Note that I don’t greet you as an investor. That’s because, even though we practice a method here that has delivered better results over time than most mainstream investors achieve, we never want to lose sight of the fact that we are speculating. And that’s a good thing.
This report will give you the essentials of the speculative method I learned from my friend and mentor, Doug Casey.
What Is Speculation?
A successful speculator is not a wild gambler. Nor are we “safe” investors, obviously. We are rational, disciplined, independent-minded people analyzing trends, doing everything possible to put the odds in our favor, and then committing capital to an idea that, we believe, has a high chance of delivering an outsized return.
Why take the risk?
To make money, of course. A lot of money.
Legendary speculators like Doug Casey and Rick Rule didn’t make their fortunes working hard at a regular job. They did it by seeing the difference between price and value in various markets. They placed their bets and stuck with them as long as the value proposition remained intact, and cut their losses when it didn’t.
The first thing these gentlemen taught me is that you have to be willing to lose money to make money as a speculator. No one wins them all. But the wins are often so much greater than the losses, they more than make up for them.
This is in direct contradiction to Warren Buffett’s famous investing rule: “Never lose money.” That’s a fine rule for a long-term value investor like Buffett. It’s completely incompatible with successful speculation.
Let’s be crystal clear on this. It’s not just that speculators may lose sometimes. It’s that they will lose, often. High rewards only come with taking risks, and that results in some permanent loss of capital. That’s the nature of the game. People who can’t handle this reality shouldn’t even try speculating.
Now here’s the thing:
The most we can lose is 100% of the capital we deploy, but…
… there is no limit to the upside.
In practice, it’s very rare to lose 100% on failed speculations (unless we use leverage, which we never do on speculative bets). When a speculation doesn’t work out, we take our lumps when failure is obvious and move on.
On the other hand, it’s common to make 100%, 200%, 500%, and more on successful speculations. We have delivered 10-baggers (1,000% gains) and better in our careers. Doug has landed 100-baggers. Wins like that more than make up for a lot of less successful speculations.
Consider this distribution of possible results from buying 1,000 shares in 10 speculations:
|Speculation||Opening Price||Capital Committed||Ending Price||Ending Capital||% Gain / Loss|
If we had average returns on our speculations like this every year, we’d be extremely pleased with ourselves. It’s certainly possible; I’ve seen better years in my career. But it only happens if we’re willing to take the losses that come with the big wins.
Anyone who can’t take losing much of the capital deployed into some of their speculations—on a regular basis—is not cut out for successful speculation.
And that’s most people.
Which is why successful speculation is so profitable. If it were easy, everyone would do it, and there would be no opportunity. Because it’s hard, and takes real courage, few do it. That makes the potential profits enormous.
If you have the courage to stand by this simple, harsh, but also exciting math, we can help you become a great speculator.
How to Speculate?
I could write a book on this—and I plan to. For now, here are the essentials:
• Be Contrarian. The essence of speculation is so obvious, it’s become a cliché: “Buy low, sell high.” But doing this takes a great deal of courage, and that is rare. Think about it. How do you buy low? You buy things of value that others don’t want. You look for things people still need, but are so hated in the market that they are in liquidation. If you’re right about these things being of value, their prices must go up, sooner or later.
That’s the theory. In practice, it means buying stocks when headlines proclaim stocks are dead, or gold when prices are down and Warren Buffett says it’s useless, or cattle when beef prices have dropped so low that ranchers are liquidating their herds and becoming wind farmers. It means doing what other investors think you’re crazy for doing. It means standing firm when mainstream brokers, fellow investors, and even spouses think you’ve taken leave of your senses.
And as hard as that is, it also means taking profits when everyone else is congratulating you for being such a genius and piling in to what you bought when no one wanted it. It means selling when prices are going vertical, and not waiting another day that might double your money again. It means exiting and staying out when mainstream brokers and fellow investors are crowing about how much more money they just made, and your spouse is convinced you’ve taken leave of your senses.
