I recently received a copy of Outsmart!: How to Do What Your Competitors Can’t, by Jim Champy, for review. I initially thought it was going to be a clone of books like “Built to Last,” as it is a book about business excellence, and company stories are profiled. Though there are some similarities there, this book focuses in on smaller companies—usually startups—and looks to them for practical advice on how to compete in the modern business environment.

In the introductory chapter, Champy points out an important theme: chaos creates opportunities. That struck me as particularly wise, as that’s exactly what I tell people about the stock markets: you want to get in when no one knows for sure what’s about to happen! I’ve never really thought about it before… but if you look at the markets as an abstract version of the business world, then many sound business and entrepreneurial principles probably translate directly to trading (and vice/versa)! But, I digress..

Topics Covered

As I mentionied above, the book looks at company stories, one per chapter. Each chapter has a central theme or lesson for the reader. Themes covered include:

• Filling an overlooked niche
• Big company turnarounds
• Bucking the outsourcing trend
• Riding the wave of another company’s success
• …more…

I was particularly struck by the chapter on Smith and Wesson. I didn’t know about the company’s decline in value prior to its turnaround—being bought out for $112M and later dumped for only $15M. If you want to see how it recovered, you’ll have to read the book :-) But, it was neat, and the only chapter that covered a big, established company.

The chapters are paced well, and I liked the “Get Smart” and “Questions to Ask Yourself” sections at the ends. They helped summarize and distill the information presented in anecdotal form in the meat of the chapter.

There is a final chapter that sums up the lessons and ties them all together somewhat. I must admit, I would have preferred to see more of that last chapter in the front of the book, before all the individual vignettes. Before I got to that ending summary, I was doubting the cohesiveness of it all. I guess one could argue that moving the summary would “ruin the ending,” but this is non-fiction, after all!

Summary

Outsmart! covers a number of companies that managed to, well, outsmart their competition. The focus is recent, small companies innovating in changing business environments. If you like books on business excellence, it’s worth a read.

Champy closes the book with a precept he says all of the profiled smart leaders would endorse: Just Do It. (Apologies to Nike) He explains that good ideas are rare and precious, and when you have one, you shouldn’t hesitate to grab it and go with it. Once again, this is exactly the kind of advice I give people about trading the markets… when you have a money-making setup, do not hesitate! Some principles truly are universal, I guess.

Why do I love books by Alexander Elder? Here’s the second sentence in Sell and Sell Short (Wiley Trading):

“That cute puppy bouncing up and down in your living room will some day become an old, decrepit dog whom you will have to drive to the vet’s office to put it out of its misery.”

True enough, I guess! So, as Elder goes on to say: “Take off those rose-colored glasses and learn to sell.”

Not Just a Selling Book, After All

The book doesn’t just talk about selling, though. I was pleased to see that the whole first section of the book goes over trading in general. In fact, it makes for a concise guide to much of Elder’s earlier work (in Trading for a Living, Come Into My Trading Room, and Entries & Exits). Though I’ve read his earlier books, it was nice for me to see as a refresher on his methodology.

Elder always comes across as a trader, first and foremost. He knows that you can’t always get in at the bottom and get out at the top, so he’s pragmatic about choosing between “fast dimes and slow dollars.” He’s also strongly in favor of monitoring your performance, and the book has a pretty neat way to grade trades based on the quality of the entry and the exit in terms of their position in the trading channel.

The cool thing about reading books from experienced traders (or experienced people in any profession, really), is the way they manage to cut issues down to their essential qualities. For instance: At the level above specific approaches that fall in and out of favor, Elder frames the trading problem simply in terms of exploiting the gap between price and value. After that, all you need to figure out is how to define value, how to track its changes, and how to measure the gap. It’s good every now and again to step back and view an issue from a higher perspective like that. Psychology and risk management are given similar treatment.

Of course Elder touches on his triple-screen method, which you’ve seen me use many times in the course of this blog. I’ve always kept reference charts up, ever since I read Elder’s earlier work. Reading this book has inspired me to put up a strict three-chart method for a while, and as you’ve seen, it’s gone pretty well!

Selling, and Selling Short

After that wonderful overview section, we get to the meat of this book, which is all about selling. Again, Elder cuts through the complexity and says you will either sell at a target, or sell with a stop, or sell because of a change in conditions. Of course there is infinite variation possible in each category, and Elder devotes chapters of his book to each one.

