Better to be dead wrong than dead right

When I was in college  one of my favorite classes was a history course on the Jewish diaspora after the Spanish Inquisition. As part of the curriculum I stumbled across  a book by a Sephardic Jew named Penso de la Vega who settled Amsterdam, became a diamond merchant and got involved in the trading of East India shares on the Amsterdam stock exchange. The book, Confusión de Confusiones, is considered by many to be a hidden gem and is the earliest western text on derivatives trading ever written. It was, in fact, the book that sparked my interest in the markets.

So I found it more than a little amusing that Ari Bergmann of Penso Advisors - a thirty year veteran of volatility trading - called it one the ten best investment books ever written. It’s true that centuries before Black Scholes de la Vega was writing about option pricing, about bear raids, about short squeezes and about every market manipulation known to man in a style that most readers would find remarkably modern. For anyone with an interest in history or markets de la Vega’s book is worth a read.

But  Bergmann himself is an interesting character with a long history of trying to find long convexity trades that are greatly mispriced. In layman’s terms that means he has been successful enough to find enough multi-baggers throughout his career to not only survive but thrive in this business. No easy task by any means.

Better to be dead wrong than dead right

When we are dead wrong about a trade we usually know it right away. We get stopped out and move on. However, there is nothing more torturous nor more dangerous than a trade that may turn out to be right in the end but could in the meantime suck out all of your capital and force you to surrender before the thesis proves true. AMC and Gamestop will eventually go bankrupt but unless you can budget enough capital and enough time (both utterly unknown variables) you can be taken out on a margin stretcher well before the turn comes.

The line between hero and zero can be very thin indeed, Mike Burry of The Big Short fame is seen as an investing savant but he could just easily be another failed short seller of CDSs if he did not bar his investors from pulling out their money when he was bleeding 20% on his positions. 

Bergmann’s point is that it doesn’t matter if you are wrong or right. The only thing that matters is if you have enough money to even stay in the game.

Don’t ever consider cheap with low prices

This is such a common mistake that all of us make. We like to buy options for 10 cents. We like to buy $1 stocks. We like to bet big on 10 pip moves. And we are doing it all wrong. Because the real question is not how little something costs, but what is the expected value of the trade. I am pretty confident anyone who buys Bed Bath and Beyond in hopes of a rebound will in fact be holding a bankruptcy bagel. On the other  hand Tesla which I personally despise may actually be great long despite its near 30 times greater per share cost if you accept the bulls thesis that this is a car company that enjoys Apple like margin is a business where everyone else is achieving the margin of a A&P.

Everyone loves to ridicule Nancy Pelosi for her superior “inside information” market trades, but if you study how she actually makes money there is very little mystery and anyone can do it. She buys LEAPs which are very expensive in terms of absolute premium but are actually great bargains in terms of time decay. So while the average joe schmoe investor loses his shirt chasing weekly expirations Nancy keeps banking millions year after year.  

Fires in movie theaters are only dangerous when you are watching the most popular movie

This is perhaps the most interesting insight from Ari.  If you are watching some horrible movie in a theater and a fire breaks out your chance of survival is actually pretty high. Most of the seats are empty and the path to the exit is unhampered. On the other hand, escaping an inferno during the first week’s release of Top Gun 2 is highly problematic because you will need to outrun everyone else in the theater.

What does this have to do with trading? Everything. Ari argues that during a 2nd leg down in a bear market it’s actually the BEST stocks that get hammered the most. This happens for two reasons. The best stocks hold the biggest liquidity, have amassed the biggest long term profits and offer the greatest absolute dollar profit potential to shorts. In other words when s-t hits the fan investors won’t dump BBBY ( how much of value is left there?) but will instead sell the FANGS and the brutal decline in those names will far exceed the “fundamental” case for a correction because flows will overtake valuation. This is a really interesting insight and could save a lot of mental and financial capital if you understand the dynamics before they actually occur.

Ari notes that in trading luck is nice to have but you can’t count on it, which is why his emphasis on process and proper budget for each trade is such a valuable lesson for us all.