Preston Pysh 6:15
If a person’s hearing that they’re going to immediately think, “Well, that’s an exit strategy, but how about an entry strategy? How do I know when to get into something based on this momentum in the volatility?”

Richard Smith 6:27
Absolutely and that was the next step. I had a good system for getting out of a stock now. Then I need a good system for getting into a stock or back into a stock that I had gotten stopped out of.

I use that same principle of volatility so if something is in a downtrend, the first thing that I want to see is that it has a very solid up move off of its downtrend, and that it moves up more than its sort of normal expected volatility, because I don’t want to get caught in dead cat bounces.

Then where the momentum piece really came in was actually combining that with a momentum based trend indicator to make sure that I wasn’t getting whipsawed too much. That combination of one, what’s the normal expected volatility for this stock? What’s the normal noise that I should be okay with, if the stock is going up, right? How much noise should I allow it and expecting the stock to tell, “Hey, this is just normal movement in this stock.”

However, if it gets noisier than that, then something else is going on and the trend might be changing.

Then the same thing, when it’s in a downtrend? How much noise can I ignore? How much noise does it need to trigger on the way up in order to tell me, “Hey, this is more than just the normal noise in this stock.”

Basically, I quantified noise.

Preston Pysh 7:48
One of the things that Stig and I have been playing around with is using a momentum strategy to help us identify falling knives. One of the biggest problems with value investing is when a company is a great value pick, it’s also usually something that’s heavily out of favor.

If for anyone that’s conducted a value investing strategy before, there are these times when you’ll buy a company that has maybe a great accounting fundamental, and it looks really cheap. However, the price action is very difficult to endure. It might just keep going down for the next three months and then it’s testing your temperament.

We’re trying to first identify companies with the great fundamentals, but then only buy those companies once we see a statistical change in the price momentum, which suggests that the pain is starting to subside. It’s not going to be so painful from a vantage point where it’s really testing our temperament. I’m kind of curious to hear your thoughts on that idea.

Richard Smith 8:48
I love it when you’re identifying your own basket of ideas, from one source or another, your own analysis, maybe following a billionaire’s. But somehow, this is what I do myself: I’ve identified my favorite stock pickers that I get my ideas from/

I put together my basket of ideas. I will not try to catch a falling knife. I will watch those indicators. When I see something basically turned green that I really like, I’m all over it.

Quick, incredible story for you. *inaudible* developed a search engine company back in the late 90s. it was a publicly traded company on the NASDAQ.

At the peak of the NASDAQ his company was generating like $5,000 in revenue a day, or $5,000 of profits a day. That stock was $20. At the bottom of the NASDAQ, his stock was worth $1 and his company was generating $100,000 a day in revenue.

Though sometimes the markets throw the babies out with the bathwater you know. That happens in sectors and can happen in industries. I think it’s John Maynard Keynes, I’m not sure if he’s the one, but it’s usually attributed to him: the markets can stay irrational longer than we can remain solvent. You have to have some kind of fundamental foundation.

I think for the individual investor, we’re not Warren Buffett necessarily, we’re not going to hold stocks for 20 or 30 years. To combine great stock picking, good momentum strategy, something like that, I think it’s the way individual investors pretty much have to go.

Preston Pysh 10:29
I’m curious, so people listening to this they might be interested in and just hearing where are you seeing momentum trends today, at the end of March 2018? What are you seeing as good momentum trends?

Richard Smith 10:42
Consumer discretionary, financials and technology are still in the green. I look at the Spyder select sector ETFs, right, that break the S&P 500 up into different sectors. So consumer discretionary financials and technology are still in the green.

By the way, those happen to be the three sectors that the billionaire investors that I follow really love and have their biggest weights in consumer discretionary financials and technology.

On the downside, consumer staples health and utilities are all in the red. I would be staying away from those.

Preston Pysh 11:18
How about commodities?

Richard Smith 11:20
I am bullish on oil. Gold has been in an uptrend now for at least 12 to 18 months and oil for 18 to 24 months.

I always had trouble investing in oil, especially when I first started investing. I was even doing a little work in the futures markets. I would just always get beat up by oil.

