Earny Asks: How to Fix Mistakes Like Warren Buffett?
Let's see if the best traders are any better than the rest of us.
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Fix Your Investing Mistakes Like Warren Buffett
We’ve talked before about how Warren Buffett’s favorite holding period is forever, but that he's quick to sell when he realizes that he's made a mistake. Take a look at his disastrous investments in Conoco Phillips COP and Paramount Global PARA, both of which he exited when he realized he was wrong.
How does he know when he’s wrong? Well, Buffett is a researcher and has well-supported reasons for any investment that he makes. When the company’s prospects change for the worse, he sells.
You should do the same.
How? Remember, in the past we’ve talked about having a framework for investing? You should ask yourself two questions: Is this a good company? And is the stock worth owning? Alternatively, you could use a framework like Louis Llanes’ QVT, which we discussed several weeks ago.
Either way, know when you’re wrong.
You'll be wrong a lot. As an investor, you should get comfortable being wrong. The best traders in the world are wrong quite frequently.
How Profitable Are the Best Traders?
For this week’s question, Earny asks about the success rates for the best traders.
Among those traders regarded as the very best, what percentage of their trades will be profitable?
- 60%
- 90%
- 30%
- 10%
The Most Highly-Regarded Traders Are Often Wrong
Let’s just say that if you’re making money on 50% of your trades, you’re doing great. In Jack Schwager’s excellent “Market Wizards” book, Steve Cohen mentions that his best trader is profitable only 63% of the time. His other traders made gains closer to 50% of the time. And these are some of the best traders out there.
The correct answer is 60%.
So, how do these traders make money if they’re wrong nearly as much as they’re right?
Risk management.
They cut their losses quickly and let their winning trades run. In other words, they might re-evaluate a losing trade when it’s down 5%, while they hope to make 15% on a winning trade. Combine those two, and the trader has a 5% profit overall.
Do that over and over across many trades, and you'll be a Filthy Rich Animal.
While your risk tolerance will be different than another trader’s, the principle is the same. You should limit your losses and allow your winners to run. If a stock is working for you and the timing is right based on the rules you defined in your framework, consider buying more.
Said another way, when you find a flower in the garden that is your portfolio, water it. When you find a weed, pull it.
