Besides being successful investors, what do Nicolas Darvas (author of How I Made $2,000,000 in the Stock Market) and Bruce Berkowitz of Fairholme Funds have in common? Both recognized the negative impact that noise from other traders had on their investment performance.
Darvas was a professional dancer in the 1950’s who, against many odds, became a very successful investor for someone with no financial training and no mentor. Much of his time was spent on the road in foreign countries but he received cables (the 1950’s version of a fax in a sense) sent to him by his broker with cryptic price information on selected stocks. Without getting into much detail, Darvas would follow the price action of his selected stocks as he found they moved in and out of boxes. He had become quite successful at trading and thought it made sense for him to trade from his broker’s office amongst other traders.
I was fascinated by my first visit to the office. The boardroom was large, with chairs placed in front of an ever-moving little machine, the stock ticker. The atmosphere was exciting, filled with electricity. The people in the room, like hangers-on in Monte Carlo, were nervous, exalted. There was an air of action, bustle and noise. Tickers, ticking, typewriters pounding, telegraph machines clacking, clerks busily rushing around. From every direction I heard sentences like: “GOODYEAR doesn’t look good to me.” “I am getting out of ANACONDA.” “The market is ripe for a reaction.”
Once he began trading from his broker’s office, Darvas’ investment performance plummeted much to his dismay. In time, Darvas recognized that he had abandoned his style of investing and was running with the crowd. Soon thereafter, he took steps to isolate himself from the Wall Street noise and focus on a handful of stocks. His great investment performance returned as a result of his ability to ignore noise.
Bruce Berkowitz is considered by many to be the best mutual fund manager of his time. In 2010, he was named Domestic Stock Fund Manager of the Decade by Morningstar, as he had managed to beat the S&P 500 every year in the past 11 years except for one (the S&P 500 was up 29% in 2003 and Fairholme was up 23%). In 2006, Berkowitz moved his fund and his family from Short Hills, New Jersey to Miami. According to a recent article in Fortune magazine, the biggest reason for the move to Miami was that Berkowitz wanted to put some space between himself and Wall Street. When he operated his fund in Short Hills, his office was in a building with numerous other money managers. The presence of other money managers inevitably led to conversations about the markets which Berkowitz believes would pollute his thinking. This is much the same problem that Darvas encountered when he tried to trade from his broker’s office in New York which had other traders present.
Noise comes to traders in many ways. At times it appears as randomness in the prices of the securities we follow. Noise presents itself as “experts” in the financial media put forth their prognostications even though research informs us that most financial forecasts by “experts” are no better than random guesses. Becoming a successful trader requires the ability to filter out noise that surrounds us. I am aware of some successful traders who, during trading hours, retreat to their offices to read books of poetry or history. Jesse Livermore said that some of the times that he made the most money was when he sat on his hands.
As we move forward in our development as traders, we must make a concerted effort to recognize that which is noise.