Professional Military Strategy:
On days we don't trust, our analysis should be strictly military -- by the book. Here is that book.
The most important issue for us is inventory control. Getting control of inventory must be the most important job and should be accomplished at all costs. If you have too much inventory and not enough cash, then you must play defense, with an eye toward an offensive breakout, rather than trying to go for higher ground.
Getting control of inventory means deciding which stocks should be kept and which should be sold in a dispassionate, off-the-desk, way. The best way to do this is by a rating system that ranks the winners and the losers. During this painful process it is vital, no matter what, that you buy the top-ranked stocks as you sell the others, because mentally, it is too debilitating (if you are wrong about selling inventory) to watch the market going higher after you have completed your selling and you did no simultaneous buying.
During those periods it is vital to retreat from the battlefield, where the casualties incur such a sting that they can affect your judgment in a negative way. As we are both extremely affected by the emotions of both losing money and losing in the face of competition, it is important to recall that we always succeed when we approach the process with teamwork and without emotion. We always prolong the agony when we are down on each other or down on ourselves. The fortunes of the firm depend on us, not the market, as we have shown an ability to make money, regardless of the market's direction.
After you make a plan, do not be afraid to tear it up within seconds of contact with the enemy. This is because much bigger competitors are also adjusting plans, making our plans obsolete after we have uttered them.
Let's take an example. After a brutal down day, with no redeeming qualities, one where you took on inventory out of a strategy of buying weakness -- SOP -- your default choice is the sell at the opening if it is higher. That is logical for two reasons:
If the opening had been tacked onto the previous night's close at 4:30 p.m., you bet you would be flipping stock up 50 Dow points.
You are an inventory manager and you must already be prepared for when the buying stops and the merchandise comes in for sale.
Just as important though, is the following: If market psychology takes the market down, but the sellers don't come with it because they are exhausted, you must be ready to take on a massive amount of inventory, in the form of out-of-the-money and slightly in-the-money calls for a coming reversal.
This reversal can be telegraphed in two forms. If the bond market gets strong, it will be telegraphed in the form of Gillette, Procter & Gamble, Coke, Merck and several ultra-high-multiple OTC stocks. If the bond market is neutral it will be telegraphed in the rallying action of a handful of high-class tech names. To ignore this change is to just be stunned. You must take action, you must reverse course. You must abandon your trenches and attack. Or else you cannot outperform. Remember, standard operating procedure is to outperform on down days, not up days. Statistically, despite a massive long-running bull market, this strategy has consistently beaten a straight long strategy. When the market is tough, it should, per se, clobber a straight long strategy if it is adhered to.
At all times the propensity to be angry or second-guess will color much of your thinking. You must consciously go beyond that. You will no doubt, in the course of the battle, replay and even undo certain trades that would have turned out to be good trades. These are casualties of war and every great army suffers them. If you dwell on them you will miss that opening in the enemy's flank that was meant for you to turn the battle around.
Remember, the Civil War of the United States should have ended in 1862, but the operative plan of the U.S. Army was to draw up a battlefield plan and then stick with it at all costs, as it was created under ideal, sterile conditions without a whit of emotion. It was not until mid-1863 that Lincoln recognized that battlefield plans do not survive contact with the enemy and what mattered was the ability to do the exact opposite of what was planned if the situation called for it. Because the enemy has no set agenda. The enemy has no battle plan. It is ad hoc by nature.
The possibility exists that you may be doing too much at one level. Given the fallibility of any human being's thought processes, this instinct is most likely correct. Even when you think there is an opening to play offensively, you must guard against committing a reserve until you feel it is right. Great generals commit reserves when they don't need them, to be sure they crush the enemy. Bad generals commit reserves because they have planned poorly and are out of options.
At some point, you will believe you are out of options. That is a false belief born of the mistaken notion that stocks are not inventory, but are fixed ballast. That is quite wrong. Everything can be moved at a price. Everything.
During periods of crisis make no long-term decisions about the firm. These are periods where your concentration should be 100% devoted to helping me and my concentration should be 100% devoted to helping you. We must be willing to tell the other person that he is wrong. Without the debate, it is likely we have missed something in the enemy's battle plan that will come back to haunt us.
Never capitulate. Here is where the military analogy fails us. The war never ends. Your army must be ready to play the next day, no matter how bad a drubbing you have taken. |