What I found from my own research was that oil as a commodity is surprisingly volatile. I came up with this metric, the volatility quotient or the VQ. On oil, it’s usually above 30%.

Then you see these articles in the media, “Oh, oil fell more than 10%. It’s in a bear market.” No it’s not. Oil has to fall 30-35% before it’s in a bear market. Anything less than 30% is just noise in oil. It may be at 60 bucks, but it’s got to fall $15-20 in order for it to be anything other than just noise or something that you can ignore.

Oil falling from $62 to $50 is no big deal. That’s just the normal expected behavior for oil.

That kind of insight using that mathematics basically to say, “No, this is something I can ignore,” or “No, this is something I really need to pay attention to,” has been immensely helpful to me.

I’ve been bullish on oil for two years now and it thrashes around a bit, but it thrashes around within its normal expected range, but that can be quite a bit. Oil is 60 falling down to 50, eh.

Some of the long term trends that I’m still keeping a close eye on the downtrend in long term Treasury yields so 30-Year Treasury yields, obviously, that’s a big question for the markets right now. We’re in a 30-year downtrend and that downtrend has not been broken to the upside.

With respect to yield, you’re saying?

With respect to yield, right? These are in an uptrend yields and are in a downtrend.

I’m not sold on the idea yet that long term interest rates are headed higher. I still think there’s going to be some flight to safety movements coming up. I think the long term downtrend in long term interest rate yields is still intact.

Preston Pysh 13:42
We’re seeing the inversion of the yield curve. Typically at the end of the credit cycle, you always see the short end of the yield curve coming up and the long tail just kind of hold and put. That’s interesting.

You mentioned this billionaire filter. I’ve seen this on your platform. Tell us more about this because this is fascinating. I absolutely love this tool. I think people hearing this are going to be pretty excited. This is neat stuff.

Richard Smith 14:08
Well, like I said, I’m not a stock picker myself, right? I need a way to narrow my investment choices down from a universe of 10,000 different publicly traded stocks down to maybe a couple 100 stocks that I feel somebody who knows what they’re doing, has really looked at carefully. Who better than some of the world’s greatest investors to do that for me?

All of that information is basically published for free. What’s Warren Buffett in terms of publicly traded companies? What’s Seth Klarman, David Einhorn, Carl Icahn, George Soros? They all have to publish their publicly-held stocks.

I started basically digging into that data and finding out what investments those guys were in. Then looking at that for my universe of investment ideas, so I’m following about 15 different billionaires right now. That collectively is 300-400 different investment ideas at any one time.

I then apply my momentum strategies, which in Trade Stops boils down to a red light, yellow light, green light system now. I say, “Hey, if Warren Buffett likes it, and it’s green, then I’m seriously considering it.”

A great example right now is Teva Pharmaceuticals. Nuffett bought Teva in the fourth quarter of 2017. Teva just recently turned green in my system. Teva has moved to the top of my list of candidate stock ideas, basically, because if Buffett likes it, that’s good enough for me and it recently turned green in my system. I’m paying close attention to that stock and considering adding it to my portfolio.

Preston Pysh 16:08
I love it. You’re basically outsourcing your fundamental analysis?

Richard Smith 16:14
Warren Buffett works for me. Buffett is my stock analyst.

Preston Pysh 16:19
I like it.

Richard Smith 16:21
It works great and it gives you confidence, right? Confidence is such an important thing to have in the markets. It’s like you have to be able to live through the storms, you have to be able to live through the turbulence, right?

One kind of quantifying your noise factor: how much noise or uncertainty do I have to live with in a stock like Teva? But then knowing that Buffett’s in Teva, it’s got to be a pretty good idea.

You need confidence as an investor in the market. I think that’s a great way to build your confidence, find great stocks, and then get in them at the right time.

Preston Pysh 16:58
Talk to us about portfolio construction. When you’re thinking through the volatility piece and you’re thinking through all the risks, it’s kind of associated with various picks in different sectors and stuff. How do you construct your portfolio? How do you think through that difficult problem?

Richard Smith 17:13
I try to keep it as simple as possible. I’ve mentioned how I came up with a measure of volatility on individual equities that I call the volatility quotient trade.

