirement funds.
In the interest of full disclosure, I’m trying to be an active manager. I treat it as a 2nd job. I love stocks. And I’m not ashamed about it. I invest in stocks actively not to keep pace with the averages but to crush them. And I have funds with other active managers who are trying to do the same.
Now there are many ways one can be successful in the markets, albeit they are all hard to find and carry out. The main way I try to is by being in strong stocks during market uptrends and reducing exposure during the downtrends. (I’m not a big fan of shorting because I feel it is too difficult and frustrating but that’s for another blog post).
Of course you can’t “time the market” — you can’t get in at the very bottom and get out at the very top. And you shouldn’t try. But you can catch the majority of the uptrend and avoid the majority of the downtrend. As Howard says: follow the money, you don’t need to be first and you should never be last.
In my opinion, here are the main skills it takes to be a successful active investor or trader:
- Willing to put in the time. By far and away the most important. It mainly makes time to learn. The best managers put in the time. They learn the language (Stocktwits is a great place to start), they read lots of books, keep up with the press coverage, constantly watch the market, run through 100+ charts every night, etc.
- Passion. The best investors I’ve seen truly love what they do. It’s the only way they are able to put in the time needed to become great.
- Experience. The pros have seen it all. They’ve been through all sorts of market cycles. Long periods of sideways choppiness, uptrends, and downtrends. And not just the short term 15-20% corrections but the big 50% corrections too.
- Adaptability. Markets change. And the strategies that were working in one market may eventually deteriorate. Good traders will change their methodology to match the new market conditions.
- No ego. None. If you go into trading with an ego the market will eat you alive. The elite investors are able to admit when they’re wrong. They even embrace it. Being wrong quickly means they can move on to being right faster.
- Emotionless. This goes hand in hand with ego. Along with pride, investors face a daily trio of emotions of hope, fear, and greed. The worst investors allow their emotions to control their trading; the best avoid any emotional attachment at all.
- Patience. Many of the best have the patience to wait for the right opportunity to present itself. They don’t force it. As Jesse Livermore famously said, “Throughout all my years of investing I’ve found that the big money was never made in the buying or the selling. The big money was made in the waiting.”
- Flexibility. The best managers are able to turn on a dime. Make a mistake? No worries. Cut your losses and get out. The greats do this without thinking about it. And will even reverse those positions if they are confident enough.
- Risk Control. I saved this one for last on purpose. It all starts and ends here. The best investors always have a lazer beam focus on risk controls. This varies person to person but they never risk more than [insert some small number] percent of their portfolio on any individual trade.
One last thing I’ve noticed about the best investors, which is less of a skill and more of an attribute, is the motivation of the game. The best traders think of it as a game. They think of wins in terms of percentages, not money. Trading just to make money is always a bad idea.
No doubt this mix of unique skills is hard to come by. But that challenge is why I love investing. So I’m willing to put in the time and effort.