In the competitive world of investing, each of us should constantly be seeking out competitive advantages. Personally, I believe that a certain degree of competitive advantage can be found in the cross-pollination of different schools of investment thought.

Many in the value school often deride trading strategies, but they cannot deny the existence of those who practice the trading style of investing and have generated fantastical trackrecords over time, even if the disbelievers cannot understand the basis of how they have done so.

The following excerpts derived from Jack Schwager’s interview with Charles Faulkner in The New Market Wizards relate to trading strategies, but I think many of the psychological and process-focused aspects are also applicable to fundamental investors.

Psychology, Portfolio Management

“Natural Learning Processes [NPL]…the study of human excellence…studies great achievers to pinpoint their mental programs – that is, to learn how great achievers use their brains to product results…The key was to identify…the essence of their skills – so it could be taught to others. In NPL we call that essence a model.”

“If one person can do it, anyone else can learn to do it…Excellence and achievement have a structure that can be copied. By modeling successful people, we can learn from the experience of those who have already succeeded. If we can learn to use our brains in the same way as the exceptionally talented person, we can possess the essence of that talent.”

This is the goal of Portfolio Management Jar: to study the rationale behind portfolio management decisions of great investors, and perhaps one day generate returns the way they do. Notice, there’s a distinction between observing the actions and decisions vs. analyzing the rationale behind those actions & decisions. The true treasure trove is the latter – the way they use their brains.

Process Over Outcome, Psychology, Portfolio Management

On characteristics of successful traders:

“Another important element is that they have a perceptual filter that they know well and that they use. By perceptual filter I mean a methodology, an approach, or a system to understanding market behavior…In our research, we found that the type of perceptual filter doesn’t really make much of a difference…all these methods appear to work, provided the person knows the perceptual filter thoroughly and follows it.”

“People need to have a perceptual filter that matches the way they think. The appropriate perceptual filter for a trader has more to do with how well it fits a trader’s mental strategy, his mode of thinking and decision making, than how well it accounts for market activity. When a person gets to know any perceptual filter deeply, it helps develop his or her intuition. There’s no substitution for experience.”

Interestingly, this is very applicable to portfolio management. Because the portfolio management process has so many inputs and differs depending on the person and situation, in order to master the art of portfolio management, investors need to figure out what works for them depending on “mental strategy, his mode of thinking and decision making.” It helps to observe and analyze the thought processes of the greats who came before you, but there’s “no substitute for experience.”

Process Over Outcome, Luck, Psychology

“…if a trader does very well in one period and only average in the next, he might feel like he failed. On the other hand, if the trader does very poorly in one period, but average in the next, he’ll probably feel like he’s doing dramatically better. In either case, the trader is very likely to attribute the change of results to his system…rather than to a natural statistical tendency. The failure to appreciate this concept will lead the trader to create an inaccurate mental map of his trading ability. For example, if the trader switches from one system to another when he’s doing particularly poorly, the odds are that he’ll do better at that point in time even if the new system is only of equal merit, or possibly even if it is inferior. Yet the trader will attribute his improvement to his new system…Incidentally, the same phenomenon also explains why so many people say they do better after they have gone to a motivational seminar. When are they going to go to a motivational seminar? When they’re feeling particularly low…statistically, on average, these people will do better in the period afterwards anyway – whether or not they attended the seminar. But since they did, they’ll attribute the change to the seminar.”

“Medical science researchers take the view that the placebo effect is something bad…However, Bandler and Grinder [founders of NPL] looked at it differently. They saw the placebo effect as a natural human ability – the ability of the brain to heal the rest of the body.”

Mistakes, Process Over Outcome, Psychology

Traders seem to place a lot of value on “emotional objectivity,” a term I found interesting since it’s definitely something that’s applicable to fundamental investors especially in situations involving mistakes.

“We’ve all been in trading situations where the market moved dramatically against our position. The question is: How unsettling or disconcerting was it? What happens when you’re in a similar situation a couple of weeks or even a couple months later? If you begin to experience some of the same unsettling feelings just thinking about it, you’ve conditioned yourself just like Pavlov’s dogs.”

“Manage of one’s emotional state is critical. The truly exceptional traders can stand up to anything. Instead of getting emotional when things don’t go their way, they remain clam and act in accordance with their approach. This state of mind may come naturally. Or some people may have ways of controlling or dissipating their emotions. In either case, they know they want to be emotionally detached from feelings regarding their positions.”

Is important question is how to un-condition oneself, to remain emotionally objective when mistakes have been made. Of course, since each of us is mentally programmed differently, the answer to this question likely differs from person to person.

Psychology, Capital Preservation, Risk

“There are two different types of motivation…either toward what we want or away from what we don’t want. For example, consider how people respond to waking up in the morning…The person who wouldn’t get up until he saw images like his boss yelling at him has an ‘Away From’ motivational direction. His motivation is to get away from pain, discomfort, and negative consequences…He moves away from what he doesn’t want. The person who can’t wait to get out of bed has a ‘Toward’ motivational direction. He moves toward pleasure, rewards, goals…he moves toward what he wants. People can have both types of motivation…but most people specialize in one or the other. They are very different ways to getting motivated, and both are useful in different situations.”

“People who move toward goals are greatly valued in our society…However, the Away From direction of motivation has gotten a bad rap…The Toward motivation may be enshrined in success magazines, but the less appreciated Away From motivation individuals can also be very successful…Many outstanding traders reveal an Away From motivation when they talk about ‘protecting themselves’ or ‘playing a great defense.’ They’re only willing to take so much pain in the market before they get out. As Paul Tudor Jones said in your interview, ‘I have a short-term horizon for pain.’”

“Very often they come in with a developed Toward motivation – toward success, toward money – that’s why they got into the markets in the first place. However, those that are primarily Toward motivated must spend the time and energy to develop the Away From motivation required for proper money management. In my studies of traders I’ve found that it’s nearly impossible to be a really successful trader without the motivation to get away from excessive risk.”

Some people are more genetically inclined to focus on capital preservation. Some people are less genetically inclined to control “risk.”