Happy Presidents' Day

10 Lessons from Baseball to Bring to the Market

Good morning everyone.

The market is closed today in honor of Presidents’ Day, which means I’m not going to sit and stare at a screen all day. If the weather holds up, I’ll be working on my golf game instead. And trust me, it needs A LOT of work.

While I’m searching the woods for hooked drives and digging my way out of sand traps, here’s one of my favorite posts from the vault:

10 Lessons from Baseball to Bring to the Market

I’ve got something a little different this week. My oldest daughter had her first ever t-ball game on Friday, so I decided to sit down and finish a post that I’ve wanted to write for a long time.

For those of you who didn’t know me a decade ago, I was lucky enough to play baseball at the collegiate level for four years. I managed to win a few games here and there, but my name doesn’t grace the record books. Reaching the next level wasn’t in the cards, either. No, my career had zero lasting impact on baseball. But the sport had a lasting impact on me.

Baseball is the root of my connection with each my closest friends. I even met my wife in the dugout (and then promptly told her to leave me alone because we were in the middle of a game. I vultured my first collegiate win in relief just a few minutes later. True story.)

Just as important as the relationships made are the lessons I learned on the field. Here are ten that apply to investing.

1. Learn how to fail

Baseball is a weird sport. You can succeed just 30% of the time as a hitter and still reach the Hall of Fame. It’s a game where failure is the norm, and failure takes a mental toll. The greats learn how to compartmentalize those failures and move on. They make the next play. They focus on the next pitch.

The worst thing you can do is compound your error: You bobble a groundball, then make an errant throw because you’re in a rush. You give up an RBI double, then fail to back up third because you’re busy hanging your head. You strike out in a key moment, then pout in the corner of the dugout instead of cheering on the next man up.

You’re going to fail a lot in this world, too. Not every decision will be a profitable one. Your investment thesis won’t always pan out. But you can’t let the disappointment of past failures affect future decisions. Good investors don’t panic when a trade goes against them. They don’t change their thesis to justify holding on to losers. They aren’t controlled by the fear of missing out.

Keep a cool head and stick to your process.  

2. Focus on the approach, not the outcomes

Good baseball players have good at-bats. Batting averages and slugging percentages measure outcomes, and outcomes are what win games. But individual outcomes depend on luck. The only thing you can control each and every time are your approach and your process.

You can work a pitcher deep into the count and then scorch a line drive straight toward a fielder. You’re out, despite a good at-bat. You can fall behind on a first pitch fastball down the middle, chase a curveball in the dirt, then manage to sneak a dribbler through the five-hole after getting fooled on an 0-2 change-up. You got a hit, despite a poor at bat. Over enough time, though, good at-bats are sure to result in hits more often than poor ones.

It’s the same thing for investors. You can make a ton of money on a hot stock tip that you got from your buddy in a bar. You can buy something you don’t understand, double-down after a drop because ‘surely it can’t go any lower’, and then get bailed out by an unexpected acquisition. The outcomes are good. The approach isn’t. For the vast majority of us, luck is not a sustainable investment strategy. We’ll have more consistently good outcomes when we take a good approach and stick to our process.

3. Trends persist

I remember reading Buzz Bissinger’s Three Nights in August right after it came out in 2005. The book is about a pivotal 3-game series between the St. Louis Cardinals and the Chicago Cubs, mostly viewed through the eyes of legendary manager Tony La Russa. (Full disclosure: I grew up in central Missouri, so I’m a bit biased.) La Russa was a matchups junkie, and he firmly believed in the persistence of trends in baseball. It doesn’t matter whether a mismatch is because of a physical advantage or a psychological one, if a hitter is 0-10 against a particular pitcher, he isn’t ‘due for a hit’. He’s due for another strikeout.

Trends persist in the market, too. A stock can drop 80%, but that doesn’t mean it can’t fall further. In fact, it’s more likely to keep falling than suddenly reverse course.

