Today I’d like to go over some classic stock market history. The focus will be on some of trading’s biggest mistakes. You see, even the greatest traders and investors of all time make mistakes that have led to some debilitating hits.
The point is no matter what level you are in the trading game, no matter how good you get, you are always only one mistake away from giving back a lot of work.
However, experienced traders will tell you that even the biggest mistakes are a part of the game. It is how a trader responds that matters. Of course, risk management is key to live to play another day and minimize the impact of errors.
The point is, mistakes will be made, and it is how we respond that matters most. If we don’t learn from history, we are doomed to repeat it.
Stanley Druckenmiller has one of the best performance records in investment history. He worked with George Soros and eventually took over and ran the Quantum Fund for over 10 years. He was a part of the trade that “broke the bank of England,” where they shorted the pound sterling in 1992, reportedly making over $1 billion, one of the greatest trades of all time. He has managed his own fund Duquesne Capital Management which posts an average annual return of 30 percent for over 30 years without any money-losing year. However, even this legendary investor was to hit a major speed hump at the peak of his career.
In early 1999, Druckenmiller shorted $200 million worth of tech stocks in George Soros’s Quantum Fund. He went short too early and was forced to cover a few months later after a $600 million loss. Through May, the fund was down 18%. Meanwhile, the NASDAQ Composite was up 15%, and the S&P 500 was up 10%. He hired two young new traders who were bullish tech stocks and got long the bubble finishing the year up 35%.
The following year while his new young traders were continuing to outperform and other young upstart funds were up 50%+ early in the year, Druckenmiller was fearful of a bubble, he told the Wall Street Journal, “I don’t like this market. I think we should probably lighten up. I don’t want to go out like Steinhardt.”
But he didn’t listen to himself. His pride and competitiveness got in the way. The NASDAQ peaked on March 10, and before the end of April it fell 45%. Druckenmiller got long tech stocks just before the bubble burst: He describes his trade like this
“I bought $6 billion worth of tech stocks, and in six weeks, I had lost $3 billion in that one play. You asked me what I learned. I didn’t learn anything. I already knew that I wasn’t supposed to do that. I was just an emotional basket case and couldn’t help myself. So maybe I learned not to do it again, but I already knew that.
The Quantum Fund was down 21% for the year, and assets at Soros Fund Management fell by $7.6 billion since their peak in August 1998, of $22 billion.
This is perhaps one of the greatest examples of a trader suffering from fear of missing out or FOMO. Druckenmiller was chasing performance and was caught at the top of a bubble. New traders may also get caught chasing stocks late after significant moves.
Bill Ackman has failed spectacularly twice in his career. Each time he has taken the big hits, he has gotten back up and has continued to be better than ever before. He is an excellent example of the resilience it takes to be a successful investor.
His first fund Gotham Partners blew up. Gotham Partners started buying Gotham Golf, a golf-course operator, in 1997. As time passed, the value of its assets declined, but Ackman and his partner kept buying up more golf courses. The company got bigger and deeper into debt. To save the company, giving it the cash injection it needed, Ackman tried to merge it with the cash-rich First Union Real Estate Equity and Mortgage. But First Union’s minority shareholders sued. They would not allow the merger to go through. Ackman ran out of time. Gotham Golf was going bankrupt, and the rest of his positions were illiquid; the timing was all wrong. He and his partner were forced to liquidate the fund, and Gotham Partners was no more.
Liquidity is important. A trader may have the right idea, but as Keynes said, the market can remain irrational longer than you can remain solvent. It is essential to have enough liquidity and trading capital to live to fight another day. Unlike Ackman, short-term traders can always re-enter if their trade idea starts to work, unless, like Ackman, they double down and blow up first.
Ackman started his current fund, Pershing Square, in 2004. By 2010, Ackman had $7 billion under management. In 2015, Pershing Square had about $20 billion under management.
In 2014 he made a deal to help Valeant purchase Allergan Pharmaceuticals — without owning any Valeant stock. Instead, he bought Allergan stock and pushed the other shareholders to accept a merger. They did not. Being swallowed by Valeant, a so-called platform company that had a business model based on slashing research-and-development spending, hiking prices, and growing by acquisition, was not attractive to these shareholders.
Ackman had a great trade anyway, though, when Actavis bought Allergan away from Valeant for approximately $66 billion, a nice premium from where it was trading.
Ackman bought some Valeant stock in early 2015, and it became Pershing’s biggest position. Things were great until, in October, accusations of misbehavior from a short seller, combined with government scrutiny over drug-price gouging, brought the stock crashing down.
Valeant was forced to change its business model; it would have to sell more drugs at lower prices. Its distribution channel for high-margin products, a mysterious pharmacy called Philidor, was dismantled by January.
Pershing Square was down 20% in 2015 in large part because of this disaster, but Ackman was unmoved. He said the market was wrong. The value is real; the environment is wrong. So Ackman held on. Finally, after Valeant had fallen from a high of $263.81 to around $8, Ackman finally admitted he was wrong and sold his stake in the company. It is estimated that Ackman took a $4.6 billion loss.
Post Valeant, Pershing was now managing around $12 billion. Valeant Pharmaceuticals was responsible for a large portion of the decline in assets under management (AUM).
However, despite this setback Ackman has since soldiered on and regained all of these losses, having one of the best returns among large fund managers in 2019 and 2020. He was one of the few to hedge his positions and limit his losses significantly as the COVID-19 pandemic unfolded.
Pershing Square’s performance over the years
Here is Ackman on dealing with failure:
“So I’ve always had this view that success is not a straight line up. If you read the stories of successful people, almost every successful person has had to deal with some degree of hardship, whether that hardship is personal hardship, health-related hardship, or a business issue. I’ve always had the view that how successful you are is really a function of how you deal with failure. If you deal with failure well and you persist, you have a high probability of being successful. So I’ve always kind of had that view, and then I’ve had to apply it to myself certainly a few times. I always like to say that experience is making mistakes and learning from them, and I’ve had the benefit of having made a lot of mistakes.”
What lessons did Ackman learn from these experiences?
“It’s interesting. In my first fund, I had a partner who remains a very good friend. The stress of the ending was enough for him that he just didn’t want to continue and do it again, where I was excited to kind of rebuild and go forward. My business plan was just to make a little progress every day. If you make a little progress every day, eventually that compounded progress will dig you out of the hole. What is difficult is you find yourself in a hole, whether it’s an investment hole or in your personal life or otherwise, it seems incredibly daunting to get back to, if you will, where you were. You’re looking up at this peak where you were before, and it’s just, you’re never going to get there. But if you don’t focus on the peak and you just focus on one step at a time making progress, eventually as the weeks go by, just make a series of smart, thoughtful decisions, use good judgment, stay healthy, eventually you climb your way out of the hole.”
This is an amazing attitude to have. And it is the type of resilience that all traders, new and experienced, need to have in order to persevere with bad times in the markets.
Even the greatest traders and investors of all time make mistakes that have led to some debilitating hits. It is how a trader responds that matters. As we have seen from these huge losses, risk management is key to live to play another day and minimize the impact of errors. However, having the will to persevere, to keep improving, and showing up for work every day, even when things have not gone to plan, that is perhaps the most important trait of great traders. As Bill Ackman states, success is not a straight line. Focusing one step at a time making progress is what is important.
You have actually become a school. I could use some more specific trading ideas, but — in general — I like your teaching.
p.s. — lifetime member of Bullseye Trade
Thank you Jeff