In each chapter, you get a breakdown of the approach, and it’s pros and cons. You’ll also get several illustrated trades that Elder has made, with commentary. I was particularly pleased that several of the profiled trades did not go as planned, or suffered from poor exits and the like. On the other hand, I don’t remember any trading losses covered, so there couldn’t have been many in that category. That’s too bad, but I do understand… The book isn’t about how to take a loss. It’s about when to take profits.

Then we get to selling short. There’s some obligatory text about what on earth short selling is, which any serious trader probably already knows. But I can forgive that, and it makes the book accessible to beginners. Again, in the short-selling section, Elder does not disappoint. He covers topics like the fact that declines in price are often much faster than rises. He goes on to explain how bottoms in price tend to look different than tops in price… which makes you wonder why almost every strategy you see published says “…and do the opposite for shorts of course.” It seems to me like perhaps strategies shouldn’t be so symmetric, if price patterns aren’t. Food for thought…

The emphasis throughout the book is stocks, but Elder does touch on differences in futures, options, and forex worlds. And, I find much of what he says to be applicable in all three arenas.

Summary

Being familiar with Alexander Elder’s earlier work, I expected Sell and Sell Short to be a treat. I wasn’t disappointed. Thanks to the nice and concise introductory chapter on finding entries, keeping records, and psychology, I can now suggest that new traders pick up this book as an introduction to all of Elder’s work. The material on when and why to sell has the ring of experience and pragmatism to it, and the provided example trades are delightfully imperfect. The charts and approach outlined are easy to grasp, and I appreciated the way the issues under discussion were distilled to their essence.

A couple weeks ago, I was given a review copy of the new book by Stephen T. McClellan: Full of Bull: Do What Wall Street Does, Not What It Says, To Make Money in the Market. Here is my review:

Much of the text is autobiographical anecdotes about what it’s like to be an analyst. Those parts reminded me of Confessions of a Wall Street Analyst, the Reingold book, quite a bit. That’s not a bad thing, really, as in both books the story is interesting and worth knowing about if you are in the markets.

Still, at first I was wondering if Full of Bull would offer anything new on the topic. Thankfully, McClellan put a new twist on his book, and interspersed his anecdotes between directly useful advice for investors. So, it’s one-part autobiography, one-part textbook, and generally pretty well-written. He gives you some history, and then looks you right in the eye and says “… and here’s what this means to you.” I liked that, and thought it worked well.

The book is structured well with ample headings, and in the text he uses an informal writing style. It’s as if he’s having lunch with you, telling you what he knows about the markets. That makes it an easy and fast read, and at the same time gives the information an air of genuine honesty.

Topics covered include:

• properties of good management
• analyzing a company’s customer base
• protecting capital
• what to make of analyst recommendations
• how to interpret events like stock buybacks
• how to analyze corporate ‘turnaround’ stories
• … and many more

Be aware that this book is targeted toward investors, rather than traders. You won’t hear much about chart patterns in here! The focus is on interpreting news, fundamentals, and of course, analyst reports. Still, McClellan is conservative, which appeals to me even as a trader. Through his examples and his stories, he tells you how and why many events that are positive on the surface are actually covering up deeper problems. He tells you what kinds of companies, industries, and executives add to his confidence in an investment.

That’s not to say the book is perfect. I found that a few of the points are made in multiple places in the book. On one hand, you could say this helps drive the point home. On the other hand, in a couple places it felt repetitive. It is good to see the investment insights tied back to real-world analyst knowledge, but at the same time, not all of the insights are unique insider gems. The book’s textbook side forces it to go over some basics that an experienced investor will already have picked up. For instance, it advises to try to hold an investment for at least a year to get the lower tax rate. You don’t have to be a wall street insider to know that!

Overall, though, I’d say that the book was worth the read. The combination of an investing guide and an insider look at the life of an analyst works very well, and should make the book appeal to a wider audience than other purely autobiographical books. It gives the book practical applications, which I appreciated.

