Apprenticed Investor: Prepare for Battle

The purpose of "Apprenticed Investor" is to teach you to become better investors. Today's lesson is about having a healthy respect -- not fear, but respect -- for your opponents.

I am always surprised at how eager and confident new investors are, entering the fray with hardly any hesitation. The reason for this is fairly simple: Many investors have achieved some level of success in their chosen field. This is how they have amassed their investing capital, and their prior success breeds a healthy self-confidence.

Healthy, that is, in your chosen fields. In the capital markets, that self-confidence is dangerous, even reckless. People tend to forget that once they become investors, they have essentially started a brand-new career -- and started at the very bottom, too.

Transitioning from a newbie to an accomplished pro will present many challenges. The self-confidence that served you so well in your other endeavors can hurt you when trading. Just as 90% of people consider themselves above-average drivers, so too do many people believe they are above-average investors. For the majority of these folks, that belief can be naive -- and potentially self-destructive.

A question I ask people who want to become traders (or even pros who want to become fund managers) is this: Do you have the skill set, discipline, temperament, time horizon, strategy and capitalization to enter into the most competitive gladiator ring on planet Earth?

The market is a zero-sum game. You win, someone else loses, and vice versa. That's certainly true on individual trades, and it's nearly true on the market overall. The only thing that prevents all of investing from being a true zero-sum game is that, over time, the pie gets bigger. At least, it has in the U.S. for the past 100 years.

Competitive Juices Flowing

It's important to understand who your opponents are on the field of battle. Sports and war metaphors abound, because they are consistent with what you are going up against. Yes, you are up against Mr. Market, but your rivals are also other people buying and selling stocks. They, too, are looking to produce positive returns.

Charles Ellis, who oversees the $10 billion endowment fund at Yale University, once observed:

Watch a pro football game, and it's obvious the guys on the field are far faster, stronger and more willing to bear and inflict pain than you are. Surely you would say, 'I don't want to play against those guys!'

Well, 90% of stock market volume is done by institutions, and half of that is done by the world's 50 largest investment firms, deeply committed, vastly well prepared -- the smartest sons of bitches in the world working their tails off all day long. You know what? I don't want to play against those guys either.

That's a brutal and, in my opinion, absolutely spot-on observation. The institutions Ellis refers to are mutual funds, hedge funds, charitable trusts, insiders, program traders -- and all of their professional traders and portfolio managers.