4. Do the work and be prepared for anything

Tony La Russa would prepare for each game by filling a 5×7 notecard with matchup statistics. No matter which opposing pitcher was brought in in relief, or which pinch-hitter was brought to the plate, he knew which of his own players were best-suited to handle the situation.

When you’re in the field, you’re constantly evaluating what to do if a ball comes your way, or where you’re supposed to go on a double to the gap. It changes depending on how many runners are on the bases, how many outs there are, how fast the batter runs, and what the score is.

The catcher is trying to outsmart the hitter based on which pitches he’s already seen and which ones he tends to hit best. The hitter is trying to outsmart the catcher based on what that pitcher likes to throw in certain counts and situations.

Baseball is a slow game to watch, but don’t be fooled into thinking nothing is happening. There’s a constant flow of ‘if-then’ analysis between the ears. When players or coaches aren’t doing that, they’re bound to be caught off guard and look the fool.

To quote the great Yogi Berra, “Baseball is 90% mental. The other half is physical.”

We have to prepare for markets in the same way. No one knows what will happen next, so we have to do our best to prepare for every possible scenario. If x happens, how will I respond? What if it doesn’t happen? What if x AND y happen?

When we’ve put in the work and prepared correctly, all that’s left to do is execute.

5. Life is easier when you’re ahead in the count

If you want to be a successful pitcher at any level in baseball, you must throw first pitch strikes. Getting ahead in the count gives you optionality. You can more confidently throw off-speed pitches, knowing a missed location can only even the count. You can nibble at the corners of the plate, rather than being forced to groove a hittable strike. You can give the hitter something to chase, knowing they really don’t want to fall further behind.

When you get ahead in the count, you significantly increase your odds of winning the matchup. Here’s some stats from the MLB last season:

• Hitters that fell behind in the count on the first pitch of the at-bat had a batting average that was 40 points lower than hitters that got ahead.

• For hitters that fell behind 0-2, the disadvantage is even more extreme. They hit just .160, while batters that were ahead 2-0 in the count hit .266.

The data says your success-rate depends on who wins the first pitch.

In investing, getting ahead early is just as important. We know that investment returns are skewed by the fat tails of the distribution curve. We also know that the best performing stocks tend to be among the most volatile. We need to own those volatile fat tails, but it’s hard to hold onto something for the long-term if the trade moves against you at the start.

It doesn’t matter what your investment horizon is. If you fail to time your entries appropriately, you’re putting yourself at a mathematical and psychological disadvantage.

6. Never throw a pitch you don’t want to throw

As a pitcher, you control the game. Nothing happens until you decide to throw the ball. You get to decide what you throw and where you throw it. Yes, your catcher is probably smarter than you, and he’s the one calling the game. But that’s no excuse for doing something you don’t agree with.

To be successful, you have to have confidence in what you’re doing on the rubber. If you’re busy complaining about what you think you should be doing, you’re not focused on what you are doing. You miss spots. Your movement isn’t sharp. You give up bombs. Then you blame it on your catcher because you didn’t want to throw that pitch. It’s not your catcher’s fault. It’s yours. Own your pitch.

Own your trades, too. There are plenty of ‘catchers’ out there to help you on your way – I try to be one here at Grindstone by pointing out trends, levels, and opportunities in the market – but only you can be held responsible for your investment decisions. It’s your money. You could be handed a highly profitable strategy, but if you don’t own it and believe in the system, you’ll find a reason to give up on it. You aren’t focused on executing. You’re focused on what you could be doing instead. That’s not a recipe for success.

7. Take what you’re given

I was a straight pull hitter. My specialty at the plate consisted of barreling up anything on the inner half and hitting hard groundballs to the shortstop any time a pitch was on the outer third.  That’s why I was relegated to the bump in college (that and because my older brother was gifted all the foot speed in our family tree). The great hitters don’t try to do too much with every pitch. They take what they’re given. They’re capable of turning and burning on a fastball when the opportunity arises, but they’re willing to sit back and slap singles to right field when they have to.

