Why some investors always make money & some lose? Gerald Loeb spots the gaps

What made Loeb really stand apart from the ordinary investors was his ability and desire to know exactly what it takes to be successful in the stock market.

“Nothing is more difficult, I truly believe, than consistently and fairly profiting in Wall Street. I know of nothing harder to learn. Schools and textbooks supply only a good theoretical background,” he wrote in his book The Battle for Investment Survival.

Gerald Loeb was a founding partner at EF Hutton & Co, a renowned Wall Street trading and brokerage firm. Loeb was born in July 1899 in San Francisco and an inheritance from his father, when he was very young, sparked a lifelong passion for investing.

He started his investing career in 1921 and was always ready to gather knowledge in trading, investing and economics. In 1923, he suffered a substantial loss of his overall trading capital and learnt to always cut losses short when market conditions are not favourable.

Loeb shared his wisdom and the lessons he learnt from his years of experience in the market in his book The Battle for Investment Survival, which is still considered as an essential guide to becoming a successful investor.

In 1971, Loeb published The Battle for Market Profits as a followup to his original book. He also wrote columns for The Wall Street Journal, Barron’s and in the Investor magazine.

Why investors lose money
Loeb said most investors lose money because they don’t prepare thoroughly or they don’t spend enough time finding a professional who has mastered the investing skill.

Loeb believed investors should take matters into their own hands and do own research before making an investment decision, and not rely on an analyst or expert to sail them through. He said investors don’t need analysts in a bull market, and they definitely don’t want them in a bear market.

“Don’t simply trust an AAA-rating for a bond or a very high price in a stock, because those are just snapshots of a security’s value in a moment of time. Instead, look for high-quality merchandise on the market with a true potential to rise in value,” he said.

Loeb said if investors can answer questions like what to invest in, why to invest and when to invest, they’ll generally pay a lot less for a stock than they do when they buy a stock that somebody else convinces them to buy.

“Before buying any investment, know why you’re buying, what you expect to make, how long you might own it, and how much you’re willing to risk. Selling becomes harder without that information. Write it all down to track your thought process on each investment. Following this basic guideline should lead to a fewer number of holdings, as you weigh opportunity with risk, versus ‘holding cash’,” he said.

Why do some investors always make money
Loeb said some investors almost always made money in the stock market due to proper trading knowledge. He described the knowledge as the “ability to interpret information marketwise,” which he felt was responsible for success in the market.

Understand trading psychology before investing
Loeb said the most important factor that shapes the stock market is public trading psychology. He said in addition to many other macro factors like inflation or deflation, trading psychology influences investing decisions greatly.

Loeb was famous for understanding and implementing trading psychology. He felt investors must develop the skill and ability to control personal emotions like fear of loss, or greed for a bigger profit, which affects most investors’ decisions.

“Never underestimate the importance of trading psychology. That is usually what separates a fairly good trader from a true master,” he said.

Cut your losses
Loeb said it was important for investors to cut their losses quickly before they become of any financial consequence.

“Cutting losses is the one and only rule of the market that can be taught with the assurance that it is always the correct thing to do,” he said.

Recognise the general trend
Loeb said it is important for investors to recognise the general market trend for securing profits as about 75% of all stocks follow a general trend.

“A picture is worth a thousand words.” One might paraphrase this by saying “a profit is worth more than endless alibis or explanations… prices and trends are really the best and simplest ‘indicators’ you can find,” he said.

Avoid too much diversification
Loeb said diversification is a crutch for ignorance. He felt investors should trade only when the very best opportunities are available, with as many factors as possible in their favour. “The greatest safety lies in putting all your eggs in one basket and watching that basket,” he said. He recommended investors to concentrate on their best investments.

“Diversification is a necessity for the beginner. On the other hand, really great fortunes were made by concentration. The greater your experience, the greater your capability for running risks, and the greater your ability to chart your course yourself, the less you need to diversify,” he said.

Avoid short cuts
In his book, Loeb also advised investors to avoid taking short cuts while making investment decisions. “Watch a stock carefully, understand its price behaviour and find correlations between its price cycles and how it relates to the company’s underlying fundamentals. Be patient, wait for all the proverbial stars to align, and then strike big,” he said.