I remember, towards the end of my college “career,” a classmate gave me a chance to go in with him to get some Red Hat IPO shares at their initial offering price (around $15 I think). I don’t remember how he managed to get that arrangement, or why the subject even came up; I wasn’t in the markets back then. Still, I knew this would be a good deal. The problem was how to raise the money in time. This was especially complicated because I would need to find money that my parents wouldn’t know about…. they were (and are) very anti-stock market. So, the next day I decided it was too much trouble, and turned the guy down.

Well, the first day RHAT traded, the stock closed at $54. Exactly one month later, it closed at $120. Wow! I told the guy he was crazy not to get out (assuming he was allowed to sell his shares that quickly… I didn’t know enough to ask, back then). But, as a fellow linux geek, he said that he believed in the company and that this was a long term position for him. I had no trading experience, but even I knew something didn’t feel right about holding through a 1000% 1 month return.

Well, I graduated soon afterwards, and for all I know that guy still owns his shares. But, I can only assume he was kicking himself when the stock traded for $7 a few months later. oops!

Worse, though, I was also kicking *myself*. Because if I weren’t so lazy, I could have pulled together the money and made a huge profit. Just by chatting with the right classmate at the right time. Think about that! Damn, a quick $150k right when I was trying to choose a post-college job could have changed the course of my entire life… at the very least, it could have gotten me into active trading right then, instead of seven years later.

An American Hedge Fund

Anyway, that college story is what I think about when I read the first half of An American Hedge Fund. Here was a young guy (Timothy Sykes, who you may recall as the only entertaining cast member of Wall Street Warriors: Season 1, although I liked the blonde chick, too). He had some capital, some market interest, supportive parents, and free time… all at the perfect moment in recent history to play in the markets. And more importantly, he took advantage of it. From 1999 to 2002, while finishing high school and continuing to college, he turned $12k into $1.65 million.

If you spend any time on elitetrader forums, you know that this story makes a lot of people on the internet insanely jealous. It’s actually kinda sad to watch.

It’s also hard to blame them… I’m jealous, too! Everyone likes to think that they could have done the same thing, in the same circumstances. Then, they would be the one on TV eating sushi with the model chick. But, that doesn’t really matter. I didn’t do it, and they didn’t do it, but Sykes did. At least he had a couple sensible strategies, mostly involving questionable news releases on penny stocks (and the tell-tale volume patterns that follow). I had no such market savvy in college. And, anyone who’s traded knows that trading consistently is hard, no matter what year it is, anyway.

So, for the first half of the book (maybe not in terms of page count, but conceptually), you get this incredible account of a college life that all traders wish we had lived. It must have been awesome. Timmay and I both skipped a lot of classes to stare at computer screens, but he was making thousands of dollars in the markets and I was just looking for the best free porn. Then, while I cooked macaroni and cheese, he took his entire dorm to a nice restaurant.

It’s fun to read, and you hear about some interesting triumphs and mistakes along the way. If you are reading blogs like this one, you must like to hear about trading stories. So, I’m not going to try to sell you on why I found them entertaining. It’s not a book about how to trade like Sykes did… they are anecdotes, and not recipes. Times have changed since then, anyway.

The Cilantro Fund

The second half of the book covers Sykes’ hedge fund, the Cilantro Fund. So, you’ve made literal millions during college trading your own money… now what? Sykes decided the next step would be to trade OPM. The book describes the troubles you have attracting capital as a small hedge fund. I was reminded of Marty Schwartz’s Pit Bull at times, because they both complain about the amount of time you have to spend finding and coddling the investors you do get.

Sykes goes into a lot more first-hand detail than any other book I’ve read about the process of starting and building up a small fund, though. I think most small traders with vaguely big ambitions would find this section enlightening and entertaining, if not a little disheartening as well. It turns out, like every other part of Wall Street, this too is a hard game…. even if you have one of those media-friendly stories about making a fortune in college. The book covers the details, so I won’t repeat them here, but the chief complaint is all the non-publicity regulations leveled against hedge funds. You need publicity to attract money (and give the public an accurate picture of the risk involved with hedge funds compared to, say… mutual funds), but that publicity is exactly what you are not allowed to have.

Aftermath

Turns out, the Cilantro Fund was not a spectacular success, and while it didn’t implode, I think it is now closed. A lot of people seem hung up on that fact, but I don’t think it hurts the book. I ask myself: would this be a better book if it said that every choice Sykes made was perfect and he made billions? Of course, the answer is not one bit. I loved that movie Rogue Trader, and it’s about a ridiculously bad trader. Doesn’t matter. This is an autobiographical book, and what happened, happened. If you are a trader, you probably relate to most of the story on some level, and that’s what’s important.

