Peter Lynch on Picking Bottoms – If they don’t scare you out, they will wear you out

Bottom fishing is a popular investor pastime, but it’s usually the fisherman who gets hooked. Trying to catch the bottom on a falling stock is like trying to catch a falling knife. It’s normally a good idea to wait until the knife hits the ground and sticks, then vibrates for a while and settles down before you try to grab it. Grabbing a rapidly falling stock results in painful surprises, because inevitably you grab it in the wrong place. If you get interested in buying a turnaround, it ought to be for a more sensible reason than the stock’s gone down so far it looks like up to you. Maybe you realize that business is picking up, and you check the balance sheet and you see that the company has $ 11 per share in cash and the stock is selling for $ 14. But even so, you aren’t going to be able to pick the bottom on the price. What usually happens is that a stock sort of vibrates itself out before it starts up again. Generally this process takes two or three years, but sometimes even longer.

How many times have you heard people say this? Maybe you’ve said it yourself. You come across some stock that sells for $ 3 a share, and already you’re thinking, “It’s a lot safer than buying a $ 50 stock.” I put in twenty years in the business before it finally dawned on me that whether a stock costs $ 50 a share or $ 1 a share, if it goes to zero you still lose everything. If it goes to 50 cents a share, the results are slightly different. The investor who bought in at $ 50 a share loses 99 percent of his investment, and the investor who bought in at $ 3 loses 83 percent, but what’s the consolation in that?

The point is that a lousy cheap stock is just as risky as a lousy expensive stock if it goes down. If you’d invested $ 1,000 in a $ 43 stock or a $ 3 stock and each fell to zero, you’d have lost exactly the same amount. No matter where you buy in, the ultimate downside of picking the wrong stock is always the identical 100 percent.

Sometimes it’s always darkest before the dawn, but then again, other times it’s always darkest before pitch black.


Lynch, Peter; Rothchild, John (2012-02-28). One Up On Wall Street. Simon & Schuster, Inc.. Kindle Edition.

18 Insights from ‘The New Market Wizards’ Book

1. I don’t think you can consistently be a winning trader if you’re banking on being right more than 50 percent of the time. You have to figure out how to make money being right only 20 to 30 percent of the time.

2. I basically learned that you must get out of your losses immediately. It’s not merely a matter of how much you can afford to risk on a given trade, but you also have to consider how many potential future winners you might miss because of the effect of the larger loss on your mental attitude and trading size.

3. The problem, in a nutshell, is that human nature does not operate to maximize gain but rather to maximize the chance of a gain. The desire to maximize the number of winning trades (or minimize the number of losing trades) works against the trader. The success rate of trades is the least important performance statistic and may even be inversely related to performance.

4. Don’t worry about what the markets are going to do, worry about what you are going to do in response to the markets.

5. There are certain lessons that you absolutely have to learn to be a successful trader. One of those lessons is that you can’t win if you’re trading at a leverage size that makes you fearful of the market. If I hadn’t learned that concept then, I would have at some later point when I was trading more money, and the lesson would have been far more expensive.

6. You could be right on a market and still end up losing if you use excessive leverage.

7. I never use valuation to time the market. I use liquidity considerations and technical analysis for timing. Valuation only tells me how far the market can go once a catalyst enters the picture to change the market direction. The catalyst is liquidity, and hopefully, my technical analysis will pick it up.

8. I’ve learned many things from him, but perhaps the most significant is that it’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong. The few times that Soros has ever criticized me was when I was really right on a market and didn’t maximize the opportunity.

9. Soros is also the best loss taker I’ve ever seen. He doesn’t care whether he wins or loses on a trade. If a trade doesn’t work, he’s confident enough about his ability to win on other trades that he can easily walk away from the position. There are a lot of shoes on the shelf; wear only the ones that fit. If you’re extremely confident, taking a loss doesn’t bother you.

10. One basic market truth (or, perhaps more accurately, one basic truth about human nature) is that you can’t win if you have to win. Druckenmiller’s plunge into T-bill futures in a desperate attempt to save his firm from financial ruin provides a classic example. Even though he bought T-bill futures within one week of their all-time low (you can’t pick a trade much better than that), he lost all his money. The very need to win poisoned the trade— in this instance, through grossly excessive leverage and a lack of planning. The market is a stern master that seldom tolerates the carelessness associated with trades born of desperation.

11. Many of the best growth stocks have high multiples and are psychologically difficult to buy. If the brokers weren’t turned off by the high P/ Es, their clients were. Also, I realized that many brokers weren’t portfolio managers but were primarily sales oriented.

12. That experience taught me that it’s not that easy to buy back a good stock once you’ve sold it. It reinforced the idea that there’s great advantage and comfort to being a long-term investor.