Spot mistakes early
Loeb said it was important for investors to recognise mistakes early and exit a losing position quickly. “Take profits often; lock in gains frequently. Many ‘long-pull’ traders ignore signs of a change of trend because they feel it is temporary. Often they are right, but eventually they are wrong, and usually at great cost. The short-term method requires the closing of the trade for a reason, and if the situation changes later, then one can re-establish the position,” he said.

Loeb believed a stock can plunge even if the market is doing fine and performance among companies can vary greatly even within a single industry or sector.

“Build your position as the stock rises in price, not falls. I believe in pyramiding, not averaging,” Loeb wrote.

He said investors too often expect too much and aim for too little and rarely consider their return in relation to loss of purchasing power. “Into this field, the outsider turns for quick and easy profit, or high income, or a haven of safety. On the average, he gives it less thought than most of his activities, and he is usually careless as to whom he consults or through whom he deals. Frequently, he fails to distinguish between results obtained by chance and those secured through knowledge. Often he is ‘sold’ something instead of buying it on his own decision,” he said.

Ignore market noise
Loeb felt experience and knowledge are two key ingredients required to understand and interpret market information and filter out the noise.

He said all relevant factors are mostly recorded in the market’s behaviour, and its progress can be expected to be in a manner consistent enough to allow reasonably accurate forecasting of news in advance of its actual occurrence.

He said the market is better at predicting the news than the news is at predicting the market.

Capitalise on your success
Loeb said more often than not investors who know how to capitalise on their success and are able to curtail their failures are the ones who achieve outstanding returns for many years.

“The difference between the investor who year in and year out procures for himself a final net profit, and the one who is usually in the red, is not entirely a question of superior selection of stocks or superior timing. Rather, it is a case of knowing how to capitalise successes and curtail failures,” he said.

Stay away from the crowd
Loeb believed that any investment policy that is followed by the crowd naturally defeats itself. So investors should really try to secure or preserve capital to detach themselves from the crowd.

Conduct proper research
The legendary investor felt concentrated portfolios are best for investors who are knowledgeable, less emotional and willing to learn every detail about their investments.

“Knowledge about a typical company begins and ends with the headlines. Few people bother to read annual reports and financial statements. This is a requirement if you want to know what and why you’re buying. Understanding financial statements and skeptical/curious/independent mindset is the best way to separate facts from rumors and misinformation,” he said.

How to find an ideal investment
Loeb said the factors that make an ideal investment are never all present at the same time. Even if such an opportunity actually did exist, it would be almost impossible for anyone to recognise it, he said.

Still, Loeb suggested a few things that investors can watch out for to help themselves find the right investment opportunity-

1. Sentiment in a stock is bearish, the market is liquid, selling at a ‘low price’.

2. Business conditions/expectations are poor. Earnings have fallen, dividends cut, etc.

3. The average opinion is a lack of faith in the company and it’s reflected in the stock price.

He said the buyer must have a contrarian opinion about the stock and should have the view that things are better than expected and should be backed by sound judgment and reliable information.

“The objective is always to buy what the majority thinks is speculative and sell when the majority believes the quality has reached investment grade. It is in this policy that both safety and profits exist. As price is the all-important consideration, the type of corporation and its characteristics are of relatively minor consequences,” he said.

Spot good opportunities
Loeb said a stock price can move significantly in a few months. Hence, investors need to keep cash in hand in order to exploit these opportunities.

“Profits can be made safely only when the opportunity is available and not just because they happen to be desired or needed. Willingness and ability to hold funds uninvested while awaiting real opportunities is a key to success in the battle for investment survival,” he said.

Accept losses
Loeb said investors must stay emotionally detached to investments, as it makes it easier to cut losses and let profits run. He believed investors like to take profits and don’t like to take losses and they also hate to repurchase something at a price higher than they sold it at.

So he felt accepting losses is the most important decision that investors can take to ensure safety of capital.

“Human likes and dislikes will wreck any investment program. Only logic, reason, information and experience can be listened to if failure is to be avoided. Accepting losses is the most important single investment device to insure safety of capital. It is the action that most people know the least about and are least liable to execute. The most important single thing I learned is that accepting losses promptly is the first key to success,” he said.

(Disclaimer: This article is based on Gerald M. Loeb’s book The Battle for Investment Survival)