Well, I also came up with a way to measure that volatility on your whole portfolio. So just like you can say Johnson and Johnson has a 12% volatility quotient, which means that if I want to hold that stock for 12 to 18 months, at a minimum, then I need to be just fine, if Johnson and Johnson falls 10% and turns back up.

However, to be able to measure that on your portfolio as a whole is really important. How do all the pieces of your portfolio fit together basically, in terms of correlation?

Some stocks are going up while other stocks are going down. You know, Ray Dalio, I believe, said that the holy grail of investing is 15 good, uncorrelated investing ideas. So finding investment ideas that are all good, but that some are going up while others are going down, that’s a very powerful way to put together your portfolio.

In Trade Stops, I came up with something that I call the portfolio VQ, or the portfolio volatility quotient. Basically, take the stocks in your portfolio, how much you’ve got in each one, how volatile each one is, projects back for three years, what the performance of that portfolio would have been, and then measures the volatility of that of that equity curve.

Now you have a new investment idea. You can add it to your portfolio just as a test and see if it increases or decreases the overall volatility of your portfolio. It’s really one of the huge pieces of the way I put portfolios together.Then I also use volatility to help me decide how much to invest.

Preston Pysh 19:02
When we’re talking about volatility, you’re not going to find anything that’s probably more volatile than Bitcoin or some of these cryptocurrencies. I’m curious, is this something that you have dabbled in because I’ve owned some Bitcoin and I’m kind of curious if you have and how you can approach it with all your volatility tools that you’re using.

Richard Smith 19:25
I have indeed gotten involved myself. I’ve really become a big believer in the cryptocurrency and blockchain movement. I’m really excited about it. I think it’s an incredible opportunity for individual investors.

I think that my work applies a lot because essentially, if I boil my work down into a nutshell, Preston, it’s like, how do individual investors who are busy but have been successful in their lives enough to accumulate some capital, right? That they have the opportunity to deploy that capital into financial markets and into speculative opportunities. That’s a very important function in our economy.

My work boils down to how successful people deploy their capital in the financial markets in an intelligent way that still allows them to sleep at night because I think the worst position to be in in the markets is when you’re unsure about what you’re doing, when the volatility is getting away from you. Then you start to get emotional in your decision making.

Preston Pysh 20:32
I’m curious to hear how the results of some of your analysis work, because we had this massive upturn in Bitcoin in December. It got clear up to 20,000, I think in less than 12 hours or something. I think you could probably say the high was more around 18,000.

I’m curious how your platform performed through that. Were you invested through that 10x jump? I’m assuming that you had very strong momentum indicators through that.

I also want to know where you saw things because we’ve been in a bear market. I think the price of bitcoin right now is clear down to 8000 with a $12,000 pull off per Bitcoin.

When were you starting this momentum sign saying that you hit a top and that it was time to not be holding a position because I’m assuming right now, you’re not holding a position?

Richard Smith 21:28
In terms of my red light, yellow light, green light system, the volatility quotient on Bitcoin was about 40%. That’s how much noise you got to be okay with.

When Bitcoin made a top at $20,000, the 40% below that is $12,000. But still, my system got into bitcoin at around $2,000. So right up to $20,000 in a ride back down to $12,000 was what you needed to be okay, in order to use this system to be long Bitcoin.

Now, I added some other indicators that aren’t part of my Trade Stops system. I’ve been a big follower of time cycles analysis for 10 years now. I had some other reasons to believe that Bitcoin was going to top in late December, and frankly, possibly bottom in late March right about now.

S actually liked the action that we’re seeing in Bitcoin today. We saw a low back in early February. We saw a higher low recently last weekend. I’ve been expecting a near term bottom in Bitcoin right about now.

More broadly, I think just what’s going on with crypto is it is incredibly exciting. I think it’s incredibly important.

I was actually at the IBM think conference earlier this week in Las Vegas. I met with two vice president level executives at IBM who basically told me IBM is all over blockchain. There’s private blockchain and there’s public blockchain. Obviously, IBM is doing a lot in private blockchain but they can’t… They told me they can’t get away from the public blockchain either, right?

