Learning from Commodity Traders
Commodities Corperations teaching's on how to be a great trader.
Charlie Munger has described Warren Buffett as a "Learning Machine" several times. There is not doubt that to be successful in investing one needs to be continually learning. Talking with several investors, most of them dismiss technical analysis and trading. While I don't want to invest on these principles, I think one can learn a great deal from them. Just like we learn from Buffett, Li Lu, Klarman or Munger, we can learn from the best in trading. In commodities that is without a doubt Commodities Corporation.
Commodities Corporation
Founded in 1969 by Helmut Weymar and Amos Hostetter Sr. with an investment of $2.5 million, they became one of the most successful trading companies to ever exist.
At the beginning of 1980 Commodities Corp. had a capital of $30 million. In that year alon they made $42 million trading profits. Even after ridiculous bonuses to their employees, they posted a net income of $17 million - more than 58 of the Fortune 500 companies. They had a mixture of investments in different commodity companies and speculated with commodity futures.
In 1997 they were sold to Goldman Sachs having $1.7 billion under management.
Not only were they incredible successful but several of the world's most revered traders like Mike Marcus, Bruce Kovner, Grenville Craig, Willem Kooyoker, Ed Seykota, Louis Bacon, Jack Schwager (author of the Market Wizard series) and of course Paul Tudor Jones either started or worked for Commodities Corporation.
One of the things that made them so successful were the principles laid out by one of it's founders who tragically died in a car accident in 1977, Amos Hostetter
A successful speculator's approach to commodity trading.
As a lot of the principles only apply to trading, I will only take what can be used as an investor. The original document can be found here.
Hostetter's trading philosophy simplified is this:
Try to acquire every bit of fundamental information available. Read extensively.
Simultaneously, post daily charts on commodities and develop a feel for trends. Follow the fundamentals in your trading, but only if and as long as the charts do not cast a negative vote.
While the second principle doesn't apply to a pure value investing approach, the first principle is remarkably similar to a quote from Warren Buffett:
I insist on a lot of time being spent, almost every day, to just sit and think. That is very uncommon in American business. I read and think. So I do more reading and thinking, and make less impulse decisions than most people in business.”
Money Management
One of the most important rules in trading and investing is to not lose money. Hostetter was aware of his own fallibility (remember even Warren Buffett made several investing mistakes) and tried to protect himself by creating trading rules. "Take care of your losses and the profits will take care of themselves" is again something that is very similar to the principles outlines in "The Intelligent Investor" as margin of safety. Hostetter was also quite strict in terms of diversification for a trader, never betting more than 10% on a single trade.
Fundamental approach
After looking at the balance sheet and statistics of the given commodity, Hostetter would ask very basic questions:
Will production exceed the consumption this season? -> Bearish premise
Will consumption exceed production this season? -> Bullish premise
While the initial premise will afterwards be defined by other considerations such as weather or economic conditions, it shouldn't be the fixed opinion. Due to the quick market movements one needs to have the flexibility of thinking. You can never know what the future will bring and one should try to protect oneself from potential surprises.
Hostetter of course would use the tools available to him as a trader, like scatter diagrams, charts and statistics, but he kept his basic set of fundamental tools quite simple.
Technical approach
While many of the principles like trend following or chart reading outlined in this chapter don't apply as a value investor there are some that do.
Patience was a main one from Hostetter. Just like Warren Buffett only hits the pitches that are best, so does Amos Hostetter. It is far better to miss an opportunity, than to jump in without a clear plan.
Hostetter computerized trading system
While in his 70's, Amos Hostetter learned programming in order to automate a lot of his trading process. While this is often not a possibility for a retail investors such as myself due to either a lack of programming knowledge or the cost of data, one can still create principles that automate a lot of the analysis, such as the debt levels one is comfortable with, or eliminating industries due to lack of knowledge or interest.
Some general principle and market maxims
Take care of your losses and your profits will take care of themselves.
When in doubt get out. Don't gamble. Be sure that doubt is fundamental not due to feelings.
All trends take a long time to work themselves out. Be patient.
Observation by Hostetter
I have omitted some of the points that purely apply to technical analysis or trading.
Dangers in trading caused by human nature
Fear - Fearful of profit and one acts too soon.
Hope - Hope in the forces against one.
Lack of confidence in one's own judgment.
Never cease to do your own thinking.
A man must not swear eternal allegiance to either the bear or the bull side. His concern lies in being right.
The individual fails to stick to facts.
People believe what pleases them to believe.
Don'ts
Don't sacrifice your position for fluctuations.
Don't expect the market to end in a blaze of glory. Look out for warnings.
Don't imagine that something that has sold at 150 is cheap at 130.
Don't try to make an average from a losing game.
Suggestions
Experience must teach. Follow it invariably.
When something happens on which you don't count when your plans were made, try to utilize that opportunity.
Stick to facts only and govern your actions accordingly.
If a market doesn't act right, don't touch it.
Thoughts
As a value investor, I often thought traders are just gambling their money away. Reading this manual opened my eyes, that they just use a different approach to their investment process. Not only that, but one can learn a lot from their thinking. Knowing how traders and trading professional react to certain market developments can open opportunities as a a value investor or help you avoid a mistake. Either way, it seems that learning different market philosophies can only help in the long term.
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