I’ve been reading through the transcript of my recent webinar with Porter Stansberry and Steve Sjuggerud. There’s an unbelievable amount of valuable information for individual investors. Between the three of us there is over 60 years of collective experience of being on the front lines with individual investors.

This week I’ve culled through the entire transcript to bring you a few of the highlights.

Our host was Jared Kelly, the Managing Director of Stansberry Research.

There’s no such thing as a rational investor
Jared: Porter, you recently said that you’re not going to succeed as an investor with or without our newsletters, without using this software. What did you mean by that exactly?

Porter: Jared, I’ve worked with individual investors since 1996. What I know about the markets and what I’ve learned about investors is no surprise to any actual investor. There’s no such thing as a rational investor. They’re just herds of people who are led by emotions, mostly fear and greed, but also conformity. Everybody wants to be an AOL when it’s the year 2000, and it’s the top of the market.

Meanwhile, you think about all the great stocks you could have bought in the 2000, 2001 timeframe that you were not paying attention to because they’re out of favor or they are unloved, Berkshire Hathaway for one example.

I’ve just seen how this happens again and again and again … how the emotions of the market place dominate any other financial reality.

What I believe, the most important thing that TradeStops will do for you very simply and succinctly is it will take your emotions out of your investing forevermore. I don’t think you’re likely to succeed without it, not unless you have the emotional discipline of a Dr. Spock of Star Trek fame. I haven’t met that investor yet.

The importance of understanding volatility
Jared: Richard, if people are looking at their portfolio and they don’t know if a new stock is going to jive with their existing portfolio, how do they know what makes sense for them?

Richard: Like I said, people don’t really look at their portfolio as a whole. They’re usually looking at individual stocks. I see Steve shaking his head, right?

Steve: Yep.

Richard: It’s hard to think about the portfolio as a whole. It’s not as exciting as thinking about individual stocks, right, Porter?

Porter: Of course, but we know that individuals are driven by the emotion and the story. As publishers we tell people great stories. Unfortunately, readers often do a poor job of applying them in their portfolios because they end up being overweight, the most volatile situations. Then they can’t handle the volatility.

My favorite expression is every investor you talk to, they start out being a buy and hold investor, but when the S&P falls 60 percent they find out that they’re a buy and fold investor. Of course, what actually establishes the market tops and bottoms is those same waves of emotion.

If you’ve been in the market for a couple cycles, what you realize right away is you have to build a portfolio that can survive those incredible emotional dynamics. The only way to do that is to know what the risk of your portfolio is.

Richard: In TradeStops I developed this metric and I call it the VQ, or the volatility quotient. It tells you exactly how volatile any individual stock is.

Take Weight Watchers for example. The volatility factor (VQ) on that stock is 46%. That tells you that Weight Watchers can move up or down 46 %without giving you any new information, without telling you whether or not you should sell. That’s a very volatile stock. Looking at that one number changes the way you would think about Weight Watchers, doesn’t it?

Porter: There’s a lot of noise in that signal.

Richard: There’s a lot of noise in that signal, exactly.

Porter: If you guys are fans of Claude Shannon and the “Mathematical Theory of Communication.” I doubt you are, but I know Richard’s read it.

Richard: Absolutely, in fact that’s what I did my PhD on, was communications theory.


Richard: Johnson & Johnson, for example, more like 12 percent volatility in that stock. Berkshire Hathaway, about 12 percent. Gold, about 13 percent.

Porter: Can I jump in one more time?

Richard: You bet.

Porter: Because, again, I have found something about volatility that I don’t think is commonly recognized in the markets today. What I’ve been thinking about is why is this so?

Why are some stocks so less volatile than others? With Johnson & Johnson it’s an easy thing to understand. They have a hugely diversified base of business. They’re one of the only remaining, or maybe the only remaining, AAA rated company. I think Microsoft is still, too.

Richard: And Microsoft.

Porter: You can understand why. Those things are danged battleships. They don’t move much.

But it never really made sense to me that Hershey would be that un-volatile, half as volatile as the market, or that McDonald’s would be that stable, or Berkshire Hathaway.

Berkshire Hathaway is an insurance company that underwrites catastrophic risk. You would expect to see a lot of volatility in that. You should, but it’s not there. I got to thinking about why that was so.

I can’t prove this, and perhaps that will render this advice meaningless in Richard and Steve’s eyes, who are the quants in the room. They want everything proved to the fourth decimal place. But what I figured out was that one of the main reasons why there’s no volatility in some of these stocks is because the shareholder base is so solid.

