Novel Investor

Compounding investing wisdom...

The High Price of Free Trades

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The cost of trading may be higher than its ever been even though trading is free. In a bygone era, the cost of trading was mostly apparent. A commission was charged on every transaction.

Commissions acted like a speed bump or a governor on a car’s engine. It was tangible. It was obvious. It forced investors to slow down, realize a cost was involved, that had to be overcome to make a profit. It also didn’t take a genius to know how the broker made money.

Today that speed bump is gone.

There’s a second cost of trading that’s less obvious and easily overlooked. It’s self-imposed. It’s driven by human nature. It comes in the form of errors and mistakes. And, put simply, that behavior can be manipulated and extremely costly.

Warren Buffett once warned about the role brokers played in the markets (in relation to derivative securities), which seems especially relevant today. Continue Reading…

The Biggest Short Squeeze of the (Last) Century

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An epic stock market battle took place in 1901. Two heavyweights fought for control of a railroad, cornered the market, and forced the biggest short squeeze of the last century.

The Union Pacific was a railroad nobody wanted to touch, not even J.P. Morgan, in 1898. It was mired in bankruptcy — receivership in the hands of the government. But Edward Henry Harriman saw an opportunity.

Through a syndicate of backers —  the Vanderbilts, Rockefellers, Goulds, Ameses, and Kuhn, Loeb & Co. — Harriman took control of the road. In total, they paid $75 million for 1,800 miles of railroad and got every penny back in profits within three years.

Harriman recognized that expansion through acquisition was the most efficient way to lower costs and ensure profitability for Union Pacific. He quickly bought up competing railroads until Union Pacific dominated the U.S. west of Omaha.

Harriman needed to expand east. So he set his sights on a key acquisition. Chicago was the railroad hub of the country. Anyone moving people or products by rail from east to west, or vice versa, had to go through Chicago. The Chicago, Burlington & Quincy Railroad was a critical piece in controlling that movement. Buying the Burlington railroad would make the Union Pacific the strongest railroad in the country. Continue Reading…

Buffett and Munger Explain How to Avoid a Bubble

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The word bubble gets tossed around loosely these days. Depending on who you listen to, there’s a bubble in stocks, bonds, housing, cryptocurrency, and a few others I’m surely missing.

There’s no way it’s all true. Not everything has to end in a bubble and a crash but it will happen eventually because humans are great at finding new ways to repeat history.

Of course, Warren Buffett and Charlie Munger have made a career of profiting from those repeated mistakes. Their understanding of history, human nature, and the experience of a few bubbles in their time allows them to recognize and avoid what draws so many people in.

Buffett explains why it happens this way: Continue Reading…

Trading Sardines

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One of the big lessons Ben Graham taught in The Intelligent Investor was the difference between investing and speculating. He knew how easily the market distracts investors from their original purpose.

Most investors start off with the idea of compounding their money over a long period of time. But some of them are bound to get sidetracked.

Before they know it, some investors start feeding their impulses triggered by Mr. Market’s manic moods. Their emotions take over. Stocks become pieces of paper, rather than portions of a business, to trade in and out of. Price moves become the only factor behind their decisions.

Seth Klarman used a funny analogy in his book Margin of Safety to describe this mistake. He tells the story of special sardines.

Continue Reading…

A Study in the Psychology of Gambling

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Why is it that some people treat the dumbest bet possible as a stroke of genius when it hits? It’s not genius, obviously, but confusing skill and luck is a common mistake made by gamblers and investors alike. It’s one of many that arise when human nature and gambling collide.

When the House has the advantage, like in most games of chance, winning has nothing to do with brilliance. It’s almost always a bad decision saved by dumb luck. Yet, hindsight bias spares us from being honest with ourselves.

Picture the person who hits on 17 at blackjack and catches a 4. Or another who goes on an amazing run picking numbers playing roulette. It’s not some uncanny ability, infinite wisdom, nor foresight. It’s dumb luck. But the story told is about skill.

The mistake is not only denying good luck after hitting the improbable 4 on a 17 but embracing bad luck after busting on a hit on 17. The failure to account for stupidity is probably worse than being falsely endowed with unnatural gifts. Who learns from bad luck?

Of course, this problem is as old as gambling itself. A case in point is a letter to the editor of The Spectator in 1873. An insightful English gentleman shared a scathing assessment of himself, and his fellow gamblers, after his first experience in a casino. Continue Reading…

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