10 learnings from the Lone Wolf of Wall Street

By Larissa Fernand |  20-05-19 | 
 
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About the Author
Larissa Fernand is Website Editor for Morningstar.in. She would like to hear from you and welcomes your feedback.

Here’s a simple trick to spot a stock market bubble.

Joe Kennedy, JFK’s father, decided to get his shoes polished one fine day. Nothing special about that, except that the shoeshine boy turned out to be a bit of a chatterbox and started doling out stock tips.

Kennedy’s reaction was not one of amusement. He was alarmed. This unsolicited advice from the young lad brought about the stark realization that the market was speculatively overbought. Despite being in the middle of a roaring bull market, he began to offload his portfolio that very day. In fact, he went one step further; he shorted the market. Well, this was the late 1920’s and he scored a massive windfall on the way down too.

Bernard Baruch, speculator, financier, philanthropist, friend of Churchill, and adviser to U.S. presidents Wilson, Roosevelt and Truman, echoed the identical sentiment in My Own Story.

Outside my old office in Wall Street there used to be an old beggar to whom I often gave gratuities. One day during the 1929 madness he stopped me and said, 'I have a good tip for you'.

When beggars and shoeshine boys, barbers and beauticians can tell you how to get rich, it is time to remind yourself that there is no more dangerous illusion than the belief that one can get something for nothing.

Baruch was extremely distrustful of tips and inside information of every kind. He believed that it was designed to mislead the gullible. Tips are most numerous when the market is booming. At that time, anyone's tip will seem good. This only draws people deeper and deeper into the market. It was apparent that he perceived speculation to be an art and was not for fools. 

There are great opportunities for a person who is willing to devote his time and thought to it. The stock market is nothing for an amateur, a dilettante, to fool with.  

I never knew an amateur to make any money in speculation.

(He defined a speculator as a man who observes the future and acts before it occurs.)

In frequent alliance with the famous Guggenheim brothers, he speculated in copper, sulfur, gold, rubber, tungsten, zinc, and iron investments in the U.S. and abroad. He made a fortune doing so and became a millionaire at the age of 30. (If that does not impress you, bear in mind that he was born in 1870).

But the market never left him unscathed.

Often as he pyramided his holdings (adding shares via margin as the price rose), he would be wiped out when the stock retrenched. A brutally honest self-analysis of his losses revealed two conclusions:

  • Insufficient knowledge of the securities in which he was dealing
  • Overleveraging his positions so that when a stock pulled back modestly, his capital would be wiped out.

At one time, Baruch heard through the grapevine that American Spirits was in the process of merging with three other whiskey manufacturers. Concluding that the tie-up would result in a monopoly of the American whiskey business, which would lead to monopolistic profits, and thus a massive share price increase, Baruch plowed all of his available cash into the stock. Contrary to expectations, the fizz went out of American Spirits stock. With no cash reserves, he was forced to sell other holdings to cover his margins. A classic case of sending good money after bad. He notes this as one of the “quickest losses I ever have suffered, and the largest loss in proportion to my total fortune.”

His first major hit was on the American Sugar Refining Company, the fortunes of which hung on a tariff. As long as cheap foreign sugar was barred from the country, American Sugar stood to gain. If foreign sugar was not kept out, the company’s profits, and therefore the price of its stock, would fall. The question on investors’ minds was whether or not the Senate would pass a bill to lower the sugar duty.  Baruch thought not. He reasoned that western sugar-beet growers had as much to gain from tariff protection as Wall Street did. He backed this guess with $300; a phenomenal amount in 1897. His profits mounted wonderfully and later in the year he walked away with a cool $60,000.

Baruch also helped finance some of the leading industrial firms of his time including Texas Gulf Sulphur, Utah Copper, and the Intercontinental Rubber Company.

The Gulf Sulphur Company was formed in 1909 by a group of investors to exploit a newly developed sulphur deposit in the U.S., using the Frasch Process. According to this process, superheated water is pumped into the underground sulphur deposit; the sulfur melts and is extracted. The Herman Frasch patent expired in 1908. Perfect timing.

After immersing himself with facts on global sulphur trade, Baruch concluded that America’s rapid economic growth would require the development of the sulphur industry.  Eventually, Bernard Baruch, J P Morgan and W. B. Thompson purchased Gulf Sulphur, and the company was renamed the Texas Gulf Sulphur Company. It went on to become one of the largest sulfur mining companies in the world. Needlessly to say, he made a killing.

Though an aggressive speculator, he also dabbled in simple arbitrage, profiting from discrepancies in the price of stocks between London and New York. In The Adventures of a Wall Street Legend, the author mentions how traders in London and New York kept an eye on each market. On both sides of the Atlantic, arbitrageurs kept odd hours (rising before dawn in NY and working into the evening in London) in hopes of buying stocks cheap in one market and selling them dear in the other. The first thing that Baruch asked when he walked into his office was “What’s London?”

According to a commentary, from 1897 to 1902, Baruch parlayed his capital of $60,000 into $3.2 million. His contrarian views and solid financial judgment earned him the moniker “Lone Wolf of Wall Street,” because he typically kept his own counsel.

Here are his 10 rules for successful trading - the fruits of his experience:

  1. Don't speculate unless you can make it a full-time job.
  1. Beware of barbers, beauticians, waiters -- of anyone -- bringing gifts of "inside" information or "tips."
  1. Before you buy a security, find out everything you can about the company, its management and competitors, its earnings, and possibilities for growth.
  1. Don't try to buy at the bottom and sell at the top. This can't be done -- except by liars.
  1. Learn how to take your losses quickly and cleanly. Don't expect to be right all the time. If you have made a mistake, cut your losses as quickly as possible.
  1. Don't buy too many different securities. Better to have only a few investments that can be watched.
  1. Make a periodic reappraisal of all your investments to see whether changing developments have altered their prospects.
  1. Study your tax position to know when you can sell to greatest advantage.
  1. Always keep a good part of your capital in a cash reserve. Never invest all your funds.
  1. Don't try to be a jack of all investments. Stick to the field you know best.
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