This is the smart money, so to speak, or the strong hands. They talk about it in a bear market. Money flees from weak hands to strong hands. These guys are the strong hands so when everybody else panics they don’t move. They don’t sell.

In Hershey’s case I’m pretty sure that 20 percent of the float is owned by a trust, the Milton Hershey School as the beneficiary, and they’re not allowed to sell. You take away some of that float off the market and it’s held in a permanent hand, there’s going to be much volatility is my theory. Again, I can’t prove it.

This is what I’ve just seen again, and again, and again, when you meet the people who own Berkshire Hathaway you realize right away why the stock doesn’t move much because these guys are all extremely wealthy and they’re not panicking.

Richard: I just think investors really need to understand the volatility of their stocks. It was really a big change in my investing when I started to look at that on a regular basis. You can go to Yahoo Finance. You can see things like beta, but they’re pretty hard to understand.

My VQ tells you, how much you should expect a stock to move around over the course of a year or more. Weight Watchers 47 percent, Johnson & Johnson 12 percent. Those are two very different stocks. They play different roles in your portfolio.

That’s why lots of times people are buying the wrong stocks. Again, I don’t mean they’re buying bad stocks. I mean they’re buying the wrong stock for them in their portfolio in that period of time.

The importance of taking losses …
Richard: Let me show you one chart …the Bill Ackman chart.

Porter: Oh, I like this one, yes. Poor Ackman, he’s had a rough go.

Richard: He has had a rough go. [laughs]

Porter: First he picked a fight with Carl Icahn of Herbalife.

Richard: Ouch.

Porter: Then he decided to pick a fight with the federal government on Valeant.

Richard: I just want to make a point here about trailing stops, because a lot of people…we have a hard time selling when our stocks get hit. Right, Steve?

Steve: Absolutely. I think part of it actually comes down to the book that we were talking about at dinner, the Thaler book.

Richard: “Misbehaving?”

Steve: He actually says it’s twice as painful to take the same dollar amount of loss as the joy that you get out of taking that dollar gain. People do not want to experience the pain of the loss, so they put it off, they put it off, and they lose more money, and lose more money.

Jared: They do it, by the way, in every aspect of their lives.

Steve: Absolutely.

Jared: Whether it’s weight management, a bad relationship, a bad job, whatever, you’re going to put off that moment of realization of the pain.

Steve: That’s right.

Richard: The point I wanted to make, here, with this Bill Ackman and Valeant trade, everybody knows about Valeant Pharmaceuticals, right? Look where a trailing stop would’ve gotten Bill Ackman out of Valeant Pharmaceuticals. (See chart above.)
The point I’m trying to make here, is we get attached to our stock, sometimes, right? We read the stories, we get excited, we get an emotional attachment to the stocks, and we don’t want to let them go.

If I know that Bill Ackman can’t understand what’s going on inside of Valeant, how do I hope to understand what’s going on inside of any of my stocks?

Jared: Nobody can.

Richard: We really have to be able to let go of our stocks when our stops get hit. We have to understand that it’s actually a small victory to sell.

Jared: Didn’t Bill Ackman double down right around then? [laughs]

Porter: Yeah, he did.

Richard: I think he probably doubled down.

Porter: He doubled down in November. I’ll tell you, the other thing, that you’re talking about, if Ackman can’t know what the real value of Valeant is, how does anybody know anything, because he knows the company inside and out, he’s on the board, he’s the largest investor, all that stuff.

I know Steven can relate to this, one of the things that just blew me away as I came along as a securities analyst, was how let down I continually felt when I met senior management teams. I would go meet these people, who I thought were brilliant based on what I read about them in their profile in “Forbes” magazine or something. Then, I would meet them, and I’m like, “I wouldn’t let them walk my dog. This is the biggest buffoon I’ve ever met in my life.”

One of the things that happens as you gain experience as an investor and as you meet people, is you realize, man, you can’t know what kind of stupid thing they’re going to do next, and you’re almost surely overestimating management’s abilities.

Steve: One critical point about this, as well, is that you have to change your mind set about taking losses, Richard. Part of it is about understanding that part of winning is taking small losses, and being willing to concede some battles to win the war. I think that’s a good analogy, because that’s what you have to do. You have to realize that, “By me doing this, at this moment, I am actually winning the war. I’m on my way.”

Porter: There’s no successful investor in history who doesn’t take losses, not even Warren Buffet. You’ve got to learn how to take losses, and you’ve got to learn what kind of losses are normal and within the boundaries of your successful strategy. That’s exactly what TradeStops teaches you to do.

Sound like great advice to me!

Best regards,