Guillotine Investing: Keeping Your Head While Others Are Losing Theirs

Table of Contents

Unique Results – Unique Thinking

My Market Entrée

Elements of Success

Elements of Failure

Clientele Risk

2008—A Career Year for My Clientele

Investing versus Trading

Investment Decision Making

Analytical Tools

Volatility and Profit

Retirement

Compounding

Extracting Profit

Time Frame

Trade Management

A Free Look at the Markets

Open (Unrealized) Profits

Investment Capital

Timing an Investment

The Last Word

GUILLOTINE INVESTING

GUILLOTINE INVESTING

Keeping Your Head While Others Are Losing Theirs

For Investors, Traders, and Strategy Designers

K.D. Angle

GSN Publishing LLC

Copyright © 2016 by K.D. Angle. All rights reserved.

Published by GSN Publishing LLC – Incline Village, Nevada, USA

No part of this publication may be reproduced, stored or transmitted for the purpose of distribution, in any form or by any means without the written prior permission of the publisher or author. Copyright clearance may be obtained by going to the publisher’s website at www.guillotineinvesting.com or by writing the author at kdangle@guillotineinvesting.com.

Disclaimer of Content and Limit of Liability: The publisher and author make no representations with respect to the accuracy of the contents of this book or any of its related sales materials or presentations. The recommendations and concepts made by the book’s author may not be suitable for the reader’s situation. Anyone reading this book should first consult with a competent professional in the field of financial services, investing or the markets before deciding to participate in any market-related investment, idea or methodology. The publisher and author will not be held liable for any action taken by a reader that results in a loss or expense of any kind, whether it be financial, emotional or any other damage that is claimed or imagined as a result of reading this book.

Profit is not possible from the markets without risk of loss. Past performance is not indicative of future results. Unfortunately, not everyone who chooses to get involved with investing, strategy design or trading the markets in pursuit of profit has the ability of developing long-term potential success. None of this book should be construed as a solicitation or an offering of services of any kind, in any manner or degree.

ISBN-13: 9780997290325

LCCN: 2016953874

Typeset by M.K. Ross

Printed in the United States of America

This work is inspired by the book

Reminiscences of a Stock Operator

by Edwin Lefèvre

Originally published in 1923

Currently available from John Wiley & Sons

AUTHOR’S NOTE:

Reminiscences of a Stock Operator may be one of the most influential books on the markets and trading that has been published over the last hundred years. Many market professionals that I’ve known are familiar with it. I have always wanted to own a more contemporary version of the book. I couldn’t find one, so I sat down and wrote it. Necessity truly is the mother of invention. I hope you enjoy it.

INTRODUCTION

Human instinct has evolved over thousands of years. Instinct serves as a survival tool during times of crisis. Instinct potentially can give people the ability to quickly summarize all of the perceived information. It also can be a tool that enables people to respond in a way to avoid something that can be harmful. Instinct may allow people to take advantage of an opportunity. Instinct isn’t necessarily logical, but it is an intuitive response. Psychology has reduced it to the phrase known as the fight-or-flight response.

Your financial survival instinct is often intertwined with your market objectives, whether you’re aware of it or not. Those individuals who are successful in their work with the markets have learned to manage their human survival instincts. This important step is fundamental in achieving success in the markets. There is a distinct difference between what is an appropriate action in the market and what feels like an appropriate action.

I have spent much of my thirty-plus-year career researching and designing algorithms that may appropriately respond to the markets without the use of human instinct.

I’m the first person to admit that trading profitably over the long term is difficult, which is even more evident when approximately eighty percent of my professional competition that existed sixteen years ago no longer exists.

What makes the act of extracting profit from the market so difficult? The answer to this question in part is why I wrote this book. At this point in my career I have earned the right to serve as a credible resource on this subject. Objectively sharing my understanding and experience may have some benefits to readers.

I have written every word of what you are about to read. I hope that the time you spend with this book will improve your working relationship with the markets, no matter where you are on your personal learning curve. Let adversity as well as your greatest successes be your best teachable moments. When it comes to acquiring new knowledge about the markets, I’m still learning new things about this work. But you have to continue to pay attention.

