Studies of Life

Learning by doing.

Why Being Zen Matters for Your Portfolio

10 October 2014 by Jim

Being “zen”, calm and peaceful, a state that students of the Japanese Zen Buddhist tradition strive to achieve, is a wonderful feeling. It is achieved via meditation, but through regular meditation it will slowly permeate life itself and become a state of mind that the Zen practitioner is in even when he is not meditating.

Why should this be important for investing?

As James O’Shaughnessy has shown in his brilliant and very thorough What Works on Wall Street, simple rules and quantitative systems [1] make investing very powerful. And what’s even better, they do not require nearly the same kind of involvement as active trading or day trading do.

For an investor in general, the best thing is to adopt a system and then stick to it. 

The chances of sticking with a particular system are increased enormously by not looking at it all the time. The shorter the interval of observation is, the more of what you see is not actually a useful signal but rather random noise, according to Nassim Taleb in Black Swan (a really wonderful book, one of my favourites!).

In order to avoid freaking out because of short-term movements, you should try to remove yourself from your portfolio as much as possible. Check your portfolio as infrequently as possible. Check it as often as your plan requires but no more. If you only invested the money you can afford to lose, there shouldn’t be anything too worrisome about this.

Checking your portfolio less frequently is a great thing if you use a long-term strategy. Checking it every day can easily throw you off course because you may freak out too much and not be able to handle it.

And even if being less mindful of my portfolio did not have any practical benefit, I would still try to develop an investing style that requires little intervention, because I don’t think my entire life should be ruled by money, even if money necessarily is a big part of how we live life nowadays. It’s no use to be depressed because my portfolio lost 7% in one week if it makes up the loss in the next week. So my personal schedule is based on checking my portfolio just once every month.

As a side note, I’ve also dropped stop loss orders, mainly due to very real danger of flash crashes[2].


 

[1] – Quantitative investing systems are based on rules, often mathematical in nature, and involve strictly following these rules with no room for individual human judgment. As O’Shaughnessy and many others have shown, individual judgment by a mutual fund manager or a retail investor generally reduces returns compared to a rule-based rational system. The quantitative investing system I use is based on the Piotroski filter and the Trending Value Ranking method in O’Shaughnessy’s book.

[2] – A flash crash occurs due to algorithmic trading. Nowadays, many big investment companies use computers to execute trades based on rules rather than an actual human being pushing a button. Sometimes, many companies’ rules may be triggered at the same time due to a programming error or a random event, resulting in massive selling of stocks. In this case, prices can drop 40% in an instant. This would activate all the stop loss orders I have, so I would sell at the next best price, maybe 40% below the previous value. Guess what? 20 minutes later the flash crash is ‘gone’. Intelligent human investors notice that the crash is not due to any actual event but rather to an error and quickly buy back shares, pushing the prices back to where they were initially. Within 20 minutes it’s all over, but if I had stop losses at that moment, I may have lost 40% in a few minutes, whereas using no stop loss orders would mean that the flash crash didn’t really affect my holdings at all. The last flash crash happened in 2010.

Leave a comment | Categories: Investing, Thinking | Tags: , , , , ,

Leave a Reply