It was 1987…
Nassim Taleb was an options trader at Credit Suisse.
But he didn’t regard himself as a mere trader.
He thought of himself more as a quasi-intellectual, pitting his wits against the hubris of the financial elite.
Yes, he was arrogant (and still is).
But he knew he wasn’t the only one…
You see, his big idea was that the market was too confident in its fancy trading models. Far too confident. And he was going to show them they were wrong by doing what all good traders do.
By taking their money from them…
For a long time, though, this professional ‘dumb’ money was beating him.
As his co-workers collected steady pay cheques at a time of low market volatility, Taleb was losing money every month, betting on volatility returning.
Imagine that for a second…
Going to work every day, the only loser as those around you cashed in.
Humans, being human, tend to benchmark themselves against their peers. So this would be an especially hard situation to swallow for anyone.
Never mind someone with Taleb’s ego!
As he put it himself in an interview with Forex Trader:
‘I was long out-of-the-money (OTM) options in just about anything that traded. People were laughing at me.’
His trading strategy was complex.
But the idea behind it was pretty simple.
He was betting on things happening that no one else thought remotely possible by buying something called options.
You don’t need to know what options are or how they work, but what you do need to know is that these options were selling for unbelievably cheap.
Which meant the market thought they had very little chance of becoming profitable.
They were priced ‘far too cheap,’ wagered Taleb…
He’d calculated that the market had grossly miscalculated the probability of volatility returning. And that’s why it was happy to sell him these options so cheaply.
By the market’s reckoning, the odds were 1 in 67,000 for any of Taleb’s investments to come off.
Taleb didn’t know the true odds, but he thought they were way less than that.
He told his concerned bosses, who began to question his regular losses:
‘Let me bleed 67,000 months before you question my strategy.’
But a strategy that loses money for years will wear down even the most ardent believer.
In 1987, Taleb went to a finance symposium. He was one of six traders doing presentations on stage.
Taleb recounts:
‘I was on stage with five other traders, and they all said this is the death of volatility. Their idea was central banks now run the world.
‘The banks are getting sophisticated and can force stability just like they can control inflation. There’s no reason to buy an option because the world is moving into a far better regime of managed movement. So, anybody buying an option was an idiot.
‘These guys depressed me. I thought my life was over, because we’re not going to have volatility — or at least no large deviation.
‘Of course, the stock market crashed a few days later and the rest is history.’
Taleb made a 67,000% gain in just one position the day after the famous 1987 Black Monday stock market crash.
No one could believe he made so much profit from risking so little.
In fact, he made enough money on that one day that he was able to retire from the markets altogether.
He has since become an academic author and New York intellectual who writes books on uncertainty, risk, and trading while generally living the life he wants.
Now, I tell you his story for a reason…
The three virtues of an exponential mindset
To be clear, I don’t think you should rush out and buy cheap options as Taleb did.
I told you Taleb’s story because it’s an extreme example of something you’ll have to accept if you want to be a successful exponential investor.
The fact is, you’ll have to be able to handle the reality that some of the time — maybe even most of the time — people won’t agree with you.
This is a solo mission.
Think about it…
You’re targeting stocks you think have the potential to go up 10 times or more. By definition, the market disagrees with you. Otherwise, they would already be 10-times more expensive!
You need to believe in your conviction even if the market doesn’t.
Do you have the courage to do that?
Do you have the courage to see a stock you hold go down 30%, 40%, 50%, or even more?
Do you have the courage to stick with your reasoning in the face of such disagreement?
Conversely, do you have the courage to take a loss if the situation changes and you realise you actually got it wrong?
These are all forms of mental courage you’ll need to have if you want to be a successful exponential investor.
Consider the story I just told…
Taleb could have easily traded along with the crowd and made regular money every week, just like everyone else did.
And he’d have been paid handsomely for doing so, too.
After all, this was the decadent era of the 1980s, and Wall Street traders were making millions gambling with other people’s money.
Why not just reap the regular quarterly bonuses as everyone else did?
It’d be the easy option for most.
But Taleb couldn’t bring himself to do it. He’d have felt like a fraud.
Instead, he bore the insults and ridicule of his colleagues in order to pursue his own path. It was a journey that eventually led to an unbelievable — and very exponential — outcome.
Don’t underestimate the courage this needed.
With hindsight, it always looks easy.
But it’s definitely not.
Humans are naturally herd animals. We feel comfortable doing what everyone else is doing. Treading your own path is a lot harder.
The second virtue Taleb demonstrated was patience.
In a way, it’s funny. In your quest to make wealth quickly, you need to be patient.
In the investing context, it means letting your investment strategy play out without being too reactive to the short-term ups and downs.
In technical terms, it means knowing what level of volatility is ‘normal’ for the investment you’re in.
That’ll be different depending on what you invest in.
For example, I’ve watched cryptocurrency investments jump up and down 20% or more in a single day without breaking a sweat.
But if my stocks were doing that, I’d be having kittens!
Like Taleb, you have to know when to just keep going with your plan. He didn’t just give up after a few months of trying. He waited years!
As he told his concerned bosses at the time, he was prepared to bleed (lose his money) for 67,000 months if he had to.
It’s unlikely his bosses would have let him do this, mind you.
But when it comes to your own investing, luckily, the only person you have to answer to is yourself (or your partner, but that’s a different book altogether!).
Now, courage and patience are fine, but you also need one more to bring them together — knowledge.
Without knowledge, courage and patience can turn into stupidity and stubbornness.
By knowledge, I mean a few things.
Some of it is financial knowledge, like the ‘expected volatility’ example I discussed before. And some of it is the kinds of strategies we’ll go into shortly.
But it’s also self-knowledge.
To be able to analyse your own strengths and weaknesses coldly and dispassionately.
How you react emotionally to different outcomes.
Because when you start building your own exponential portfolio, you’ll need to play to your strengths. And make sure your weaknesses don’t hinder your ability to execute your plan.
Not many would have had the emotional fortitude to make money as Taleb did, even those with the knowledge to understand it.
You have to be honest with yourself from the start.
The good news is that, for the most part, you can build knowledge. With courage, patience, and knowledge comes conviction.
Conviction to move towards your goals, no matter what the future brings.
Good investing,
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Ryan Dinse,
Editor, Money Morning
