To become a really great trader takes more than smarts; it also requires you to make a cold, hard assessment of your strengths and weaknesses. You have to know exactly what you can and cannot do, trade to what you can, and not let your weakness dominate. The following lesson form Warren Buffett should be instructive in this regard.
Back in September of 2008, Goldman Sachs was looking for a â€œstamp of approvalâ€ so the company turned to probably the most famous and respected trader in the world, Warren Buffett. Goldman agreed to pay Mr. Buffett an extraordinary rate of interest-10% a year on $5 billion worth of preferred shares.Â Buffett however wasnâ€™t satisfied with that-he insisted on obtaining warrants which gave him the right to purchase Goldman stock for $115 per share, about where the stock was trading at the time.Â In fact, Buffett never would have gotten into the Goldman investment in the first place without receiving the warrants-they were a â€œkickerâ€ on the deal that he absolutely insisted upon.
Buffett probably could have negotiated a better price for the warrants because remember, it was Goldman who came looking for Buffett, not the other way around. Hereâ€™s where it gets interesting.
As Mr. Buffett has often said, heâ€™s a long term investor with no ability whatsoever to trade in the short term. But he doesnâ€™t let his inability to trade in the short term (his weakness) get in the way of his long term trading ability (his strength). Within three months of making the $115/share deal, Goldman was trading at about $52, making the warrants virtually worthless because no one is going to exercise the right to buy something at a loss. Aside from that, the deal looked even worse because remember that Buffett never would have bought the preferreds without the warrants in the first place.
When Goldman sank to $52, Warren Buffett didnâ€™t turn tail and run by cashing in his preferreds because they now were attached to worthless warrants. In other words, he didnâ€™t let himself get stopped out of the trade. Why? Because Warren Buffett was trading to his strength-the long term; he wasnâ€™t going to let a short term fluctuation (which he admittedly has no ability to trade anyway) interfere with what he knows to be his greatest abilities.
In the meantime, Goldman closed at about $162 on Friday, meaning that Mr. Buffett is up around 40% on those warrants. And heâ€™s still getting paid 10% a year on his preferred shares.
What would have made this trade even more difficult for mere mortals is that his positions were played out all over the financial press. And although I donâ€™t have the exact quotes, I distinctly remember an article on CNBC which postulated that the â€œold boy had lost his touchâ€ when Goldmanâ€™s price was declining. Meanwhile, Buffett had warned during an interview that it always was possible (one could argue probable) that he might get things very wrong in he short term.
So, what are the trading lessons here? First, you always want to trade to your strengths. If you have a system that works for you, stick with it. If you donâ€™t, get one that does. Second, if Warren Buffett is one of the worldâ€™s great traders, and he sometimes has to hold a trade at a loss in order to eventually become profitable, chances are that you and I are going to have to be able to do the same thing. Most importantly, donâ€™t get into a trade if you arenâ€™t willing to hold a loss and donâ€™t get into a trade if having a loss is going to make you believe that your original opinion was wrong to the point where it forces you to close your position. Those are pretty high standards-it probably means that youâ€™re going to have less trades but it also probably means that the ones you have will be that much more successful.
On a different subject, hereâ€™s why stabilization in U.S. housing along with rising equity markets are so vital to a global economic recovery.
U.S. homes prices lead the way because theyâ€™re the ultimate collateral for the $11 trillion of US home mortgage debt, a significant share of which is held in the form of asset-backed securities by foreigners. Some economists are now saying that prices appear to be stabilizing (even though they could drift a bit lower into 2010) due to the decline of inventory overhang being brought about by the sharp drop in the number of new homes coming onto the market.
Rising stock markets are a major contributor to global business activity in two major ways. First, rising share prices will lead to increased household wealth and spending. Weâ€™re seeing this happen in China, where a 50% increase in stock markets has led the way to a 30% rise in consumption on the part of consumers. Second, as the market value of existing corporate assets (proxied by stock prices) relative to their replacement costs grow, it will make economic sense for business to make new capital investment, a significant driver of GDP.
One factor that is likely to remain as a huge driver of improving equity prices is the continued policy of monetary expansion. During a Town Hall interview with PBS on Sunday night, Fed Chairman Bernanke retained the dovish outlook displayed in his Congressional testimony last week by implying that the emergency liquidity programs will be unwound only when there is certainty of economic recovery while reiterating his expectation of low inflationary pressure over the next couple of years. He also forecasted unemployment above 10% and suggested that the first half 2010 may not mark the peak jobless rate, meaning that at this time the Fed in not expecting to raise borrowing costs until well into 2010 and possibly later.