Exactly Wrong

After reading what I wrote in early March I was tempted to delete the article (the first post on this site), but a more productive thing to do is find out why I was so wrong on the exact day of the low. To remember my thought process is, after all, the reason I'm keeping a journal. I said that 750 or 800 would be "shortable" and that stocks were "not historically cheap."

The most curious thing is that I managed to arrive at this conclusion even while considering and publishing the most important piece of long term valuation information in the same article! Clearly this means I was emotionally involved in what was happening and allowed that bias to influence my interpretation of the facts. The mistake I made was preferring the short term valuation metric (the 1-year trailing S&P PE) to the long term one (10-year average S&P PE) at a time when earnings went negative and distorted the PE ratio's denominator (as earnings approach zero, PE approaches infinity). The 10-year average trailing PE ranges from -60% (worst recession) to +300% (biggest bubble) over time, and on March 9th that number was -34%. So at that price the worst case scenario is minimized and the long term prospects are excellent. This is easy to see now, but why not then?

I don't really know the answer. A monkey would have made the right decision given those numbers. The reasons must be related to my environment and psychology at the time. I had started to buy at 780 and by 720 I was 3x or 4x leveraged and by 670 I was really sweating it. First, I was far too affected by relatively minor price changes. Second, I was starting to look for the reason that my position was wrong. That is the right thing to do but it is extremely difficult to be unbiased when the leverage prevents rational thought, or thought altogether. It's like trying to do math on a roller coaster: if you have to think about the problem at all, you're in trouble. I was on something like the Raptor at Cedar Point, trying to "solve" S&P derivatives. Third, and maybe this is a bit personal, but I had mentally tied my confidence to the results of my investing and trading because it was all I was focusing on. Working hard is good, but this kind of unbalanced focus is actually counter productive. I ended up overly concerned with details, not seeing the big picture.

Lessons learned:

• 1) The long term information is most important. Give it precedence.
• 2) Don't use leverage, or contain it by deferring to a small account.
• 3) Focus on maintaining a balance between work, play, and rest. This seems deceptively trivial, but I think it is critical for people who love to work.
• 4) Avoid perfectionism. Getting the big picture right is much more important than missing a few details.