Buying low and selling high is easy to say and understand, but so very hard to do. Again, if it were easy, all investors would do it. There would be no such thing as a contrarian opportunity. As Rick Rule says, you have to be a contrarian, or you will be a victim.
To be fair, Buffett also said: “A simple rule dictates my buying: be fearful when others are greedy, and be greedy when others are fearful.”
This is the essence of being a contrarian.
• Understand Value vs. Price. Where does one find the courage to be a successful contrarian? The best foundation for courage is conviction. When you fully understand a specific market situation, the knowledge becomes the solid foundation on which courage can stand firm.
For example, copper has obvious and important value. From cars to refrigerators to having lights in our homes, it’s absolutely essential to modern life. But in the crash of 2008, copper prices fell below $1.30 per pound. At the same time, it cost an average of about $2.00 per pound to mine the metal. I was sure back then that copper prices had to rise. It was either that or a lot of people would have to give up refrigeration, transportation, and illumination. Absent WWIII, that wasn’t going to happen. I was right. Copper recovered after 2008, soaring to more than $4.50 per pound.
When you study a market and understand it well enough to grasp situations like this, it becomes much easier to stand your ground against the naysayers. That’s essential because, by the very nature of your contrarian position, they will outnumber you.
That’s the theory. In practice, the nuts and bolts to focus on are price and value.
Price and value always converge. Hyped-up, overbought assets see their prices fall—or collapse—back to reality. Hated, oversold assets see their prices rise—or leap—back to reality. When you fully grasp such a situation, when you’re sure that a price must move in a particular direction, you have a firm basis for speculation.
You see, markets are only rational over the long term. They tend to be right and favor those who are right in the long-term. But day to day, week to week, and sometimes year to year, they can act like drunk freshmen throwing darts on a Friday night out. Some will over- or undershoot. The beauty of the market is that when hundreds of drunk freshmen have been throwing darts over many years, on average they will hit the target.
Your job as a speculator is to be there when this pattern emerges. And the greater your knowledge of the case, the firmer your conviction, and the easier it is to find the courage to wait for the pattern to emerge, resulting in a successful speculation.
If this sounds like value investing to you, you’re not wrong. Rational speculation does share something with this most reputable investing school. Much like Buffett, we look into cases where value is higher than price and we can expect prices to rise to meet value. But we’re also not opposed to finding overpriced assets and shorting them, betting that prices will fall to levels closer to actual value. And as above, we’re different from Buffett in our strategic use of higher risk to generate higher gains.
We do agree with Buffett, however, that we should only look for opportunities in markets and assets that we understand.
• Focus. The immediate corollary to the above is that you should focus on what you know or want to learn. If you’re very keen on green energy, it’s a good area for you to invest in. If you love geology, focus on mineral exploration. If you’re excited about biotech, go for it. And so forth. Never stop reading, exploring, and learning more about the areas that interest you. Happily, indulging your interest increases your expertise. That increases your ability to spot opportunities. This, in turn, gives you the courage to see your speculations through.
You can’t master all markets, of course, but there’s no need to try. Developing expertise in a few areas that you really like and understand is enough to supply you with abundant ideas over time and the ability to cull all but the best ones.
• Diversify. This may seem to contradict our point about focus, but not really. There is such a thing as too much focus. It creates unnecessary risk. Buying and holding just one stock—even one as dull and theoretically stable as General Electric—is too risky, as recent history showed.
Doug Casey taught me that the ideal speculator studies, monitors, and invests in ten completely unrelated markets. It doesn’t have to be ten, and should not be more areas than any of us feel confident we can grasp well. But it should be more than one. This is simple risk mitigation.
But don’t spread yourself too thin, either. That would contradict the importance of focusing on areas you can master. All I’m saying is that the old adage about not putting all your eggs in one basket applies to investing in general, and to speculation in spades.
