“We try to exert a Ted Williams kind of discipline.”
— Warren Buffett
Take a moment and read the below expert and the corresponding diagram from Ted Williams in his book, The Science of Hitting.
Speculation is one part art, one part science, and a whole lot of patience and discipline. As we head into the new year, I want to take a moment and breakdown the above diagram.
If you are not familiar with baseball, here is a quick summary of the batting rules
A pitcher throws a ball towards a batter. The batter has a strike zone over home plate. If the pitcher can get three strikes without the batter hitting the ball, he is out. Therefore, he must swing at pitches in his strike zone. This forces play and makes the game move forward. I will call this a direct force as in the batter has a direct force that makes him/her swing at pitches. If they do not, they strikeout.
Poker has a similar situation. If you sit at a poker table, you must pay the “antes” or blinds when it is your turn. This forces you to pay money to sit at the table and encourages action. You are not able to sit there for free and see hand after hand waiting for the best. Eventually, you will lose all your money paying the antes.
Again, this is a direct force that mandates action.
Speculation is NOT the same. Where baseball is a “three strikes and your out” game, speculation is a “no strikeout game”. You can sit and wait for the perfect pitch and no one can force you to act. There is no penalty for patience in speculation. There is no direct force that mandates action.
However, there are indirect forces that create the “need” for action.
Indirect forces are things like the fear of missing out, needing to make money, opportunity cost of not acting, the enjoyment of trading and a whole myriad of other factors that “create” a sense of urgency in our operations.
It is important to understand that investing, trading, and speculating are a “no strikeout game”. This places a huge advantage on your side.
Let’s quickly breakdown four rules that Ted Williams applies to baseball and we can apply to trading.
First Rule - Getting a good ball to hit
Ted knew his “happy zone” down to percentage points. He understood what pitches would lead him to have the greatest chances of achieving success.
You need to find your happy zone.
What “pitches” are “fat”. This is your edge. If you do not have a quantifiable edge, you should not be actively speculating.
Edges can be anything where you have a higher probability of making money over a series of trades. You do not need to win every trade, or even win 50%. If you have an edge trading momentum names with a trailing stop and tight initial risk, you may only have 1 out of 4 winning trades. However, on the 1 trade you win, you might make 8 times what you lose of the other three. That is an edge.
You need to find what your own happy zone is.
I have found mine. It took me 7 years to dial it in.
Through rigorous self examination and study of my trading, I have found my happy zone is primarily in pullbacks during market weakness and finding thematic trends to invest in.
I love to search for names displaying relative strength during periods of market weakness and pounce on them when the pressure is taken off the market while sniffing out new and emerging themes.
I enjoy that process. It is my happy zone. Those are my fat pitches.
Second Rule- Know Your Strength
We all have our own unique abilities and skills in life. We all have different strengths and weakness. Some baseball players prefer high pitches while others like low pitches. Some traders love breakouts, others love pullbacks. Some have the mental ability to trade concentrated size, others do not.
Once you know the happy zone, you can fill it in with your strengths. For example, my strength is loving the process of trying to find the next investable theme. I enjoy the process of reading wide, seeing what is on the horizon, and trying to catch it. My strength lies in my enjoyment of the process.
Likewise, I do not “need” money from trading. My strength is the work I have done to separate direct action from indirect action. I can sit on my hands and do nothing for an extended periods of time (both in trades and in cash). Once in a trade, I have worked on the strength to not let it go until it has given me everything it can.
I constantly sharpen my strengths by reviewing and journaling like a psychologist, I trade my plan strictly, I study my mistakes, I have clear goals, and I do not care about anyone else’s success.
My strength lies in the intersection of enjoying the process and hunting big game while knowing myself on a deep level after decades of playing the market.
Third Rule - Discipline
When you start swinging at setups and ideas that are just a fraction outside your happy zone, you have lost the advantage. The market (or pitcher) will sniff out your indecision and recklessness. It will take advantage of your weakness and separate your money from your pocket.
The ability to stay disciplined is a superpower in this game. This is the discipline to follow your plan, to put in the work each and every day that is required, to never stop learning, never stop growing, and limit the amount of trades you take outside your happy zone.
For me, that looks like really waiting for a emerging trend or new breakthrough thematic idea to develop. I try and limit the amount of capital I deploy to mediocre ideas and work on the discipline to wait for the game changing ones. It is hard, and you never know which ones are really going to take off. Like I said, there is an art to this game.
Fourth Rule - Patience
Above is an email excerpt from Warren Buffett. The sentence I read over and over at first sounds a bit like self deprecating humor. But when understood with the power of hindsight (this was written a long time ago) we see he is really talking about patience.
Buffett writes “ I am sure, moreover that you can hit balls better in my happy zone then I can in yours just because they are fatter pitches in general”
Buffett admits the recipient in the letter can also do extremely well if he only swings at Warren’s pitches. This is because Warren is a master at patience. In a no strikeout game, he is willing to sit and wait until that fat pitch comes down the middle. So perfect, almost anyone can hit a home run.
Patience is preached by many of the top stock operators in the world. Livermore talked extensively about how it was the sitting, not the trading, that made the money. The patience to stay in… or stay out… of the market for extended periods of time and wait for the stars to align is known by many, but executed by few.
Conl:
If we can know what a good trade setup is, have the patience and discipline to wait for them, study our strengths and weakness so we can execute with confidence when the situation arises, I bet we all will have an incredible 2024.
— Nick Smith