Sincerely,

K.D. Angle

kdangle@guillotineinvesting.com

1

Unique Results – Unique Thinking

My favorite scene in the movie Money Ball is when a young baseball novice privately speaks with the manager of the Oakland Athletics about what he believes is wrong with the way baseball teams select their players. He passionately shares his opinion about what he thinks is truly wrong with the baseball selection process. This conversation tells the audience that Traditional methods and thinking will have a difficult time producing unique results.

The concept of solving familiar problems in an unconventional manner is a practice that runs dear to my core. It’s why I had to include this concept from Money Ball to start the first chapter of this book. I love this film because of its theme of solving old and tired problems in unique ways. In my view, this is the real story of Money Ball.

The film is adapted from the book by the same name written by the excellent writer Michael Lewis. Lewis started his career working with the markets for the firm Solomon Brothers.

The film isn’t a story about baseball, although baseball certainly is the context in which the story is told. The film is a true-life recounting of how someone ignored the conventional wisdom that the baseball industry had been using to select players in order to fill a baseball team roster.

The lead character is Billy Beane, the manager of the Oakland Athletics. When he realized that his team couldn’t compete against the larger market teams, such as the New York Yankees and their seemingly unlimited financial resources, he decided to listen to a recent economics graduate from Yale University. This graduate professed taking a different approach toward selecting players that might give Beane the edge that he needed to compete.

The concept of solving familiar problems with new solutions is an approach that I have incorporated into my own work with the markets over the last several decades. By looking at many sides of a problem and with enough time and acuity, one might discover a new and unique way of designing unique investment strategies.

In Money Ball, the Oakland Athletics began to examine and use players’ performance data in a way that had never been ever used before. Their approach to understanding performance statistics was really rather simple. Up to that point, the baseball industry had looked at a player’s batting average as a tool to understand the player’s ability to get on base. If you know nothing about baseball, you may not be surprised that the better hitters in the game also generate some of the better on-base percentages. A natural assumption is that good hitters with high batting averages also get on base a lot, which is why teams perceive a good hitter as a player with high value and why they’re willing to pay them more.

For the purpose of this discussion, I first have to define what a good hitter is in baseball. Most people who know the game would agree that a very good hitter is someone who gets a hit approximately a third (or .333) of the number of times that he goes to bat.

That same batter fails twice the amount of time that he succeeds. In other words, in baseball, someone who is really good at what he does will fail the vast majority of the time or in this example, .666 percent of the time. Hitters with less ability will fail at even higher rates. Hitting a ball smaller than three inches wide, with a stick that is about the same width, coming at you between 80 and 100 miles per hour, isn’t easy. Big League batters who fail two-thirds of the time receive millions of dollars a year for this high rate of failure. Why do they make this much money? Because they’re doing something that is extremely difficult.

The hitting scenario that I’ve described is similar to the percentage of successful trades that produce a profit from the markets using a well-designed investment strategy. Producing a profitable result with a quality investment strategy only about a third of the time isn’t uncommon. The way these investment programs ultimately can be profitable over the long term with such a high failure rate is by holding on to the profitable trades much longer than the trades that eventually lose money.

The conventional wisdom in baseball hadn’t discovered that some players have a similar on-base percentage, but they don’t hit as well as the better hitters. These players tend to walk a lot and get on base. But because these players don’t have a high batting average, they’re overlooked. When the market overlooks something useful, it’s often undervalued. Because the Oakland baseball team is in a small market, it doesn’t have the money to buy the better hitting players as compared to the big market teams in which they compete. By looking at the players’ performance data differently, the Athletics management discovered something that could give the A’s a cost-effective advantage and be competitive against other teams in larger markets with more revenues.

A player who hits well below .300, but has an on-base percentage near .330 or above is an interesting player because he gets on base with a similar on-base percentage as the better hitters. The management of the Oakland Athletics came to the conclusion: The way a player gets on base isn’t as important as long as he gets on base. When you think about it, a not-so-great hitting player who gets on base with the same batting percentage of the better hitters is as valuable of a player as those players who can hit the best. But because no one was thinking how getting on base contributes to winning games, the not-so-great hitters who got on base weren’t receiving any attention. By looking at the game in a new way, the Oakland A’s began to acquire undervalued players at a fraction of the cost of what it would take to buy better-hitting players.