This may seem obvious, but I’ve met many, many investors over the years who fall so in love with their favorite asset class that they ignore all other opportunities. Worse, they sometimes let this intense focus become a set of blinders about the very thing their expertise should make them good at. This is what makes people who are in love with the idea of, say, Bitcoin, insist that prices going vertical in late 2017 was a sure sign that they must go still higher, rather than being the loud warning that clearly was.
Don’t become a one-trick pony. A rut is just a grave you haven’t come to the end of yet.
• Don’t Gamble. It’s a common misconception that speculators are “just gamblers.” This is incorrect. The odds are against the gambler. Over time, the house always wins.
As a rational speculator, I do take chances. But I also do everything possible to put the odds in my favor. Honestly acquired knowledge of a market, an industry, a specific company, or a new technology can do this. This is not cheating. It’s due diligence that anyone can do… but few people bother with.
And yet, strange as it may seem, failures of due diligence are the norm among investors, not the exception. Shrugging off the responsibility of learning about our speculations would make us gamblers. We do have to take chances, but we should never close our eyes and place blind bets. If we did, we’d not have the knowledge to bolster our conviction. Without that, we’d be more likely to panic and sell at the wrong time than to see our speculations through. Luck can complement a solid investment idea, but successful speculators always have a sound foundation underpinning their theses.
Let me say that again: successful speculation is more the result of hard work than luck.
There’s more. If we understand an asset or a market well enough to spot differences between price and value, we not only tilt the odds in our favor, it makes it possible for us to speculate on “when,” not “if” questions. This is crucial.
Consider: Whether a new drug will cure a dread disease is an “if” question. Which new gadget might become “the next iPhone” is an “if” question. Things like this may happen, or they may not. Investing on such hopes and dreams is gambling, not speculation.
On the other hand, betting on uranium prices rising when the prices are about one-third of what it costs to mine uranium, is a “when” question. This is the case as I write, in early 2018. Many years from now, the world may be able to do without nuclear power, but it cannot at present. That means that if people want the lights to come on in large parts of the world, uranium will have to be mined. And that means that prices must rise. I don’t know exactly when, but I’m sure they will. This is a clear case of “when, not if.” This is a rational basis for speculation.
I want to be very clear on this. Our service is designed for diligent and disciplined speculators, not gamblers. We will share our due diligence with you, but we will count on you making sure you understand the opportunities as well as your own financial position, goals, and risk tolerance well enough to make your own speculative investment decisions.
• Value Volatility. Doug Casey is famous for telling people to make volatility their friend. That doesn’t mean we should all become masochists. It means that market volatility creates opportunities.
Ideally, we’d all spot powerful trends right at their beginnings. We’d buy at the very bottom, as low as it gets. Then we’d calmly ignore the ups and downs, and sell high during a market mania. That’s when all the emotional, momentum-chasing masses pile in for fear of missing out. Extremely disciplined speculators with 5- to 10-year time horizons, or longer, can do this.
This is another thing we’ll admit we share with Buffett. Long-term time horizon works for speculators just as well as for classic investors. Rome wasn’t built in a day, and neither are multi-million-dollar fortunes. Any investment idea, regardless of its riskiness, needs time to grow. Often, we’re talking years.
But we know that most people have more immediate goals and needs. That’s where volatility becomes our friend. Just because we missed the very beginning of a trend, that doesn’t mean we have to wait 10 years for the next one. If the market experiences high volatility, we can watch for big retreats in prices to create buying opportunities mid-trend. Sometimes these can be almost as good as getting in at the very beginning—but with the added advantage of already being able to see the trend in motion. On the other hand, mid-trend market rallies can send prices soaring well ahead of any rational valuation, creating opportunities to take profits. In an extremely volatile market, both of these buying and selling opportunities can happen several times over the course of a larger market trend.