I think a big part of the crypto and blockchain movement is about trust. We’re seeing a lot of lack of trust in big institutions. What happened with Facebook this week is an incredible indicator of when you can get too big and too powerful and lose that trust almost overnight, and with a massive amount of people.

That new model of trust that blockchain and crypto represent, I think, is a paradigm shift. It’s something that I think is very worth investors attention. It is something that I’ve applied my tools to, basically to help investors know how to be in this space and be in it for the long term.

You know how much uncertainty or noise to inspect to expect to be comfortable with so that you can be in this space and ultimately capitalize on the potential of this space as an investor, not just get whipsawed and lose your money.

Preston Pysh 24:07
I think that the volatility on that one, man, you better really be prepared for some wild swings.

Richard Smith 24:15
My indicators are basically saying it’s stormy seas in crypto right now. We’re not out of the woods. I personally think it’s an interesting time to do some bottom dipping right now.

You may be catching a falling knife, but as long as you’re not putting more money into it, then you’re comfortable not seeing for a year or two. I think it’s an interesting time to be doing some bottom dipping, but some of my favorite cryptos and alt coins in the space… I actually really like Litecoin rand Monero, which is in just an unbelievable uptrend that was hardly dented by the recent downturn at all.

There’s a site called coincheckup.com and they have an algorithm ranking system there that looks at the teams and the public support of the network, essentially. The past track record of the teams, what their model is, what their ideas, Ether Classic, Monero, and Bitcoin rank at the top of that algorithmic.

Preston Pysh 25:15
That’s like corporate governance for crypto.

Richard Smith 25:17
You have to be looking into because you’re basically betting on these teams, on these networks and on these ideas at this point.

Warren Buffett is not in crypto, because there is no way to fundamentally value what amounts to a new paradigm at this point. It is a bet on the teams and on the ideas and on the people that are attracted to that new business model, essentially.

I think Ether Classic and Monero both have some great technical encouraging signs, though. They’re both in the red right now, according to my system This is definitely bottom fishing here. This is not, “Jey, we’re waiting till it turns green.” And it just turned green, but I think those are a couple that people who would be well served looking into.

Preston Pysh 26:06
When we were talking, and this is a little bit of a plug, sorry, guys. This is a little bit of a plug for our Berkshire meeting. We had lunch and I asked Richard. I said, “Richard, you’re going to come out to the Berkshire meeting in May.” He said, “You know what? I think I will do that.”

I’m kind of curious, are you excited for the meeting?

Richard Smith 26:25
I’m very excited about it. I’m very excited to spend time with you and your colleagues. I’ve never been to the Berkshire meeting. I really started focusing on the billionaires in the past 18 to 24 months. Buffett obviously stands out.

By the way, just for your readers’ benefit, my favorite billionaire to follow is David Einhorn. I don’t want to get too far off the track of Buffett here. Charlie Munger was one of the first people that really turned me on to the psychology of investing.

There’s a YouTube video of Charlie Munger giving a talk at Harvard about the work of Robert Cialdini who wrote “Influence” and “Persuasion.” I had come across Cialdini’s work through looking into marketing myself and being a business owner you have to know a little bit about marketing.

Then later on seeing Charlie Munger talk about the psychology of investing, basically, and how he learned about it from reading this book by Professor Cialdini was very influential on me. it gave me a heads up to how smart Charlie Munger really is.

Preston Pysh 27:34
It’s funny you were talking about Einhorn, because I read his book, “Fooling Some of the People All of the Time.” You can see how just in his writing of that boo how smart that dude is. It’s just a diatribe of a book about one one stock that he was investing in through all this painful experience, and just clobbering the corporate governance in the company. It was a fascinating read.

I don’t know if we could do it on the show. I don’t know that it would be a good fit for reviewing on the show, but if anyone wants to read a really interesting book, go ahead and read Einhorn’s book.

Richard Smith 28:16
Going back to Buffett for just a minute, one of the stocks that Buffett has been buying recently is Apple, right? So he first bought Apple back in 2016 and then Apple has been at around $100, maybe average price. He’s still buying Apple today at $170 a share. He’s actually adding to his winners on the way up, but as individual investors, most people tend to add to their losers. You’re doubling down on your losers, right?

