I have always been interested in probabilities. Whether it be sports betting or fantasy sports or speculating in stock markets.
When I was a senior in high school during 2008-09 I dragged my father to Wells Fargo (NYSE:WFC) to open up a brokerage. I speculated in biotech stocks. Not because I knew anything about them, but because they were incredibly cheap and oversold. For instance, one of my first stocks was ACADIA Pharmaceuticals (ACAD) and I bought it for less than $1 a share.
A few years later at the end of 2013 it was over $27. Another stock was Krispy Kreme Donuts which I bought for $1.50 and it was over $20 around the same time in 2013.
I felt extremely smart. As if it was my own genius that created these gains. That I saw something special in them no one else did.
I took the money I made and looked at the market. It was the end of 2013 and gold stocks were getting hammered. It had striking similarities to that of the biotech/pharma stocks did in 2009 & 2010. Oversold, cheap, and no one wanted them.
In 2014 I studied metallurgy and mining and piled through tons of gold (GLD) and precious mining stocks to find what I wanted. I threw every dollar I had into them. Financial industry friends of mine thought I was insane to not diversify.
"Gold is an ancient relic. No one cares about it anymore. It will fall below $500," they all told me.
But their angst against it, and without telling me reasons behind their distaste for gold, only fueled my speculations. It was as if no one could give me an answer why gold wouldn't go up again. Only telling me simply, "only fools own it" without any other explanation.
There was more to it, but long story short, it was a brutal two years from 2013 to 2015. . .
I owned large equal amounts of stocks like Gold Resource Corp (GORO), Kinross Gold (KGC), IAMGOLD (IAG), Yamana Gold (AUY) and smaller junior miners/explorers such as Teranga Gold (OTCPK:TGCDF), Perseus Mining (OTCPK:PMNXF), and Sirios Resources (OTC:SIREF). My focus was to find stocks that could survive a bear market. The only problem was, it was taking far longer than I ever imagined.
I was down over 50% at October 2015. Three years since gold started its bear market. I wanted to kill myself.
"But. . . They're so cheap? Last time in 2009 it wasn't this bad. The pharma stocks at-least didn't keep falling," I said to myself.
I had to rethink my strategy. Being contrarian wasn't enough this time. Especially in such a cyclical sector.
Unfortunately, I had to sell my stocks for immediate liquidity (yes, at large losses) because of an emergency that I did not foresee happening (something I later learned from significantly).
There I was. Sitting alone in my bedroom, with a decade worth tax-loss write off's that wouldn't do anything for me today, but still confident in the gold market. I had to formulate a new strategy.
I looked at my bookshelf. Over the last 3 years I had bought 100 plus books on finance, economics, history, philosophy, etc.
I saw a few books I had bought buried under my "to read" pile. It was The Dao of Capital by Mark Spitznagel and Fooled by Randomness, Black Swan, Antifragile by Nassim Taleb and the Misbehavior of Markets by Benoit Mandelbrot.
I remembered I tried reading Black Swan a couple years prior and I couldn't stand Taleb's narcissism. But, for some reason, I decided to give it another shot. I was down more than half my fortune. Everything was on the table.
I picked up and read Antifragile first. And I was hooked.
"This was the missing piece. This is where I went wrong. Not just in 2014 with gold stocks, but I went wrong way back when I made a small fortune in 2009," I said to myself.
I couldn't believe I didn't read this earlier. The feeling of a pit in your stomach settled in, realizing I could have prevented such losses and unforeseen events.
I bought a pack of Moleskine notebooks and pens and literally re-wrote the best parts of each book in my own words to use as a practical guide.
It was now the end of December 2015. Feeling awoken, I told my friends I bought each gold stock again. They laughed at first, thinking I was insane.
Insanity: doing the same thing over and over again and expecting different results - Albert Einstein
But this time, I bought 1 year, way out-of-the-money CALL options on those stocks. I paid less than a dime for the IAMGOLD, Yamana, Kinross and even less for the Gold Resource Corp options.
The only way these would have worked would have been if gold suddenly spiked. And when you pay for something less than a nickel, all it needs to do is double to a dime to make you 100%. That type of optionality I learned from Taleb is indispensable.
Worst case scenario? I would lose my premiums I paid if they expired. Then I would simply re-evaluate the market and if I still see the shining upside from gold, I would buy another years worth. And on and on.
This way I paid 1/10th the cost with 10x the leverage. This type of asymmetry (low risk - high reward) is what speculating is about.
Thankfully - luck went my way. And gold spiked in the beginning of 2016 all the way until November.
Looking at Gold Resource Corp as a case study, you can see how giving yourself a lengthy period of time, and paying extremely low costs, sets yourself up for higher probability of success. All while risking less upfront capital.
It isn't that I had to be perfectly right. I just had to be generally correct, and let the probability of sudden volatility or a sudden market sentiment change happen.
That is what I realized. The future is uncertain. Fads and markets change. Economists use models and equations to justify what they believe comes next. When in reality, instead of having to constantly try and predict the future and bet for things to perform to perfection, make the uncertainty your ally and be only sorta right. Even if you're right for all the wrong reasons (for example, you buy stock XYZ because of event ABC, but something else happens that sends the price higher - still making you money).
I would always watch those gold analysts in 2014. All of them thought they knew why and when markets would turn. "Gold will rebound because of ABC in two months," or, "the price of gold has bottomed here because XYZ, we can expect upwards momentum from here," they said. Only to be crushed.