13. I want to make sure I get off the horse if it starts heading in the wrong direction. Most people believe high turnover is risky, but I think just the opposite. High turnover reduces risk when it’s the result of taking a series of small losses in order to avoid larger losses. I don’t hold on to stocks with deteriorating fundamentals or price patterns. For me, this kind of turnover makes sense. It reduces risk; it doesn’t increase it.

14. There’s a saying, “You can’t make a harvest in the wintertime.” That was the situation initially. It was wintertime for small cap, high growth stocks. The market just wasn’t interested. Once this general attitude changed, the market focused on the company’s excellent earnings, and the stock took off.

15. I won’t buy a stock when it’s dropping even if I like the fundamentals. I have to see some stability in the price action before I buy the stock. Conversely, I might also use a stock’s chart to trigger the sale of a current holding. Again, the charts are a very unemotional way to view a stock’s behavior and potential.

16. I would much rather invest in a stock that’s increasing in price and take the risk that it may begin to decline than invest in a stock that’s already in a decline and try to guess when it will turn around.

17. Another example in which Driehaus’s ability to do what is uncomfortable enhances his profitability is his willingness to buy a stock on extreme strength following a significant bullish news item. In such situations, most investors will wait for a reaction that never comes, or at the very least will place a price limit on their buy order. Driehaus realizes that if the news is sufficiently significant, the only way to buy the stock is to buy the stock. Any more cautious approach is likely to result in missing the move. In similar fashion, Driehaus is also willing to immediately liquidate a holding, even on a sharp one-day decline, if he feels a negative news item has changed the outlook for the stock. The rule is: Do what is right, not what is comfortable.

18. Another important point to emphasize is that a small percentage of huge winners account for the bulk of Driehaus’s superior performance. You don’t have to be right the majority of the time, but you do have to take advantage of the situations when you are right. Achieving this dictate requires two essential elements: taking larger positions when one has a high degree of confidence (e.g., Home Shopping Network was Driehaus’s largest position ever) and holding such positions long enough to realize most of the potential. The latter condition means avoiding the temptation to take profits after a stock has doubled or even tripled, if the fundamental and technical conditions still point to continued higher prices.

Source: Schwager, Jack D. (2009-10-13). The New Market Wizards: Conversations with America’s Top Traders – HarperBusiness. Kindle Edition.

The Art of Taking Profits

“Timing the sale is more difficult than timing the purchase because stocks reach their bear market lows simultaneously, but their bull market highs are attained independently. Following the stock averages and selling when the primary trend turns down is often unsatisfactory, since numerous stocks reach their peaks prior to the peaks in the averages. The price and volume trend for each stock must be studied independently and action taken accordingly.”

Source: Superperformance Stocks by Richard Love

Value is often Subjective. Price is What the Market is Willing to Pay You Now

“A piece of property is worth as much as someone is willing to pay you for it. So it is with common stock. Find stocks for which you think someone will be willing to pay you a higher price at some time in the future. This approach is applicable to any type of investment—in a diamond, a painting, a bushel of corn or wheat, a house, a piece of land, or a share of common stock. The market price of the item reflects the psychological factors—the extremes of optimism and pessimism—that can cause the value of an item to vary widely, sometimes in just a few hours or days. When the market value of an item is plummeting, it reveals that the fear many people have of lower values for their property is stronger than their hopes for higher prices.”

Source: Superperformance Stocks by Richard Love

The Difference between a Bull and a Bear Market

Bull markets reward risk-taking, but when the bear puts out honey, he is usually laying a trap: “In recent years, U.S. investors have felt that they must be playing the market—even when the risks are high,” Marc Faber observed. “They learned to think that they should invest like George Soros—but the average investor is not George Soros. When I play tennis, I don’t try to play like Agassi,” Faber added. “I have to play a different game. Agassi can play to win. I have to play a game where I don’t make any mistakes.” In a bear market, this is what is most important: not making mistakes. The goal is to conserve capital. When a long bear market finally ends, those with cash will find bargains galore.

In each case, investors were following the rule that they learned in a bull market: “The trend is your friend.” But in a bear market, “you have a whole different rule book,” Ralph Wanger observed. “In a straight-up growth market, your rule is to be 100 percent in equities all the time. Buy strength. Disregard risk. Only look at the income statement. And all stories are true because we want them to be true. It’s like the nice guy you met in the bar telling you he loves you truly—and he does. “In the volatile bear market that tends to follow an exponential growth market, many of these rules invert,” said Wanger, speaking from experience. “You don’t buy strength; you sell strength. You don’t look at the income statement, you look at the balance sheet [which shows a company’s debts]. All stories are false. It turns out that the guy in the bar is a married orthodontist from Connecticut.”

Source: Mahar, Maggie (2009-10-13). Bull! – HarperCollins. Kindle Edition.