The truth that spoke to me from this film that could be applied to working with the markets is what can happen when you look at the work with a new and unique perspective. Additionally, someone in a position of authority had the courage to listen to this new approach and give it the chance to work. Receptivity to new ideas and the courage to risk pursuing them is an uncommon quality in almost every organization whether it be sports teams or teams in businesses. It’s particularly true for those individuals who have the responsibility of making decisions that will impact results. Most decision makers believe that new methodologies contain greater inherent risk. They’re reluctant to embrace ideas or methods that will take them into unfamiliar territory.

How well did this new approach work in the first season for the Oakland Athletics? During 2002, the A’s had a losing record in the first two months. But by sticking to the innovative approach for the entire season, Oakland ended up with the best record in the American League West. Oakland also broke the American League record for the most games won in a row in a season—a record that the New York Yankees had set in 1947 with nineteen consecutive wins. Oakland broke this record with a group of players that basically none of their competitors wanted.

Innovation Never Comes Easy

History is full of thought pioneers who resist accepting the ways of the establishment. Some of the oldest examples include the early great thinkers, such as Plato or Galileo. In many cases, the mere mention of unconventional thought based on newly perceived facts or ideas could potentially have placed a unique thinker’s life in danger. History reveals that when new ideas threaten those individuals in authority who control the reins of tradition and power, authority will often ridicule the new ideas or make sure that the people who advocate them are silenced in some way.

The struggle between innovation and those people in power can exist in every organization. It doesn’t have to, but it almost always does. It’s an organizational component that stems from human nature. Innovation doesn’t come from a culture of conformity. Innovation typically stems from individuals who refuse to accept what everyone assumes to be normal, which is why entrepreneurs and innovative thinkers should always expect a culture of non-receptivity to their ideas. They should be prepared to persevere against this wall of resistance as they attempt to turn ideas into reality.

Let me give you another contemporary example that illustrates solving old problems in new ways. A couple of years ago I was having dinner with my younger son. We were questioning some of the conventional wisdom that many college and professional coaches use when coaching football. It’s the type of conversation that people who love sports typically enjoy.

We asked a theoretical question: Why don’t more football teams go for the first down on their fourth-down possession instead of automatically giving the ball to the other team by punting? We also questioned why didn’t teams kick more onside kicks when making a conventional kickoff? The preferred action seemed to go for the first down on a fourth-down possession and kick onside kicks as much as possible. After dinner we concluded that if a team could do these things with at least a fifty-one percent success rate, it would be statistically favorable to take new actions rather than use the traditional plays that automatically gave the ball back to the other team 100 percent of the time.

Nearly all football teams make these two predictable choices because it’s the prevailing conventional wisdom that dominates the game. It’s how most coaches, players, and fans view the proper way to play the game of football. My loose definition of proper is making the safe and predictable move that most people are comfortable making.

No one in the game seemed to be asking whether taking these actions was smart football. Coaches made these decisions because they were comfortable doing so, without evaluating their decisions. This trait also commonly prevails within human nature. Most professionals who make their living in the markets do what feels comfortable to them. Many have no idea as to whether their actions are statistically a good decision or not. In this football example, nothing is forcing coaches to make these decisions. The conventional wisdom—of how to play a proper football game—is what drives the actions of most coaches.

I can safely assume that the majority of football coaches don’t have the inclination to rely on math or statistics to make their decisions. This explains why almost no coaches have evaluated the long-term statistical ramifications of making these particular decisions when coaching football.

The first step in improving performance is to ask a simple question: Why are coaches doing things this way? For years, I thought that no one in football wanted to know if a statistical advantage existed to onside kicking and trying to go for a first down on a fourth-down possession. After doing some research, I discovered one football coach—Kevin Kelley, a high school coach in Little Rock, Arkansas—who has been willing to challenge the prevailing conventional wisdom when making these two key decisions. Years ago Kelley, the coach of Pulaski Academy, gave these two play scenarios some serious thought and started looking at math in order to better understand the statistical advantages associated with certain play decisions in the game.

