Rudi On Thursday

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(This story was originally published on Wednesday, 24 June 2009. It has now been republished to make it available to non-paying members at FNArena and readers elsewhere).

In the past few weeks my analyses (including my weekly editorial) have zoomed in on longer term investment horizons, so this week I thought I’d balance it out by dedicating my editorial to those readers with a short term trading horizon.

Is there a better teacher around than Dennis Gartman?

I like Dennis Gartman. I like reading his daily newsletter. Not because he is always right, but because there’s so much market depth and wisdom emanating from his daily market comments and insights – both of which have had the chance to develop and mature over decades of actively trading the markets.

I chose the following story because I believe it goes right to the core problem many traders (and investors) struggle with.

Twenty years ago Dennis Gartman married his wife. Being a Certified Accountant (CPA) they decided she would take care of the finances, the admin and the accountancy, while he would concentrate on what he did best: trading the markets and providing ideas to the readers of his daily newsletter.

At the end of the first year they sat down and evaluated. Said his wife: Dennis you did reasonably okay. You generated a profit overall with your trading, but the sad thing is 58% of all your trades turned out loss-making. That’s even worse than a simple toss of a coin. She made him promise he would do a better job next year.

One year later they again sat down and evaluated. Said his wife: Dennis, this is actually very sad. You had a good year, you made more profit than last year, but 62% of all your trades were loss-making. He again promised he would do a better job the next year.

One year later and it turned out profits were higher than the two previous years combined, and yet 76% of all trades had generated a loss. Surely this would prove disastrous for the publisher of a daily newsletter which purports to provide its subscribers with daily, profitable trading ideas?

One year later, however, trading profits exceeded those over the three previous years combined. But the percentage of total loss-making trades had now climbed to 83%.

The response from his wife was: I think if you can be 95% wrong next year, we’ll be stinking rich! To which Dennis replied: Darling, I think I can do that, being wrong 95% of the time.

The key message to remember from this real-life anecdote is that the best performing trader is not the one who is correct most often, it is the trader who can easily admit he was wrong and quickly cut his losses.

Talk to Dennis Gartman about the many lessons he has learned throughout his career and he will tell you this has proved to be his most valuable one: admit when you’re wrong, cut your losses and move on. The same theme is reflected in the seven market rules drawn up by Standard & Poor’s chief investment strategist Sam Stovall: “Let your winners ride, but cut your losers short”.

As you would expect following the anecdote above, Dennis Gartman’s motto while trading is: there’s nothing wrong with being wrong, but there’s everything wrong with remaining wrong.

As such, Dennis Gartman will never, ever, never average into a losing trade.

It is a lesson he learned the hard way when, in the early phase of his career, he put on a trade in the US bond market and when the market turned against him he added to his position, believing he would be proved correct ultimately. It wasn’t to be and he ended up on the brink of bankruptcy.

This lesson learned proved to be key many years later, when he took on another market position and suggested to his readers they’d do the same. One of those readers was Nick Leeson, the man who would become famous as the rogue trader who blew up Barings Bank in the nineties. The difference between Gartman and Leeson? Gartman acknowledged after two days he was wrong and he closed out his position, at a loss.

Leeson, however, kept on adding to his loss-making position and ultimately became responsible for such large losses that it brought down one of the most prominent members of the British financial sector at the time.

Personally, I have never averaged down myself. I never understood why the principle is being suggested widely in trading and investment magazines. I have always been of the view this was a technique only suitable for investors with deep pockets, like cashed up fund managers. It is not that it doesn’t work if the market eventually goes your way, it is because it can be nothing less than devastating if it doesn’t.

And Gartman’s lifelong experience should be a testament to this.

For readers hungry for more insights and lessons from Dennis Gartman, here’s a link to a speech he gave a few months ago:

http://remotecontrol.jetstreammedia.com/index.cfm?fuseaction=player.showPlayer&presentationID=16007

With these thoughts I leave you all this week,

Till next week!

Your editor,

Rudi Filapek-Vandyck
(As always firmly supported by the Ab Fab team of Grahame, George, Rob, Greg, Chris, Andrew, Pat and Joyce)

P.S. I – Some readers have been asking recently whether I still subscribe to the view that the global economic outlook is for a long and drawn out, modest economic recovery, in particular for developed countries such as the US, the UK and the rest of Europe, and Japan? My response remains an unequivocal affirmative. In fact, as I pointed out to some of those readers, I increasingly spot other experts, economists and market commentators now expressing similar views.

Last week, AMP chief economist and head of investment strategy, Shane Oliver, issued an analysis titled “Where are we in the short and long-term share cycles?” The document almost reads like a summary of my analyses and forecasts over the past year or so. (Mind you, I am by no means suggesting that the document itself has been based upon anything other than in-house research and analyses at AMP). Following on from my FY11 theme over the past two weeks, I note that Oliver sees a positive underlying trend for equities for the next two years.

P.S. II – Paul Fiani, once upon a blue Monday the UBS funds manager who did not blindly follow the self-interest of the firm’s investment banking arm, is nowadays managing director of boutique Integrity Investment Management. In an interview with the Australian Financial Review today (Wednesday 24 June 2009) Fiani forecasts: “I think this is going to be a long, drawn-out economic recovery”.

Fiani suggests investors start zooming in on defensive stocks, the ones that largely missed out during the March-May rally. He names Woolworths ((WOW)), Westpac ((WBC)), QBE ((QBE)), Origin Energy ((ORG)), Coca-Cola Amatil ((CCL)) and Sonic Healthcare ((SHL)).

P.S. III – Daniel Goulding, publisher of the weekly Sextant Report, remains as bearish as ever on the prospects for the Australian share market. For those readers who’ve missed out on Goulding’s previous predictions: he remains convinced the ASX/S&P200 is ultimately heading for 2700, or more than a thousand points below the current level. Goulding also believes, similar to the TechWizard (see FNArena Technicals on the website) that the current share market correction will go much deeper than what we’ve seen thus far. He has also noted a striking similarity between the remaining bears in the market: they’re all Elliott Wavers.

P.S. IV – I cannot help but note that market speculation is increasingly zooming in on what China might do with all the commodities it has been importing in such large quantities since early this year. One analyst pointed out this week China has already imported the total amount for some metals he thought it would buy for the whole of 2009. So what comes next? Macquarie analysts suggest China might start selling some copper, and drive the current price down. The good news is, the analysts believe the Chinese will start buying again from the moment the price sinks below US$4400/t. Others don’t see China as a seller, but they suspect imports will soon dry up. What if there’s no demand yet elsewhere? I guess we’ll all find out in the weeks ahead of us.

See also my Weekly Insights earlier this week.

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