“In the jungle among the money funds, there is only one king” – Dreyfus Funds slogan
It was the 1950’s – the Silent Generation and the first baby boomers were in the workforce, and post-war prosperity had brought about a lasting boom to the US economy. The stock market was doing well, but the man on the street had neither the skill nor the opportunity to put his hard-earned money to work in that seemingly big and complicated clockwork. ETFs would not make their debut for many decades, stock indices were few and far between, and the rare managed funds that did exist were reserved for high net-worth individuals and institutional clients.
It was at this time that a buoyant young man came along to turn the mutual fund industry upside down. Jack Dreyfus, who would many years later be in his Life magazine profile as a ‘slender soft-spoken perfectionist‘ that loved to walk Battery park barefoot in his expensive but unassuming suits, was a maverick in the world of finance. In fact, whatever Jack touched he did with a combination of vehement ferocity and out-of-the-box thinking – tennis, golf, horse training, card games, and later campaigning for epilepsy drugs. A combination that would turn out pivotal to his success launching, running and managing the portfolio for the first mutual fund available to the common man, with minimal deposits starting at $10.
Let’s delve into the story of this elusive man to see what we can learn for our own trading as well as long-term buy & hold strategies.
“I don’t really belong”
As he would reveal to Marshall Smith from Life magazine, Dreyfus would feel like an outcast for most of his career on Wall Street. Born in 1913, he started his early adulthood trying to find professional footing in many areas, ranging from music-, latin- and economics studies at Lehig University (in which he ‘didn’t kill himself’, as he admitted in his 1996 memoir), to candy making, to the US Coast Guard, and more. The one though that got him started in finance was a menial job at a brokerage, where his task was to post several hundred stock charts a day – an experience that would spark his interest in the markets and heavily influence his later trading strategy, as after some time he started seeing recurring patterns on the charts.
With the help of a friend and borrowing from family, he raised enough money to purchase a seat on the NYSE in 1946, and founded the small brokerage Dreyfus & Co. a year later. For the next 2.5 years, he experienced a harrowing time of only attracting limited client business, underperforming the markets, and living on minimal to zero income – often sustaining himself on the benevolence of his friends, family and colleagues.
These years of suffering however were not in vain – they became the ashes out of which his highly successful trading strategy was to arise like a phoenix. A few years later and with rising success, he founded the Dreyfus Corp. Mutual Fund in 1951, which was later to be seen by many as a pioneer for a new age of the mutual fund industry.
The Lion of Wall Street
Richard Dennis, interviewed around the millenium turn in Jack Schwager’s famous Market Wizard series said, “You don’t get any profits from fundamental analysis; you get profit from buying and selling. So why stick with the appearance when you can go right to the reality of price and analyze it better?”.
In this context, technical traders argue that stock charts contain all the information necessary to make good money in the markets, a view I wholeheartedly agree with. The success experienced by a wide range of market virtuosi, spanning from the early 19th/20th century traders such as Jesse Livermore or Richard Wyckoff to more recent examples of Richard Dennis or Nicolas Darvas surely suggest so.
Dreyfus set out to apply technical analysis to his own trading strategy running mutual funds. Here, his early work experience in a niche brokerage office using charts would have been pivotal. As he wrote in his memoir, “I had used weekly bar charts, posted daily, from my beginning in Wall Street” – to great effect, as you can see in the chart of Polaroid Inc. below, one of his great winning positions (>800% return).
This was breaking with industry tradition. At the time, no fund manager with self-respect would have even dreamed about ignoring fundamentals – they were akin to the holy trinity in investing. At the time, only few people would even dare to touch charts, and as good as no fund manager would allow small investors to put money into the stock market. Dreyfus did both. Of course, he was initially ridiculed. Soon after, however, his results started speaking for themselves.
The problem with fundamentals is that a great company can have a bad stock, and vice versa. In fact, there are myriad companies with amazing fundamentals which stocks are stuck in stark downtrends, while fundamentalists are expensively trying to feel for the bottom that must now arrive at any moment. As master technical trader Ed Seykota relates with a humorous (but hopefully imaginary!) anecdote: “One evening, while having dinner with a fundamentalist, I accidentally knocked a sharp knife off the edge of the table. He watched the knife twirl through the air, as it came to rest with the pointed end sticking into his shoe. ‘Why didn’t you move your foot?’ I exclaimed. ‘I was waiting for it to come back up,’ he replied.”