I personally remember one stock I recommended buying and selling at roughly the same price. But in the intervening time, we were able to buy the troughs and sell the peaks, doubling our investment three times. That’s how you make volatility your friend.
• Build your positions. Another way to make volatility your friend is to use it to build positions on a lower cost basis.
You see, even after I’ve researched a speculative opportunity thoroughly and I’m ready to buy, I still don’t know which day and what price will maximize my profit. Remember: nobody can time markets reliably. Timing individual stock tops and bottom is even more impossible.
But if prices are volatile, I can use that to my advantage. For example, I start by considering what would be an ideal position in a stock I want to buy. That might be $10,000 for a smaller, less liquid company, or $100,000 for a bigger one with excellent trading volume. When I’m ready to buy, I buy only part of my ideal position. If the stock takes off the next day, at least I have a stake and will benefit. More likely is that the stock will fluctuate, and I’ll have a chance to buy a second slice of the pie at a lower cost. Depending on how volatile I expect the stock to be, I might buy it in two or three slices. The first and second might be equal slices on a less volatile stock, or 40% and 60% slices if I expected near-term fluctuations. For a more volatile pick, I’d typically take an initial 20% slice, then another 20%, and hold off on a 60% slice in case of a major corrections without any bad news regarding the specific speculation.
1. Let’s say my ideal position in Company X is $20,000. It sells for $1 per share when I decide to buy. It’s a more volatile stock, so I decide on a 20% first slice. I buy 4,000 shares for $4,000.
2. Nothing happens to the company, but the stock rises for a while, then drops to $0.90. I buy a second slice of $4,000, which adds another 4,444 shares to my position. The stock takes off again, based on solid, value-adding results, and I’m happy. I already have a good 40% of my ideal position, and the stock is doing well.
3. The next week, there’s a big scare in irrelevant financial news that puts all stocks in this sector on sale. Company X shares drop to $0.75. I’m even happier, because the company is more valuable than when I started, but it’s even cheaper, making it a better value. I buy my third, 60% slice, picking up 16,000 shares for $12,000. More ups and downs follow, but I’ve got 100% of the pie I wanted, so I sit tight.
4. Now let’s say I made a great pick, and the stock doubles to $2. Great! But I bought 24,444 shares for $20,000, averaging 82 cents per share. I didn’t know where the bottom was, but I used market volatility to get a low average price, fairly close to the bottom, boosting my gains over 44%.
5. Or let’s say it was a bad pick. It drops to $0.60 on actual bad news from the company. But instead of being all in at $1, resulting in a 40% loss, my average cost of $0.82 reduces my loss to about 27%.
Building low-cost positions this way can both boost profits and cut losses. It makes volatility a valued friend instead of a feared enemy. This makes it easier to hold on to our courage, stand by our convictions, and see our speculations through to their conclusions.
• Don’t bet the farm. This should go without saying, but like so many important things that should be common sense, this one must be stressed:
Speculate only with money you can afford to lose.
Yes, I do everything in my power to put the odds in our favor. Personally, I hate losing money. But I understand that if I swing for the bleachers, I’m going to strike out sometimes.
Going all in on any single investment, no matter how sure I am about it, is the “eggs in one basket” mistake. Putting all of my capital into higher-risk/higher-reward speculations falls in the same category.
Keep in mind that the name of my monthly newsletter is the Independent Speculator. That means that my research, ideas, and actions are honest—independent. It doesn’t mean I’ll always be right. Our promise is unbiased due diligence, not guaranteed success.
Understand this. Embrace it. And don’t get carried away.
• Take profits. Remember that no unrealized gain is… well, real, until you have your profit in your pocket. Don’t let greed get the better of you. If you don’t sell high, “buy low, sell high” doesn’t work.
Losing money on a bad speculation is bad enough. Far worse is to suffer the stress of taking a risk, sticking with a plan through all the ups and downs, being proved right—only to let it slip through your fingers because you didn’t take profits when you had them.
