So, how do we incorporate Taleb's socioeconomic lessons into our trading/investing playbook, and how do we deal with a market without memory from day to day?

Many of my most successful hedge fund friends as well as investors such as Warren Buffett have made their fortunes in buying and holding -- namely, by discovering investment acorns that rise into mighty oaks. They contend that, regardless of the environment, there will always be those opportunities.

Many of these hedge-hoggers have prospered by bottoms-up stock picking and have often downplayed the macroeconomic backdrop and the market's short-term volatility.

But perhaps the landscape has changed, and the investment fields are simply not as fertile as they were in the old days.

Perhaps substandard and meager returns lie ahead and buy-and-hold is dead or dying.

Perhaps, trading more aggressively in the future is a way to deliver better investment returns.

Perhaps a trading-sardine strategy will trump an eating-sardine strategy.

Investment Conclusion: How Should We Operate?

I would conclude that, while my hedge-hogger friends might be correct -- as for many, it has paid mighty dividends -- the unique conditions that exist today make the harvesting of those great investments ever more difficult in the future relative to the past. Indeed, there are numerous fundamental, valuation, sentiment and technical factors (and uncertainty) that support the notion that volatility, randomness and a market without memory from day to day will be more of a mainstay.

Generally speaking, my tactical response to an unsteady backdrop is to err on the side of conservatism. Here are my rules in the market's new normal:
  • Maintain lower-than-typical long exposure. For example, if your normal invested position is net long 70%, think about maintaining net longs of 40%-60%, depending on your risk tolerance.
  • Be careful of large, maturing companies whose time has passed. More often than not, they are value traps subject to disruptive competition. (See Taleb's rule No. 3 above.)
  • Be receptive to committing an expanding part of your investing portfolio to smaller and more disruptive stock positions.
  • Reduce the amount of investing you do while expanding your short-term trading activity. Be more active in long and short rentals.
  • While being more active in trading, be more patient than usual in your longer-term investing and wait for your right pitch, both with regard to an earnings and price timing setup. Volatility and disorder are accompanied by repeated opportunities to capture attractive entry points.
  • Be more active on the short side. Volatility encourages disappointment for those companies' managements that are inflexible, that are unable to respond to shorter economic cycles, whose margins might come under pressure (and pricing power limited) and whose profit stream is vulnerable to an economic wind no longer at the global economy's back.
  • Avoid concentration by diversifying your portfolio across industry lines, and keep individual equity commitments lower as a percentage of your total investment book.
  • Learn to trade based on specific catalysts, ranging from generic industry developments, earnings and other factors.
  • In order to be a nimble trader, you must learn how to buy red and sell green. To do that, you have to overcome your emotions and learn to acquire more of a contrarian streak.

In summary, looking out over both the near and intermediate term, as unappetizing as it appears to me (and others), we must learn how to operate successfully in a trading-sardine market, not in an eating-sardine market.

At the time of publication, Kass had no positions in stocks mentioned.

Doug Kass is the president of Seabreeze Partners Management Inc. Under no circumstances does this information represent a recommendation to buy, sell or hold any security.

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