The monumental success Dreyfus was about to experience was due to many factors, but two main levers were his ability to think disruptively and break with tradition in developing his trading strategy, and his enabling of the common man to enter the stock market. Aggressive and never-before-seen advertising campaigns (including a famous television ad of a lion walking strutting down Wall Street) brought money of the small investors into his fund, while his chart-oriented strategy, jealously decried by the Wall Street Dinosaurs as “frivolous and beneath note“, achieved his fund >600% growth in just over a decade. He further outperformed the Dow Industrials Index by 22% annually on average – a rather monstrous feat for this by then multi-billion-dollar mutual fund, outperforming even the best rivalling fund over the same period by nearly 100%. He thus gained his nickname “The Lion Of Wall Street”.
Lessons by the Lion of Wall Street
Financial publications would later crown Dreyfus as one of the most influential money managers of the 20th century, a name to be mentioned along the Kennedys and Baruchs of this world, despite his relatively short career on Wall Street. Saying that only a dearth of information concerning his trading methodology is available would be an overstatement. However, from the little tidbits there are, the remainder of this article is dedicated to synthesize a general pot of principles and rules he set for himself and his colleagues – he loved flat hierarchies in his company, discussing business while picknicking in the park – to make big money in the market:
Make it yours and become obsessed by it
Dreyfus always went about matters with an ‘all-in’ mentally, and changed things around until they fit his character and contrarian nature.
When he developed an interest in the card game gin rummy, he didn’t dabble as most people do – he went so far to develop a new probability-based strategy that made him almost unbeatable even to the professionals of the day, earning him the label of the ‘best American player of gin rummy’ in the Encyclopedia of Bridge. When he played golf or tennis, he became obsessed with it, ironing out flaws in his own game until he became master of the sports and winning local and national championships from the age of 16. When he ventured into horse breeding, he did not go low-key either – he established his own breeding farm, and there bred, trained and raced thoroughbreds, and became chairman of the New York Racing Association. He poured his life blood into the task with so much dedication that he was later awarded the Fitzsimmons Award and Eclipse Award of Merit – the highest honor lifetime awards for thoroughbred breeding and racing.
Don’t just use someone else’s trading strategy – make it yours. Adapt your method to suit your character, and make it more efficient. Think originally – what do you really want, what do you need to get there, and how do you set out to get it? Be ready to break with generally accepted wisdom, industry traditions and smart-sounding but unfounded assumptions (you know what they say about those). Challenge any premises that underlie popular trading approaches – because what most people use it almost worthless in the market. Dreyfus wrote “I developed my own theories about the charts, and read no books on the subject. It seemed best to make my own mistakes—at least then I’d know whom to blame“.
Become obsessed with your own strategy, make a plan for every and any scenario, and challenge any widely-accepted assumptions on trading the market.
Follow the trend and act when the time is right
One of the general rules that Dreyfus set for his employees was to always determine and follow the trend of the overall market. “The first key is to determine the trend of the market— everything else comes from that” he wrote.
The market trend is a necessary (but not sufficient) condition for you to decide whether to go long, short, or flat stocks. It’s like a fish swarm – as a fisherman, you might catch one or two fish that are swimming the other way, but you should really cast your net where the swarm is going if you want to sell your catch for a good buck.
Of course, this is not all: “When you study the technical side of the stock market you deal with two components. One component is major market trends—bull or bear market. The other is the timing of the purchase or sale of individual securities.”
As outlined above, Dreyfus was a chartist, and knew exactly that timing is critical. You can find the best stock, but if you buy it at the wrong time, you can still lose money. This is especially so when you are managing risk, cutting losses, and trying to avoid drawdowns.
His approach to timing was to not try to participate in every single percent of a move, but rather to look for a stock that is already trending up, currently consolidating, and to buy it at the exact moment it is starting to confirm the continuation of the trend. I describe this process here. Why buy a stock that is in a downtrend and hope it will go up? Look for the strongest, and let them get even stronger – an approach that can be summarized as “buy high and sell higher“, as opposed to the usual Wall Street bottom-fishing idiom “buy low and sell high”.
When in doubt, stay out
As many master speculators before him, including Loeb or Watts, Dreyfus realized that when the odds turn against you, it is wise to not just switch gears but at times even to exit the market completely. On many occasions, such as in 1957 (see chart below) or in 1937 – long before his debut as fund manager – he went to cash positions with his fund and/or private accounts, calling and sitting out the ensuing bear markets against the bullish opinions of other professionals surrounding him.
As a chartist, Dreyfus understood that stocks move up and down because large amounts of money are pressuring them in the respective directions. But buying would not just suddenly appear when a new uptrend had already established itself, nor would selling just surprisingly take over when a market had topped and was already irretrievably in the hands of a downtrend. There are early signs, and significant buying and selling in the market leaders can give a projection on what is about to happen to the market. Dreyfus was a master analyst of leading stock chart action, and when doubt crept up in him whether a market still healthy, he would simply stay out – no need to be a hero, as there are always plenty of other fish left in the ocean, even if he was wrong.