He studied the data generated from the results of these two single plays and concluded that going for a first down on fourth down and always attempting an onside kick (with some minor cases to override these rules) statistically gave his team an advantage. Kelley had come to the same conclusion that my son and I had—that intentionally giving the ball to the other team was a bad decision in football.

Without going into the specifics of the math that Kelley discovered, I can tell you what his decision produced on the playing field. After ten years of applying his unique approach to coaching football, he generated a career win-loss record of 114 wins and 22 losses along with three state championships.

Despite Kelley’s proven track record, I am further compelled to ask an even more interesting question: Have any of the other football teams in Kelley’s league adapted these unique decisions into their own play books?

No, they have not! Every single team in his league continues to remain in its historic comfort zone. His competitors have refused to take the risk of incorporating something new, even though someone else has proven to be successful by employing new techniques over many years.

This lack of imitation when something improves performance speaks volumes about how humans make decisions. Most human beings establish beliefs on many different issues in early adulthood. Then for the rest of their lives, many invest much of their time and effort in seeking information that will confirm their long-held beliefs. Many will ignore innovation or factual information out of the fear of discarding their security blanket of perpetual ignorance. I understand this. It takes self-awareness and confidence to change old ways and do something different that produces a better result.

It’s common, especially in science, that many things that were believed to be true can eventually be proven to be factually false years later. I’ve seen this many times in my own life. Over time, new information can be discovered that can cause long-held beliefs to move from what was accepted into an entirely new normal of acceptance as fact.

If people don’t base their core beliefs on fact, then most will continue to ignore new facts. This flaw, the ability to be receptive to new information or the inability to question knowledge accepted by the establishment, is capable of promoting stupidity on a massive scale. I’m convinced that this is one of the primary reasons why human nature is the only thing on the planet that has been completely insulated from the forces of evolution.

By definition, stupidity is the act of someone continuing to make the same decision about a particular issue despite having new knowledge based on fact that would alter conclusions or results. Even though the person has access to this new and proven knowledge, there are those who will continue to not pay attention to it. Ignoring new knowledge based on fact doesn’t make the person bad. It just means he is doing something stupid.

Let’s examine an act of stupidity in the context of Kelley’s methods. Although Coach Kelley has proven that his unconventional methods work, those methods haven’t become a true game changer in football. Other coaches perceive Kelley’s actions as risky to their own positions of authority if they were to attempt them. Despite the evidence of their success, other coaches continue to follow the belief that Kelley’s methods don’t work and using them isn’t worth the risk. Coaches of thousands of high schools, hundreds of colleges, and numerous semi-pro and professional teams have avoided imitating Kelley’s winning football formula. Embracing methods that work that aren’t in use by the majority requires courage and intelligence.

What does this example have to do with asset management and the markets? It describes exactly the dynamics that I have had to contend with in my investment career. The financial services industry is full of points of view that are frozen in concrete, resulting in an unwillingness to consider alternatives that just might produce better results for those who properly employ them.

Secondary Motives Drive Investors

Many people who invest their hard-earned savings with a financial professional aren’t really doing so for the primary purpose of producing a net gain on their capital. Of course, the net gain is their desired result, but other reasons drive this motive. Here are a few things that motivate investors to act:

•Invest with someone with the belief that they’re being responsible with their investable net worth. They’re buying a feeling that they’re taking care of themselves or the people that they care about.

•Select a financial professional who a friend has recommended without undergoing any serious due diligence as to what the professional has actually produced from the markets over the long term. They take comfort in knowing that other people have decided to use a particular financial professional.

•Feel the need to be diversified, but they often do so without realizing that they can be diversified to the point of dilution where making any serious long-term money is impossible. As a result, they’re more likely to lose money slower. They believe that they’re reducing risk but actually may be eliminating much of the potential for a return. In some cases where there is an attempt to reduce risk, they may actually have increased risk and made it impossible to achieve a profitable result.