We don’t get to invest in the market we want. We get to invest in the market we have. Good traders take what they’re given. If their preferred strategy doesn’t work when markets are rangebound, they’ll employ a new strategy in those environments. If they can’t make money in stocks, they’ll find a way to make money in commodities. If commodities aren’t working, they’ll look at crypto, or fixed income, or currencies. And if all else fails, they’ll sit on the sidelines, rather than try to force something that isn’t there.

8. Know how to respond when the odds are stacked against you

When you fall behind in the count, it’s not a great time to be swinging for the fences. Last year in the Show, there were more than 5,000 home runs hit. Only 3% of them came on 0-2 counts. Statistically, there’s no worse time for batters who are looking to go yard.

That’s not to say you can’t be a good 2-strike hitter. You just need to be willing to adjust your approach. Successful hitters get defensive and find a way to get the bat on the ball. They shorten their stride, choke up on the bat, simplify their swing. Trying to get out front and lift a ball in the air when the pitcher has the advantage is a good way to strike out a lot. Good things happen when you put the ball in play.

Similarly, you won’t hit a lot of home runs when the odds are stacked against you in the market. Bottom fishing and trying to catch falling knives is a good way to go broke, especially if you’re betting big. Is it possible that Mr. Market accidentally leaves a ball up in the zone, allowing you to clear the bases? Absolutely. But that’s not the higher probability outcome.

If you’re on a losing streak and you feel confused by the market action, is that the time to be doubling down and trying to recoup losses? Any great trader will tell you it’s better to get defensive and decrease position sizes until the advantage is back in your favor. There’s nothing wrong with a single every now and then.

9. Play to your strengths, not someone else’s

I wasted a lot of my playing career pretending I was something I wasn’t. I played shortstop in high school because that’s where my superstar brother played. My slow feet and long arm action made me ill-suited for the position. When I turned my focus to pitching, I wanted to be Nolan Ryan and blow fastballs by people, even though my velocity was little better than average.

It wasn’t until the second half of my college career that I found real success, and it was because I began playing to my strengths: the ability to throw a plus curveball in any count and to any part of the plate, and the ability to keep my very average fastball on the black. I was a lot better at being myself than trying to imitate someone else.

I’ve found the same is true in this industry. You don’t have to be a subject matter expert on every single thing. It’s a nearly impossible task, and it’s not a prerequisite for success. There are dozens, if not hundreds, of ways to make money in the market. You can be a pure technician, a bottom-up analyst, a quant-driven algo trader, or a macroeconomic asset allocator. The ‘best’ strategy is the one that works for you. If you try to invest the exact same way that Warren Buffett does, you won’t have the same success that he does. You have different strengths. Focus on what you do well, then be the best at it.

10. Fighting the people in charge is a waste of time

Everybody loves to hate umpires. There’s an entire ecosystem out there dedicated toward pointing out bad calls, complaining about rule interpretations, and asking for Angel Hernandez to retire. It builds a lot of camaraderie among fans – no matter which team they root for, they’re united in their hatred of officials.

Players and managers, too, love yelling at the umps. Sometimes, they’re justified in their anger. Other times, the game’s participants don’t even understand the rules they’re arguing about. In all cases, the outcome is the same: the call stands and the umpire goes back to doing his job.

Complaining about umpires is fun. But it’s a waste of time.

Complaining about the Fed, the SEC, or the President is a waste of time, too. Does screaming about rate hikes or the debt ceiling build camaraderie by uniting people against a common enemy? Sure. Will your 20/20 hindsight analysis of every mistake policy officials make change what they’ve already done? Does your opinion about what Jerome Powell should do have any impact on what he will do? No and no.

It’s easy to judge from the peanut gallery, but just as most baseball players don’t know the intricacies of the rule book, most investors don’t fully grasp the puts and takes of policy decisions in a global economy.

Umpires and policy makers are humans. They will make mistakes. We can spend our time bashing the people in charge. Or we can focus on finding ways to profit from their decisions.