I’ve heard a lot of people swear by How To Make Money In Stocks: A Winning System in Good Times or Bad, 3rd Edition, so I read it this weekend. (yeah, after two books reviews this weekend it’d be hypocritical of me to post a weekend non-reading entry, so I’ll skip it)

I thought How to Make Money in Stocks was dated. It says “completely updated” right on the cover, and the copyright says 2002. Yet, it still covers controversial topics like:

• Is it safe to buy Nasdaq stocks?
• Decimalization of the markets
• Transactions should be reported on the tape within a couple minutes after they occur on the trading floor, but sometimes get behind

huh? I’m pretty sure that either the word “completely” or “updated” does not mean what the author thinks it means…

It describes the CAN SLIM stock picking method in great detail. It seems like a sensible enough strategy, and I know a lot of people use it. In terms of technical analysis, the book goes over cups+handles, and double bottoms, and gives example charts of stocks just before they broke out big. The general advice here is buy high and sell higher, rather than looking for a bargain.

It warns against day trading, which is typical of books like this, so I can forgive it. It also spends a lot of time pimping Investor’s Business Daily, which the author founded. I can forgive that, too (I kinda expected it).

What I’m finding more and more with non-fiction books is that it’s hard to compete with the internet. There’s nothing in this book you haven’t read on the internet, if you’ve been looking. Aside from autobiographical trader books, I think the days of trading books are numbered, if not already past. The same is true in most technical fields, as well. I’ve bought very few comp sci books in the last few years, since everything I’d want to know is on-line. So, even though there’s some good information in this book, it’s hard for me to recommend that you purchase it.

This weekend I read: Just One Thing: Twelve of the World’s Best Investors Reveal the One Strategy You Can’t Overlook. Like an idiot, based on the title, I thought the book was about one thing that twelve great investors agreed on. In fact, it’s individual chapters written by twelve different people, each about something different.

But, don’t let my stupidity keep you from reading this book… I thought it was pretty interesting throughout. The standout chapter, in my opinion, was the one on human behavior/psychology by James Montier. It outlines ways that humans are wired to make bad investing choices, which is something we’ve all heard before. But it’s pretty exhaustive, and describes the justification and relevant psychological studies very clearly. In some cases it also suggests ways to counteract our human deficiencies. I liked this chapter best partly because it was applicable to short-term trading (whereas a lot of the book is investor-oriented), and also just because I am intrigued by the way people work.

Another memorable chapter is by John Mauldin, the editor of the book. It describes trends in place now that are likely to shake up the world in decades to come. Again, it’s stuff you have heard before if you are interested in such things, like: the population in the West and Japan is set to decline, even as it ages. Looking ahead, what might that mean? I disagree with some of the conclusions he makes, though, about the population and the workforce. I think he’s forgetting how much technology can help us in those areas. For instance, he talks about how the west needs to desperately import young educated immigrants to fuel our workforce and support retirees. But, who’s to say that elderly people will need (or even want) to retire, or need a lot of care from human workers? If I’m going to live to be 150, I don’t want to be out of the game and bedridden from age 65 on… and I’m betting I won’t have to be.

Common themes in other chapters were: Don’t hold on to losses. You can’t make money with information everyone knows. Compounding works.

At the risk of this blog becoming idempotent’s gambling journal, I wanted to mention that in the last week I have become infatuated with poker (limit hold ‘em in particular). I’ve read somewhere that lots of traders are also avid poker players, and now I know why! It’s an uncannily familiar feeling when judging when to wager and how much! Cutting losses when a hand turns against you, winning big when it doesn’t… poker’s got it all for people with trading in their blood!

Mini-Review
I got interested when I read The Professor, the Banker, and the Suicide King: Inside the Richest Poker Game of All Time just on an impulse. It’s not a poker how-to book, but rather it’s about a Dallas banker who took up poker and played several extremely high-stakes games over the past few years. His name is Andy Beal, and from the description of him, he’s like my new hero. He’s done a little bit of everything in his career, from real-estate, to banking, to mathematics, to aerospace engineering, and now poker.

