A mature oak> tree may produce tens of thousands of acorns, but on average only one in 10,000 will put down roots. The same goes for what ends up in our portfolios. Even the best investors plant lots of acorns that never sprout. However, the losses on those seeds end up being dwarfed by a few ideas that grow. As the financier Bernard Baruch explained many years back, "Even being right three or four times out of 10 should yield a person a fortune if he has the sense to cut his losses quickly on the ventures where he is wrong."
That's why I don't try to predict how exactly Sony's (SNE)
For example, a few weeks ago, I wrote about a short position in U.S. Treasurys, essentially a bet on higher interest rates. After showing initial profits as rates jumped, the trade reversed somewhat when bonds rallied. The trade stands as only a small gain. So now what?
Because we believe in our analysis, because we want to be right and because we want every acorn to grow, the natural tendency is to try and bully the market or add to a faltering position when it doesn't go our way.
That's the wrong approach. When it comes to the market, our instinct should be toward "flight" not "fight." In the case of my shorting of U.S. Treasurys, I'm still far from being stopped out on the trade, but the market has put me on notice that my outlook hasn't been confirmed, at least not yet. And despite my early confidence, no investment should be beyond one's discipline. Ultimately, the trade will perform or get cut.
As portfolio managers, we deal in dollars, but we're really trading positions. And because even the best investors aren't always right, money management is largely that process of deciding which acorns to water and which to toss. So, for example, when faced with option of adding to an open, winning trade notching multi-month highs or continuing to hold onto the insignificantly-sized loser we've been lugging around for two years, we know the former represents a much higher probability opportunity.
As investors, we plan dozens of acorns not knowing which, if any, are going to bear fruit. Turns out, we don't need to know -- the market itself tells us. The challenge is quieting our ego and having the courage to listen to the market, even when it tells us what we don't want to hear.
Jonathan Hoenig is managing member at Capitalistpig Hedge Fund LLC. At the time of writing, Hoenig's fund held positions in many of the securities mentioned.