•Are more comfortable with investments in the stock or bond markets because that is where most people put their money. There are many aspects in nature that confirm the phrase safety in numbers. People love to be with the herd because it’s more comfortable.

•Investing with the herd applies to all levels of investors, which is particularly true with many in the super wealthy class of investing. Most in this level hate to miss out on a deal that one of their friends has discovered, which can have a significant influence on their decision-making process.

•Invest with a financial professional and keep their money with that person for many years, even if he or she loses money for them. In many ways, mainstream financial professionals who work in stocks and bonds can retain their client relationship simply by maintaining contact with their clients, regardless of performance. It’s amazing to me how sending a birthday card, attending the wedding of a client’s child, or making an occasional phone call to the client can keep the client on the books, even with poor performance over the long term.

•Many decision makers of larger allocation sources would rather lose money in a conventional investment and avoid the possibility of being ridiculed or losing their job than allocating funds into what their peers might consider to be an unconventional investment vehicle—even if that vehicle has proven to have outperformed stocks and bonds over the long term.

Are these examples common? From my experience of decades in this business, it’s an unequivocal yes!

You may believe that what you’re doing in the markets has generated the best possible performance. But I never assume that there is no room for improvement. Improving something requires change. You should be willing to move out of your historical comfort zone, if the research and data is compelling enough for you to do so. However, you should also recognize that change for the sake of change isn’t an option either.

The allergic reaction to doing things differently exists in almost every business, organization, and group of humans that have ever banded together to pursue a common objective. It doesn’t just apply to those who are involved with the markets.

I can certainly understand why many people are reluctant to approach their market investments from a different perspective. You have thousands of asset managers to consider when deciding with whom to allocate your money. Managers do different things in an attempt to grow wealth. Unfortunately, many of them or their products will no longer exist at some point in the future due to failure.

Managing or trading capital in any market is a performance-based skill. However, many financial professionals don’t think of it that way. When producing a net return with a portfolio of markets, the profession is both difficult and highly competitive. The edge tends to go to those individuals who are paying more attention to what most would consider to be insignificant details. Making good, small decisions on a consistent basis can produce potentially exceptional results over time and enhance performance above the competition.

Coming up with unique and original solutions to what can appear to be tired old problems from the markets isn’t easy. But if you constantly question why and how something is done and continue to look for unique solutions, innovation tends to appear. Innovation can be discovered sometimes by calculated design or by just pure chance. In the long run, what’s the difference as long as the effort produces improved results?

Lessons Begin in the Details

Are you capable of seeing things beyond what conventional wisdom is telling you? Test your ability by asking yourself a simple question:

How much actual playing time exists in a typical nine-inning game of Major League Baseball? I’m referring to the amount of playing time when actual game play takes place in a single game.

I define game play as those actions that start from the point that the pitcher begins his windup until the catcher catches the ball, the batter fouls the ball out of play, or a player returns the ball to the pitcher standing on the mound after a play is made. To give you the best possible advantage with your answer, assume the game has relatively poor pitching, and most of the batters will go to full pitch counts, which would theoretically produce a longer game.

Carefully think about this question. Then go to the last page of this book to find the correct answer.

In order to be successful in a performance-based business, you must be capable of seeing the minutiae that most everyone else doesn’t even know exists. Seeing the minutiae isn’t as critical in running most nonperformance-based businesses. But it is a requirement when operating in any activity that is absolutely performance based, especially when working with the markets.

Having the ability to actually know what the important minutiae is in a performance-based business will develop over time, if you strongly desire to survive and succeed. You’ll one day wake up with the ability to see and understand things that many people either take for granted or just don’t realize is there. I’m not unique in this way, nor did I start out with this ability. I just have a fierce determination not to give up and to get better at what I do. As a result, my skill, experience, and knowledge have been able to grow over the years.

The longer you work at a craft, the more you learn about it, if you’re paying attention. This asset can lead to generating many new ideas as well as acquiring some game-changing concepts involving just about any area that requires a specific set of skills.