Volatility is great when it gives us a sudden boost, but it hurts when the floor drops out from under us. It is our friend, but only if we have the discipline to sell when we’ve booked sufficient rewards, without trying to peg the very top of the market.
The standard procedure I learned from Doug Casey is to take profits on volatile stocks the first time they double in price. This means selling half of my position on a 100% gain. That leaves me with the same exposure I started with, but with my initial investment safely back in my hands. This gives me risk-free upside for the remainder of the speculation. And if the stock drops to zero for some reason, well, my loss would be… zero.
This is how savvy speculators manage to take chances without becoming nervous wrecks.
When to Speculate?
I could just say that “buy low, sell high” answers this question. But such general guidance leaves us fumbling about, waiting for opportunities to fall into our hands. Sometimes they do. One of the best ways to look for and find speculative opportunities, however, is to monitor highly cyclical markets.
Economists and politicians may decry boom and bust cycles, but for speculators, they are the stuff fortunes are made of.
The essential challenge of speculation is not knowing what will happen. If we did know for certain, it wouldn’t be speculation. It would be a sure thing. It’d be easier for me to believe in Santa Claus than in a “sure thing” investment. But if we work with highly cyclical markets, we can pretty much know that it’s time to buy when they’ve fallen and time to sell when they’ve risen. As long as we’re not talking about something obsolete, banned, a passing fad, etc., we can know that low prices are a buying signal.
Speculating in cyclical markets is all about harnessing the power of investing in “when, not if” questions as described above. Understanding the prices and values of things in cyclical markets answers the specific questions of when to buy and when to sell. We look for good buys when cyclical markets are oversold, and we look to exit our positions when those markets are overbought. In neither case do we try to time the markets. That’s a fool’s errand. But looking at the difference between price and value tells us generally when it’s time to buy and sell.
The details, of course, are determined by the specific commodities, equities, options, debt offerings, and so forth.
Who Should Speculate?
This may seem like a silly question, but it’s actually central. With no intention to insult anyone, the frank fact of the matter is that not everyone should be a speculator. Among those who are better off staying away are people who:
The timeless dictum, “know thyself,” is essential for speculators. Success here takes courage and discipline. Those who know they have these strengths can do very well.
It starts with being honest with oneself. Make an informed decision. Then stick with it.
Why take risks and deal with the stress of speculation? As I said at the outset, we do it to make serious money. But there’s more to it than that. At least for me.
The kind of rational, disciplined mind that succeeds at speculation tends to be the kind of mind I’d like to see succeed in life in general. I’ve known many speculators in my life, and none was like the evil profiteers depicted in cartoons. Real speculators, acting in their own self-interest, help the market’s invisible hand make the world a better place. The ones I know tend to be interesting, forward-looking people.
I bring this up because many financially successful people are prone to feeling guilty about having while others have not.
I’m here to tell you that honest market participants have nothing to feel guilty about.
We do not get rich by making others poor. We do so via voluntary transactions that both side feel are in their interests. This is not only ethical—it is the very engine of human progress.
Everybody can learn. Everybody can take calculated risks, if they dare. And everyone has the right to profit if the make the right call. This is not only fair, it’s just.
Entrepreneurs who bring to market a better mousetrap, a more effective medicine, a cheaper refrigerator, or even a pocket device which puts more music at the average person’s fingertips than the mightiest kings and queens had access to in the past… these people are heroes, not villains. Even if the motives were the pursuit of profit, these developments are win-win transactions for all of humanity.
As speculators, we are part of this market process.
So don’t feel guilty. And don’t be scared. Remember, the odds aren’t set against you—if you’re willing to learn. And as long as you participate in the market on a voluntary basis, you are a force for good in our world.
As Earl Nightingale used to say, the wealth you accumulate is a measure of your service to others.
You should be proud to be a successful market participant.
I hope that, with our help, you become a great speculator.
Sunday, April 22, 1:47am, EDT, 2018