I turned $50000 into $35000 in 2 years, here's what I learnt
Documenting my mistakes and how they've shaped my investing process
I’ve been lucky enough to do really poorly in my first couple of years investing. This means that I’ve made a bunch of mistakes before settling into a specific style, getting any confidence or having a large capital base to work with (which I think have all been issues for growth bros coming into 2022). The mistakes I’ve made have shaped my investing style more than anything else. Even having heard a lot of these lessons from other smarter people, I didn’t really understand many of them until they affected me in real time. I figured I would share them with you all to give you a bit of an insight into my investing style and process. I hope you enjoy this record of my fuckups.
Position Sizing
I’m not smart enough to go hyper concentrated in a stock. I don’t know what I don’t know. I currently have a ¼ hit rate on companies that I’ve made a significantly concentrated position (>20%). Despite solid stock picking, I’m significantly down due to these significant detractors. It’s worth missing some upside to avoid significant downside.
Examples: Overly large positions in ASX:MME, ASX:ZGL and US:BABA which were all bet’s I think were fair to make at the time, but I sized way to large.
What I do now
I now have set position sizes: speculator (1%), starter (2%), buy (4%), full position (8%) and double down (16%) which is reserved for when a stock I know well becomes significantly cheaper with nothing about the thesis changing. I can’t double down more than once, or on a stock that has significant downside risk.
Capital Impairment
Related to position sizing, I understand better now why so many funds focus on capital preservation and companies with low downside. I underestimated the downside risk of many of the larger investments that I’ve made, with many of them being fairly binary outcomes with significant chances of permanent capital impairment.
Examples: See above. All three had significant chances of going down significantly.
What I do now
I now make sure to identify what type of bet I’m making. Is the probability distribution a bell curve or binary. A bell curve distribution I’m happy making a larger impairment as the there is a lower probability of significant capital loss. Binary bets (such as regulatory bets, companies with significant leverage and shitco’s) are fine, but should be approached quantitatively, not allowing any individual big blow up to significantly impair my portfolio.
Leverage
In my second year of investing my stock picking has been significantly improved. The biggest source of losses has been poor decisions around leverage. This was 3 part: not being conscious of factor exposure, being too concentrated in specific stocks and being long only. This meant that when those positions went against me it hit my whole portfolio really hard.
Examples: I had way too high leverage in SBLK and STNG, which dropped significantly in the leadup to the Ukraine war. This forced me to sell, and then miss out on the huge rip that followed. I got the bet right but the trade wrong.
What I do now
Firstly, I run my leveraged portfolio long/short so as to reduce risk, adjusting exposure minorly based on the market. I also have a set position size for every position, with 1 double down allowed. I try to somewhat balance my longs and shorts by factor as well, though not just for the sake of it. I also generally avoid going leveraged long more speculative companies with higher downside risk.
Commodities/Highly Cyclical Stocks
Almost every commodity play I’ve made has gone against me. These areas are highly complex and heavily exposed to broader macroeconomic factors. My already weak experience and knowledge is exacerbated in these markets as I really have no idea.
Examples: Almost every one. Lumber with GFP, Tin with MLX, Dry Bulk with SBLK (which was the right call in the end, but I didn’t have the conviction to hold), housing with CCS.
What I do now
I now generally try to avoid commodity stocks. My largest commodity position allowed now is a buy (4%) in rare circumstances, with 2% being my maximum usually. The value proposition needs to be extreme, with at least some level of capped downside. Capital returns are essential.
Doubling Down
Doubling down is another one of those things that’s great in theory, but doesn’t always work out as well in practice. Obviously, Buffett’s a big fan, but Buffett is also way smarter than me and less likely to make a mistake. The fact is that I get a lot of ideas wrong, and if I double down everytime I’m just buying more of my poorly performing ideas. This is not to say I’m against it in concept, I just need to have rules and structures in place to ensure I don’t get hurt if it goes poorly. Being aware of thesis creep is the most important, when the initial thesis goes against me just cut it.
Examples: I bought the dip all the way down with both BABA and MME as both periods deteriorated.
What I do no
I only double down on companies without significant long term capital impairment risks (like leverage or regulatory risk). I get one double down, after that I don’t keep buying, and only if nothing has changed in the business (eg. no poor results or shifts in the macro outlook).
Shorts
Despite being 50% short in my trading account coming into 2022, I didn’t perform as well as I would hope relative to the market. The shorts I held were crowded and high borrow fees and trading fees (from overtrading) ate away at my returns, the extent of which I only realised when looking at my P&L statement. I also wasn’t thoughtful enough about correlation, so much of my gains were wiped out during one of the great shitco squeezes on the way down.
Examples: FFIE, AMC and SAVA all cost me a crap ton in borrow, and forced me to trim by squeezing hard at various times.
What I do now
I’m much more thoughtful about the companies I short now. I avoid anything with high borrow, as I believe I will be able to find just as good shorts with lower cost. Furthermore, I avoid meme stocks, or just anything that has the capacity to squeeze me out. Finally, I aim to find shorts that are fairly uncorrelated.
Management
Execution risk is pretty huge, poor management should be discounted significantly as they can ruin any good thesis, as they have for a few of my companies. Heavy insider ownership isn’t always a good thing if the owners aren’t shareholder friendly. Furthermore, heavy insider ownership doesn’t help with incompetence. Management confidence and bullishness is great, but means nothing if they’re incompetent or inexperienced.
Examples: ZGL was a good thesis that was ruined by crap management. NNM is a good example of majority ownership that screws minority holders. MME is a good example of motivated, incentivised management making mistakes from being inexperienced.
What I do now
I now place a much larger discount for poor management than I used to. While I value insider ownership, I value manager track record much more. Reading past earnings calls is now an essential aspect of my due diligence. Also, I now put a discount when valuing companies with majority owners (I used to think it was a good thing) as minority shareholders can get screwed.
Some other smaller lessons I’ve learnt:
Be wary when everyone’s interested in a trade. The ship has often already sailed. Eg. GFP, META, BABA, Tin companies.
Buybacks are great in most situations, but not all. Buybacks with significant leverage can hurt a company's liquidity position and destroy value in spite of how cheap it is. Eg. BBBY, QRTEA.
Geographic and regulatory risk shouldn’t be understated. As soon as you ignore it will be when it manifests.
Avoid trying to trade, it hurts both through fee’s, but also psychologically.
Complex situations are a great way to gain an edge in theory, but in reality they’re really complicated and I don’t know what I don’t know.
Be aware of macro, but don’t invest based on it. Try to find ideas that work decently regardless of the environment.
Technical and sentiment analysis can be useful. I don’t invest using technicals, but they can be a good way to time entries into positions and to dictate weightings, especially in my long short portfolio.
Things that are disconnected from valuation can get more disconnected. Don’t try and catch a falling knife or short something that’s mooning. Wait for sentiment to at least stabilise.