As a creative person, I learned early in my career that all information isn’t relevant and that not all ideas are worth pursuing. I have forgotten or placed most of my ideas throughout my life in some file folder in an obsolete hard drive. I, like most people, don’t have enough time or money to implement every idea that suddenly pops in my head. This is why I restrict my creativity only to the area that I have accumulated the greatest amount of expertise—working with the markets in pursuit of long-term profitability.

All ideas are extremely cheap. To turn the best of ideas into reality requires a respectable percentage of one’s life, effort, and risk capital, which is why I’m deliberate about the ideas I decide to pursue.

So, what is my area of expertise? When people ask me what I do for a living, I typically respond with the following: My core expertise is the creation of rules-based investment strategies for use with computers in the markets. I then employ those strategies with third-party capital as well as my own.

2

My Market Entrée

I had a unique introduction to the markets—so unique, in fact, that I felt compelled to memorialize the experience by writing a book entitled, One Hundred Million Dollars in Profits – an anatomy of a market killing and a realistic trading plan, published by Windsor Books. The book retold how I watched my father turn two million dollars into one hundred million dollars during the gold bull market of 1979.

My father had just sold a business that had given him the two million dollars in capital to use in the markets. He felt compelled to place all of the proceeds into a single, gold futures position. In late 1978, he believed inflation was creating a significant market opportunity that could be exploited in the gold market.

He was the type of businessman who believed that if he felt strongly enough to invest money into something, you should invest big. Otherwise, why do it? My father’s assumption proved to be correct at the time. In seven months, his market position in gold futures generated a little more than 100 million dollars in profit. By January 1980, he closed out the entire position and banked a net profit of sixty-five million dollars from a single trade in only fifteen months—a return that was 32.5 times his original investment.

In hindsight, my father was completely correct in his assumptions as to the direction of the price of gold in 1978. However, he did enter into this investment activity with zero market experience. When I say zero, I mean absolute zero! Despite his lack of experience, he still managed to produce more profit in a little more than a year than he had produced in all of his twenty-five years in the oil and gas business.

Was he smart? Courageous? Stubborn? Or just plain lucky? In fact, it was a combination of all of these things. He was smart enough to have seen the inflationary factors coming that would be reflected in a hundred-year rally in the price of gold. He was courageous enough to bet enough on his market idea that if proven to be correct, the results would significantly alter his net worth. He was stubborn enough to ignore those around him who encouraged him to take his short-term profits. He continued to hold on to an insanely profitable position for more than a year. Given his lack of experience in the markets, he was certainly lucky to come out of the trade with a significant profit.

Hanging on to the trade during its duration wasn’t easy. After his position had initially accumulated about three million dollars, a senior level executive from the brokerage firm he was trading with flew from Chicago to advise him to take his profits. Had he listened to this experienced market professional, my father certainly wouldn’t have made nearly as much profit as he did listening to himself.

My father was certainly fortunate to have unique market conditions working to his benefit. He also had some key personality traits that further contributed to a significantly positive result. The event reminds me of the statement: If one has to choose between being smart and being lucky, one should choose luck every time.

After he took his gold profits in early 1980, he did manage to buy a few businesses for cash in order to diversify himself from the oil and gas industry. That decision proved later to be an extremely smart thing to do.

He purchased one hundred percent of the fourth and sixth largest banks in Kansas, along with the state’s tallest office building, where he had leased most of the top floor as office space during most of his career. From one of the bank purchases, he also acquired a 128-room luxury hotel. He bought them all, entirely with profits from his gold trade.

For the first time in his career, he was completely debt-free, not bad for a boy who spent six of his first eleven years growing up in an orphanage while his mother was quarantined for tuberculosis.

Upon completing that gold trade, he was nearly sixty years old, in good health, and had plenty of enjoyable remaining years ahead. If the story had ended there, it would have been a typical Hollywood ending.

By all standards, most people would conclude that my father had it made in the shade at a great point in his life. All he had to do was maintain his businesses and enjoy the fruits of his labors. Most would never have guessed what his next move would be.

Remember that my father’s huge profit in the gold market was his first experience with the markets. What does anyone learn when things go incredibly right the first time they do something? Absolutely nothing!

After his initial positive experience, my father didn’t