Buy the strongest, don’t fish for bargains
In line with the above, Dreyfus never bothered with lagging, slow, weak stocks. He instead bought stocks that outperformed their peers by magnitudes, had momentum, and traded near the all-time highs. As in sports, the strong tend to get even stronger.
As he wrote, “We didn’t often buy ‘cats and dogs’“. He bought the best of the best, the strongest, those stocks other people deemed ‘overvalued‘ or ‘overpriced’. And then he let them become more and more overpriced.
Understand buying and selling power
Dreyfus remarked that bull markets top not for esoteric reasons, or fundamentals for that matter – markets go up because of broad buying, and they top out because there is no buying power left – everybody is already holding shares in all the stocks they talk about, and there is only potential selling power available. Thus, he notes, it is wise to get out of overheated markets when optimism is uniform across the investment community. The opposite is true for bottoms. Markets go down because of selling, and downtrends end because selling power has been exhausted. Tops and markets are psychological phenomena, an understanding that can be used to not fall victim to herd mentality in both euphoric or panic-stricken times.
He told Life magazine in 1966 “Sell when there is an overabundance of optimism. When everyone is bubbling over with optimism and running around trying to get everyone else to buy, the are fully invested. At this point, all they can do is talk. They can’t push the market up anymore. It takes buying power to do that.” He goes on to explain in his biography that “we must keep in mind that being bullish doesn’t put the market up – having purchasing power does. Being bearish the market doesn’t put the market down – having selling power, being long of stock, can put it down“. Lastly, he noted that downtrends only end when the last of selling, especially forced deleveraging from margined market participants (today that will most likely be ill-positioned and margined hedge fund portfolios), has exhausted itself. Though he admitted that market dynamics have changed over the years, including the pooling of more and more money in funds, and I believe we can include central bank intervention here, the general principles are overall still a good learning experience to understand how markets work.
Picking apart this psychology is what made him heavily enter the market at the beginning of 1958 when heavy pessimism was found across the investment community, and ride the strongest stocks until 1959 – where he again commented on the occurring excesses in the market, just to get back to a defensive cash position.
Stay objective
Keeping our emotions and ego out of the game is key to success in financial markets. It’s all about consistent application of a clearly laid out strategy that is focused on risk management and has statistical edge.
“Don’t pound the table when you have an idea“, Dreyfus admonishes. “Once you pound the table, you take away some of your flexibility, it’s harder to admit you were wrong. And admitting we were wrong was something we [the Dreyfus Fund] put high on the list.“
Focus on risk management
Even a mediocre stock picker can outperform a great stock picker by a good amount, if he cuts losses short while the better stock picker does not. Read a detailed introduction into the topic as part of my free introduction to stock trading here.
“Be prepared to take a quick loss; your conclusion may be wrong even though you approached it the right way. When the stock didn’t act as we expected, we took our loss. We didn’t want to become what was called ‘involuntary investors’“.
The Dreyfus fund made the admission of being wrong and merciless loss-cutting one of its primary operating principles. This was in order to avoid portfolio managers insisting on their faulty opinions and get stuck in a loss-making position with the hope of at some point – perhaps years later, perhaps never – getting back to breakeven … what Jesse Livermore first referred to as the ‘involuntary investor’ in his 1923 classic Reminiscences of a Stock Operator.
Further, it was important to buying decisions made by the Dreyfus Fund to never accept bad reward/risk relationships, i.e. to never put money into a proposition if one cannot expect to gain at least a multiple of the money that was risked. For example, you should not buy a trade that by your best judgement/estimate might net you a perhaps 30% gain if you are right, but will cost you 20% of your position if you are wrong. This is just not a good relationship of potential monetary reward to the money risked – aim for reward/risk ratios of a barebone >2:1, ideally much much higher.
Embarking on new adventures
The Dreyfus Fund went public in 1965, and would merge in 1994 with Mellon Bank Corporation. However, Dreyfus would not be part of this side of the story anymore – he retired in 1965 with an estimated $100M net worth (roughly a billionaire in today’s money) to dedicate himself to other pursuits until his death in 2009 at the age of 94. Of course, he did not turn his back to the market completely, as he purchased another NYSE chair in 1971 to trade for his own personal and family accounts.
For the Dreyfus funds that continued carrying his name at Dreyfus Corp., his departure came at a hefty price, dipping into mediocre performance over the years.
Though the lion share (pun intended) of Dreyfus’ writings is focused on other parts of his life, specifically his later adventures in lobbying for regulatory of a medicine that had helped him personally to overcome depression, I’m sure the above can give the aspiring stock trader as well as the long-term holder valuable ideas on how to avoid risks and perform better over time traversing the stock market.
If you learn but one thing from this article, let it be to always admit when you’re wrong and swiftly act on it – your bottom line will thank you immensely.
So long,
TGS
