Lessons on Trading and Markets from "Adam Smith" And The Money Game

If you’re wondering why “Adam Smith” is in quotations, it’s because the name is the pseudonym adopted by the author who wrote The Money Game, a 1967 market classic. In the author’s own words, the book is about “image and reality and identity and anxiety and money” —  everything that makes up markets…Here’s some of “Smith’s” teachings:

You and I know, that one day the orchestra will stop playing and the wind will rattle through the broken window panes… We are all at a wonderful party, and by the rules of the game we know that at some point in time the Black Horsemen will burst through the great terrace doors to cut down the revelers; those who leave early may be saved, but the music and wines are so seductive that we do not want to leave, but we do ask, ‘What time is it? what time is it?’ Only none of the clocks have any hands.

Successful trading is a game of gauging sentiment in order to discern timing; all while trying to stand apart from the crowd (no easy feat). The irony is that the “Black Horsemen” tends to burst through the door the moment party revelers finally stop asking “what time is it?”

‘The market,’ says Mister Johnson, ‘is like a beautiful woman — endlessly fascinating, endlessly complex, always changing, always mystifying. I have been absorbed and immersed since 1924 and I know this is no science. It is an art. Now we have computers and all sorts of statistics, but the market is still the same and understanding the market is still no easier. It is personal intuition, sensing the patterns of behavior. There is always something unknown, undiscerned.’

Investors today are even more awashed in statistics and data, or what we at Macro Ops call “noise”. The game of speculation will always stay the same because it’s always changing.

If you are a successful Game player, it can be a fascinating, consuming, totally absorbing experience, in fact it has to be. If it is not totally absorbing, you are not likely to be among the most successful, because you are competing with those who do find it so absorbing.

These are true words… I’m endlessly amused by the droves of traders who spend an hour or two of half-hearted study in the markets each week and expect to produce alpha. If you want to win in this game, you have to go all-in on learning and constant evolution. This takes an extreme level of dedication. There’s no half-assing long-term survival here.

What is it the good managers have? It’s a kind of locked-in concentration, an intuition, a feel, nothing that can be schooled. The first thing you have to know is yourself. A man who knows himself can step outside himself and watch his own reactions like an observer.

“The first thing you have to know is yourself.” This is paramount. The greatest traders all possess an unusually high level of self-awareness. The road to trading mastery is as much a journey in self-discovery as it is one in producing high-risk-adjusted returns.

If you are not automatically applying a mechanical formula, then you are operating in this area of intuition, and if you are going to operate with unition — or judgement — then it follows that the first thing you have to know is yourself. You are — face it — a bunch of emotions, prejudices, and twitches, and this is all very well as long as you know it. Successful speculators do not necessarily have a complete portrait of themselves, warts and all, in their own minds, but they do have the ability to stop abruptly when their own intuition and what is happening Out There are suddenly out of kilter.

A couple of mistakes crop up, and they say, simply, “This is not my kind of market,” or “I don’t know what the hell’s going on, do you? And return to established lines of defense. A series of market decisions does add up, believe it or not, to a kind of personality portrait. It is, in one small way a method of finding out who you are, but it can be very expensive. That is one of the cryptograms which are my own, and this is the first irregular rule: If you don’t know who you are, this is an expensive place to find out.

In my years in the markets I have found that there’s been a strong correlation between my trading performance and my mental state outside of markets. When things are out of kilter in other parts of my life, my trading will usually reflect it. It’s important to maintain balance and reduce or step away from trading when you’re in a poor mental state.

The first thing we know, says good Dr. Le Bon, is that an individual in a crowd acquires — just from being in a crowd — “a sentiment  of invincible power which allows him to yield to instincts which, had he been alone, he would preferred to keep under restraint… the sentiment of responsibility which always controls individuals disappears entirely.”

It’s just plain human nature to give in to herd instincts and get caught up in irrational exuberance. The market serves as a perfect window into this phenomenon. You have to always try and separate yourself from the thinking of the crowd. Like Mark Twain said, “Whenever you find yourself on the side of the majority, it is time to pause and reflect.”

There is one other rule you ought to keep in mind, and that is to concentrate, and not only in the Zen sense. Sweet are the uses of diversity, but only if you want to end up in the middle of an average. By concentrate I mean in a few issues only. There are, at any one moment, only a few stocks that have a maximum potential, and I, for one, am not smart enough to be able to to follow more than a handful of stocks at a time.

Conventional wisdom on diversification is plain stupid. If you’re trying to beat the market, then you’re going to have to play the game a bit differently. It’s much easier to pick and hold a handful of really good assets than to manage a hundred of them. Like Druckenmiller, you actually want to have all your “eggs in one basket, and watch the basket very carefully”.

A stock is, for all practical purposes, a piece of paper that sits in a bank vault. Most likely you will never see it. It may or may not have an Intrinsic Value; what it is worth on any given day depends on the confluence of buyers and sellers that day. The most important thing to realize is simplistic: The stock doesn’t know you own it. All those marvelous things, or those terrible things, that you feel about a stock, or a list of stocks, or an amount of money represented by a list of stocks, all of these things are unreciprocated by the stock or the group of stocks. You can be in love if you want to, but that piece of paper doesn’t love you, and unreciprocated love can turn into masochism, narcissism, or, even worse, market losses and unreciprocated hate.

Know this, internalize it, and never forget it.

Personal intuition does not mean that you can translate last night’s exotic dream into some brilliant choice in the market. Professional money managers often seem to make up their minds in a split second, but what pushes them over the line of decision is usually an incremental bit of information, which, added to all the slumbering pieces of information filed in their minds, suddenly makes the picture whole.

Soros would argue for hours with someone on why he was bullish on a particular thing, only to completely reverse his position and be a raging bear the following day — usually due to a single new piece of information that caused one of his “backaches”. Mental flexibility is key. Strong opinions weakly held. Never become wedded to an idea; remain fluid like water and open to that new piece of information that “makes the picture whole.”

The Money Game is timeless market wisdom. Learn it, live it, and you won’t end up like “John Jerk”. John Jerk is from an article titled “The Day They Red-Dogged Motorola,” written by Adam Smith, where Mr. Jerk is the typical individual investor. Here’s more on John:

In more polite circles, John Jerk and his brother are called “the little fellows” or “the odd-lotters” or “the small investors.” I wish I knew Mr. Jerk and his brother. They live in some place called the Hinterlands, and everything they do is wrong. They buy when the smart people sell, they sell when the smart people buy, and they panic at exactly the wrong time.

There are services that make a very good living out of charting the activity of Mr. J. and his poor brother. If I knew them I would give them room and board and consult them…. I would push the pheasant and champagne through the little hatch of his cell and ask Mr. J. what he was going to do that morning, and if he said, “buy,” I would know to sell, and so on.

Don’t be a “John Jerk”...