So this momentum thing and wanting to get away from being risk seeking with my losses to being risk seeking with my gains instead. If you think about it in terms of businesses, we’re owners of businesses as investors.

Essentially, when we’re putting more money into the businesses that are losing us money, and taking money out of the businesses that are making us money, it’s not logical.

Then you see Buffett putting more money into the businesses that are making him money. Apple’s going up and he still feels it’s a good value. He’s buying on the way up, and it’s the exact opposite of what most investors do, especially individual investors. They just keep buying on the way down feeling better and better about, “I’m getting a lower cost basis.”

I understand dollar cost averaging. I think it’s a very valid way of going about investing but that’s not what most of us are doing. We’re doubling down because we are risk seeking when it comes to our losses. We want to get back to breakeven as quickly as possible.

The break even theory actually won last year’s Nobel Prize in Economics from Richard Thaler. He followed up on Daniel Kahneman’s work who also won a Nobel Prize.

Richard Thaler basically showed that we do try to get back to break even and we’ll take extra risk in order to do that. We got to get past that.

Watching Buffett buy Apple on the way up and add to his winners is another thing that just kind of changes my confidence as an investor. That is the right way to do things.

Preston Pysh 30:22
Richard, I’m curious, because I can see behind you and you read a lot of books. I mean, your bookshelf behind you is just loaded with books.

I’m curious, for the topics we were talking about today with using statistics and volatility and investing, and Ray Dalio’s approach, what book out there would you recommend to the audience that you think really kind of encapsulates a lot of the stuff we were talking about today?

Richard Smith 30:52
Well, a lot of the stuff I read tends to be surprisingly a little more on the psychological side. I think the work of Taleb around his black swan ideas, just understanding risk in the markets and the way that interacts with us psychologically.

A lot of the work on booms and busts. There have been big booms and busts and mini ones in our own portfolios to kind of understand the psychology of investing again.

I really believe that investing is largely a behavioral challenge. There’s so much good information out there right now, Preston. There’s so many good tools. You can find good sources of investment ideas, you can find good tools, what you really need are good investor habits.

There’s a lot of good information out today about how habits are formed and how to develop new habits. I think it was maybe “The Power of Habit” by Charles Duhigg. There’s a lot of great insights today about how to develop great habits.

We need great habits as investors. That’s what is really going to make the difference between success and failure. I think reading about successful investors, it’s an old book, but the “Market Wizard” books, right? That was another place where I learned successful investors, they’ll tell you, “Hey, 95% of the stuff I do ends up being a wash, and 5% of my decisions lead to 80 to 90% of my gains.”

Unfortunately for investors, it’s the other way around 5% of our decisions lead to 80-90% of losses. Reversing that, imitating great investors and reading the work of great ambassadors, really that gets you in the mindset of being a great investor. That’s what you really need.

Preston Pysh 32:47
Love it. Richard, tell the audience where they can find you. I don’t know if you’re on Twitter, but you just tell people where they could reach out to you.

Richard Smith 32:55
TradeStops.com is my service online. I also post a couple articles a week there on the blog. We are on Facebook and Twitter. I’m not very active on social media right now. I tend to be a more private person, but I am in business so I know I got to get out there a little bit. The blog and Trade Stops is a great place just to learn about the product and our offerings there.

Preston Pysh 33:22
That is awesome. Well, Richard, all I can say is thank you so much for coming on the show. I’m a fan of your work. It was really fun for me to sit down and chat with you to kind of hear how you got to where you’re at today, your mindset and how you’ve designed your platform. This was really a lot of fun. Thank you for your time.

Richard Smith 33:42
Preston, I think you are a great voice out there for the individual investor. I think individual investors actually have advantages over big investors and institutions that we don’t fully appreciate. And so, I love the work that you’re doing and it’s been a real honor to be on your show. Thank you.

Preston Pysh 33:58
Thank you so much, Sir. I appreciate that.

Alright, so that concludes our interview here with Richard Smith. We appreciate your time and we look forward to talking with you guys next week.

Outro 34:08
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