Successful investing is composed of Speculation and Capital Management

All Investments are "Speculations"

Most forms of investment are speculative in nature, be it value-based stock investment, technical analysis based stock investment, currency speculation or macroeconomic asset hedging. By speculative, I mean they all involve assessing probability of some future events. The subject and approach of assessment are different, but it is ultimately speculating.

Value-based stock investing may not speculate on whether stock prices will rise or fall. However, it does speculate how well relevant company will perform in the future. You can buy stocks of a company appearing under-valued on all metrics (e.g. PE ratio, PB ratio, PEG ratio, price to cash ratio). However, even such a company can end up worthless with a bad management.

Different styles of speculation may have different amount of merit, depending on the quality and nature of institutions in that market. For instance, value-based investment in stocks or bonds assumes rights of security holders will be enforced (e.g. change management). Technical analysis based investment works best when significant portion of people in the market buy into the approach.

 

Some may argue that one form of speculation is absolutely superior to another (or all others). We won't get into that argument here, save to say that as long as you have the ability to assess odds required fairly accurately over the long-run, the speculation approach should be considered successful. It is sufficient to result in out-performance, as long as you can capitalize it with good capital management.

Second part of Investing: Capital Management

 

Speculation (or probability assessment) only forms one portion of investment. The other part that is at least equaly importance is capital management: i.e., how to avoid capital loss and maximize long-term performance when you are always making bets with less than 100% probability of winning. Some like Taleb uses options to limit downside of each bet, and spreads his bets. Some like Buffet uses convertible bonds to ensure capital preservation; he also keeps significant portion of total funds in cash to preserve cash and take advantage of future opportunities. Others like Soros tests market sentiments with small positions, and is always jittery and have the tendency to close positions when he feels he read the market wrong. All successful investors have stressed the importance of preserving capital.

To that extent, capital management in investment is like money management in poker. In the real world, the successful poker player rarely stakes everything unless winning (or a draw) is a certainty. In some ways, good capital management practice also depend on personality as well as intelligence.

Implications

One imlication of these two separate parts of investment is that a fund manager needs to excel in both to be successful. Just assessing future probabilities accurately does not guarantee successful investment strategy. That is why research analysts, stock-tip gurus, and even insiders don't always make good investment managers in the long-run. As a poker analogy, you can be great at calculating odds, memorizing cards and reading others' cards, but if you went all-in on every single hand, you are still a bad poker player.

Also, capital management style may need to be matched to particular investment speculation approaches. Buffet's no-leverage buy-and-hold capital management style worked for his value-based speculation approach, but it may end badly for Soro's style of speculation. Buffet's approach also does not apply to Taleb's investment approach, given the latter only buys options.