The book has a lot of colorful history of big gamblers, and their lifestyles. They acknowledge that their money-management is pretty reckless, and they all seem to balance that by taking money out of the casinos as often as possible, and doing their best to leave it out, for good.

So, I looked up how to play on-line, and started playing in fake-money games on yahoo. Just like in the stock markets, the whole key seems to be to wait for good opportunities. I think my trading experience really paid off here . By simply folding about 70% of the hands I got, I doubled my first fake $1000 stake in just 4 hours. I am hooked! It seems that the legal status of real-money poker in America is iffy, so I have so far resisted it. But, it’s tempting!

That got me thinking… what does poker have going for it that the markets don’t? Probabilities are easy to compute, and reliable. That is, I can get a reliable probabilistic lower bound on the expected value of my hand at any point. In fact, just quickly calculating, there are only about 2 trillion unique games with two players–less if you consider that lots of hands are equivalent, differing only by suit. Technology’s getting close to the point where you could just precompute them all on a large workstation. If you wait til after the flop, there are only 1.2 million possible outcomes with two players. On the other hand, in the markets, it’s not clear to what extent past behavior implies future behavior (some say, not at all!), so any probabilities you have calculated based on past events could be useless. So poker hands are a ton more predictable.

A downside of poker compared to the markets is the binary result–you can have an awesome hand, and still lose. And, you can have the a royal flush, but still only win a small amount of money. In the markets, everyone who is right, wins, and the amount they win is proportional to how right they are.

More directly related to the stock markets, I’ve started reading Fooled by Randomness : The Hidden Role of Chance in Life and in the Markets, and it seems promising, if a little long-winded. I will write more about it when I’ve finished it.

I’ve read a few more trading-related books in the last few weeks that I thought I’d share. For the most part, these are about traders and trading, rather than “how to beat the stock market” type books. I think, having mastered the basics of trading, these are the best kind to read. It’s more wisdom and less technique.

At some point I may make a post about what I think the best trading books I’ve read to date are.

First we have Trading with the Enemy: Seduction and Betrayal on Jim Cramer’s Wall Street, which I thought was a lot of fun to read. You get pretty much the same information, trading-wise, that you get from Jim Cramer’s Confessions of a Street Addict. In other words, they paid brokerages tons of commissions in return for getting the first call when new information goes out from the analysts. You also get a real flavor for the high-intensity environment of a hedge fund. I really think the two books are best when read as a pair, so you get the dual perspectives. Based on what I had heard about the book, I expected something much more negative, but it really just paints the same picture Cramer himself paints, but presents it in a harsher light.

Next, there’s Stock Market Wizards : Interviews with America’s Top Stock Traders. I haven’t read the other two “wizards” books, but have certainly heard of them. I picked this one up and was thrilled with it. We get interviews with traders that are still getting press today as the top traders of 2005, like Stephen Cohen. And, the paperback was updated around 2002 to get the traders’ perspectives on the stock market slump in 2000. It was fascinating, but one theme was clear: these traders are all confident, and all consistent even when losing. They are all doing spectacularly year after year with completely different strategies and methods, which just further reinforces that there are lots of ways to skin the market cat.

Sort of tangential to trading, I read Confessions of a Wall Street Analyst : A True Story of Inside Information and Corruption in the Stock Market. It was eye-opening, for me anyway. It outlines the author’s career as one of the top telecom analysts during the 90’s telecom boom, and points out how many conflicts of interest are inherent in the financial system between the analysts and the bankers.

These last two are ones I don’t recommend:

The book: Trend Following: How Great Traders Make Millions in Up or Down Markets didn’t impress me much. Its message amounts to: use a winning strategy consistently even during drawdowns. Maybe I missed something, or read it too fast, but it seemed to me that the focus was on mechanical trading, rather than following trends.

Lastly, we have Stock Trading Wizard : Advanced Short-Term Trading Strategies for Swing and Day Trading. I don’t know… this book might have been good in 1999, but today it read like it was a bit dated. I will say that it had some of the best-illustrated information on Level II quotes, but prices were still listed in fractions of a point, rather than in cents. I think for an introduction to swing and day trading, Short-Term Trading in the New Stock Market by Toni Turner is much better, up to date, and complete.