As a macro-speculator who’s been playing the markets since I was eighteen years old – I’ve spent a lot of time developing my framework.

And just recently turning 28 – I wanted to share with you the four key principles I’ve learned after losing (and making) large sums of money in the markets.

First – Understanding Cycle Theory Is Extremely Important (Especially For Commodities). . .

We’ve all heard the investing truths “never fight a trend” – or what I like to say, “don’t catch a falling knife”.

This means: no matter how good a security looks – if it’s in a sector that’s in decline – avoid.

For example – back in 2014-15 – there were still plenty of gold mining equities that had high quality projects, making money at $1,100/oz, and had clean balance sheets. But that didn’t matter.

They were dragged down with the rest of the entire sector as capital fled.

Another example was the oil industry in 2014. . .

After a few years of high oil prices (between 2009 – 2013 WTI crude was over $100+ per barrel), the entire industry was in a boom that seemed like it would last forever.

But – eventually – everyone was producing oil at max capacity to take advantage of the high prices (at the peak – Russia, the U.S., and Saudi Arabia were all pumping over 11+ million barrels per day). And soon enough – a ‘glut’ occurred (too much supply) and oil was oozing out of everywhere.

Within days – everything tied to the oil and gas sector was sinking like a stone – regardless of ‘company fundamentals’ or ‘project economics’.

There are many examples of boom-bust cycles throughout history – and across many asset classes.

And this is why understanding cycle theory is so important in markets. You don’t need to know the exact date a boom will turn to bust (or vice versa) – but you know it will eventually happen.

Understanding how cycles work and using optionality (more below) gives speculators a thick margin of safety.

Second – Finding Favorable Optionality (aka Positive Asymmetry). . .

One of the most important concepts I’ve come across is favorable optionality – or aka – positive asymmetry. And I discovered it by reading former-trader-turned-philosopher Nassim Taleb’s books.

(I’ve written an entire piece about optionality before – you can read it here if you haven’t yet).

Now – I believe there are three things that make up favorable optionality:

It must have a low fixed cost/risk. . .

It must have (theoretically) unlimited upside. . .

And there must be a reasonable probability of the event occurring (what I mean is – for example – I wouldn’t buy tsunami insurance in Arizona because there’s a near-zero chance of that event happening).

So – putting it simply – favorable optionality (positive asymmetry) equals low risk and high reward.

Or said another way – it’s about giving yourself downside protection while keeping your upside intact from an unknown event (like a black swan).

And my three trading rules for favorable optionality (positive asymmetry) are:

• 1. Always look for optionality by first understanding what is fragile, robust or antifragile (more below)
• 2. Look for open-ended payoffs with fixed-low costs (such as buying options) – instead of fixed gains with open-ended risk (such as selling options).
• 3. And even if I’m wrong, I won’t “blow up” my portfolio – but being right just once can make up for many previous small losses.

Third – Be Antifragile (Gain From Disorder). . .

Many investors set up their portfolios (or their wealth managers set it up for them) to make small annual gains – only to lose it all suddenly in a spurt of turbulence.

Think about 2008 for instance – investors slowly made 5-8% annually for years, then watched it all collapse suddenly within a matter of moments.

This known as being ‘fragile’. . .

For perspective – imagine an antique glass vase that sits on your coffee table for years, only for a small bump or minor shake to send it falling to its destruction (it will shatter the moment it hits the ground).

Thus – being fragile is to be harmed by volatility and disorder.

So then – why not instead harness the potential volatility or disorder of a sudden event occurring and benefit from it?

This is known as ‘antifragile’ – to gain from chaos (a term coined by Nassim Taleb).

And it’s the opposite of fragility.

Rather than being harmed by volatility and disorder – it becomes stronger and more valuable.

Imagine then – during 2008 – you owned some put options on housing stocks? Or even owned gold and U.S. bonds. These items would have benefited from the crashing markets (which they did).

Thus – instead of watching your portfolio collapse – it would gain in value (at least the antifragile positions – which would offset the losses from the fragile side).

Look at the chart below to visualize all this. . .

You can see that the more stress there is – the better the antifragile does (compared to the fragile). 

So – it’s wise to make volatility, chaos, and uncertainty your friend. And make it work for you – instead of working against you.

Therefore: avoid the fragile – and become antifragile.

Fourth – Beware Of The So Called “Experts“. . .

One thing I caution against – especially in markets – is falling for the ‘Authority Bias’.

Let me explain.

The Authority Bias – in behavioral economics and finance – is the general concept that humans tend to overweight anything they hear from an “expert”.

Or – even worse – that they will feel stupid if their own opinions contradict the experts.

This is a strong mental bias – one that we’ve all fallen for.

Think about it – how many times have you thought one of your teachers was flat out wrong. But you refrained from saying anything because you thought, “well – they are the teacher – so they probably know better.”

I know I sure have. . .

But – thankfully – I learned early on that above all else: a person’s profession does not determine who they are.

For example – just because someone’s a money-manager doesn’t mean that they truly understand markets – or put their client’s well-being first.

There have been many money-managers – claiming to be “experts” – that were actually frauds. And eventually lost all their clients’ money (remember Bernie Madoff?).

Another example is to believe that every police officer is a person of integrity and aims to protect the public.

But – unfortunately – there are instance of bad people becoming cops for all the wrong reasons (Although most are good).

Even our world leaders (politicians) cause us to suffer from this bias. . .

So – in summary – do not always trust the expert or the conventional wisdom.

To be a speculator, you must be an independent thinker and use healthy skepticism.

I’ll be breaking each of these principles down further in future articles.

So stay tuned.