The mistakes I learned from 2009-13 was that I confused what I thought was my own genius with a bull market. Everything was going up after years of a bear market post-2008 and Ben Bernanke's money printing. You could be the smartest and luckiest guy, but going against a rising tide, especially backed by the Fed, is fatal. Even worse than that is estimating you know the future and when the tide will turn (you won't).
That is why the practicality of the 'barbell strategy' is important. You won't blow yourself up if the market has turbulence.
After adapting my new "Hunting for Fat Tails" strategy by making uncertainty my friend and looking for asymmetric opportunities, I have studied and learned much and actually made practical use from some theories.
These are the five things I learned after losing a fortune before my 25th birthday...
1. Most Economic Theories Don't Work and You Can't See the Future - many believe that what we learn in economics helps us predict the future. For instance, if inflation rises then so will interest rates or if inflation rises unemployment decreases (Philips curve). Rate hikes are bad for gold and vice versa. But there are many schools of economic thought. Each have something interesting to say. Take it all with a grain of salt. Understanding economic fundamentals is important, but remember, it is only theory. Many have been burned trying to replicate what worked in the past. Instead, be practical and understand you cannot see the future. Position yourself to profit from uncertainty instead of being crushed by it.
2. Cycles Are Extremely Important - no matter how good a stock looks, if it is in a sector that is in decline, beware. There were plenty of gold stocks that were still making money even at $1,100/oz gold but they will get dragged down with the entire sector. For instance, look at oil since 2014. Many enjoyed the boom years of $100+ oil until a glut occurred and the supply of oil was oozing out everywhere. Everything tied to "oil & gas" got killed, regardless of their fundamentals. Using cycle theory for investing is important, especially in commodities, to position yourself with options. You don't have to know the exact date a boom will turn to bust, but we know it will eventually happen. After years of oil going up it would have been logical and profitable to buy long dated put options and wait. Understanding cycles and the use of optionality to give yourself a thick margin of safety and ample time can be very attractive.
3. Become Antifragile - many strive to make 5-8% annual gains for years, only to lose it all suddenly. This is being 'Fragile'. Imagine an antique glass vase that sits on your coffee table for years only for a small bump or shake to shatter it.
Instead, harness the potential randomness of an accident occurring and profit from it. This is being antifragile. The opposite of fragility. Shaking and disorder make it stronger and more valuable. Therefore, make volatility and uncertainty your friend and let them work for you instead of trying to always avoid them.
4. Optionality - there are 3 prongs that I look for that give me favorable optionality. It has to have a low fixed cost, theoretical unlimited upside, and reasonable probability of occurring. What I mean by a "reasonable probability of occurring" is that many think certain things are a 'sure bet' or 'could never happen'. Don't go buying Tsunami insurance in Phoenix Arizona, but buying Puts on a stock like Amazon (AMZN) has a bigger chance than many think to play out. Remember in UFC 193 when Ronda Rousey got KO'd by Holly Holm? Everyone was crazy about Ronda that the bookies made unreal odds thinking she would never lose.
But in reality, there was a 50/50 chance of her losing. I call this 'Rousey Effect'. . .
Optionality is giving yourself protection and to profit from the unknown, or better, protection against what the crowd thinks they do know. My 4 rules of optionality are:
- Always look for optionality by first understanding what is fragile, robust or antifragile.
- Has open-ended payoffs with fixed-low costs (buying options), instead of capped gains with open-ended risk (selling options).
- Is asymmetric (low risk with high reward)
- Being wrong won't "blow up" your portfolio, and 1 time being right can make up for 99 small losses.
5. Beware of the So Called "Experts" - beware the 'Authority Bias'. In behavioral economics and finance, this is the general notion that we tend to believe anything we hear if it comes from an "expert". Or that we feel stupid if our ideas contradict theirs.
How many times have you thought one of your teachers was flat out wrong. But you refrained from saying anything because you wondered, "well, they are the teacher. They do know better."
I know I sure have. . .
But I learned early on that above all else, a person's profession does not determine who they are. Just because someone is a banker does not mean they understand finance. Or because someone is a doctor they are a caring, good person who's only concern is to save lives.
It's like were conditioned to think this way. As if very police officer is a man of integrity and justice seeking and keeping the peace. But we see bad people becoming cops for the wrong reasons all the time.
Even our world leaders cause us to suffer from this misperception. . .
Therefore do not always trust the expert or conventional wisdom. To be a speculator you need to have an independent opinion and healthy skepticism. Riches are made betting against these commonly held precepts once they implode on themselves.
I have learned much since those losses. I try to look at it as if "I learned how to fish instead of someone always giving me a fish" i.e. learned the fundamentals, rather how I was simply lucky in 2009 and was basically given money.
As the Fed starts tightening and cheap money has chased assets higher, I am worried many will think it was their own diligence that made this happen.
Beware at all cost.
Disclosure: I am/we are long VIXM, GLD, AUY, GDXJ, GORO.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I found more asymmetry (low risk/high reward) from buying 1 & 2 year PUT OPTIONS that are "out of the money". By buying the PUT options the investors downside is limited in case my thesis is wrong. And if it proves correct, upside is unlimited within the options time frame. I have strike prices that are between 50-75% lower than current share prices, as I fully expect the stocks to suffer significantly within that time frame. Also the optionality instead of shorting protects investors from potential rallies or short term swings from Fed jawboning or etc. This allows investors to pay a cheap premium today and wait until the market reprices in the future.
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.