Michael Steinhardt is a legendary investor. In 1967, Steinhardt founded the hedge fund Steinhardt, Fine, Berkowitz & Co. From 1967 to 1995, the hedge fund returned 24.5% annually after fees. After retirement in 1995, Steinhardt became chairman of Wisdom Tree investments, a company providing a variety of exchange traded funds. Steinhardt is profiled in Market Wizards, where he shares keys to his investing success that are summarized and analyzed below.

Contrarian Perception
The star investor first discuses his theory of variant perception that is rooted in contrarian ideas. Steinhardt attempts to develop perceptions different than the consensus market view. He then trades on these variant perceptions until the general market perception aligns with Steinhardt’s opinion.

A tobacco trade provides a great example of the application of the concept of variant perception. Steinhardt shorted a specific tobacco ahead of a pending litigation decision. At the time, tobacco companies rarely lost these cases. Therefore, Steinhardt believed the general market perception would also expect the tobacco company to win the case. Because a victory was discounted into the stock price, if the tobacco company did not lose, Steinhardt expected the stock price to barely increase. The limited price appreciation potential if pending litigation was won caused Steinhardt to short the tobacco company. This was a low risk trade with high upside if the company lost the case, and low downside if the tobacco company won the case. Trading these favorable odds is a strategy echoed by many star traders including Larry Hite.

Top characteristics of successful contrarian investors are also highlighted by Steinhardt. “In order to win as a contrarian, you need the right timing and you have to put on a position in the appropriate size. If you do it too small, it’s not meaningful, if you do it too big you get wiped out if your timing is slightly off. The process requires courage, commitment, and an understanding of your own psychology.” Thus, successful contrarian investing is also dependent on excellent trade execution and commitment.

The Opposite Side of the Trade
Steinhardt stresses the importance of understanding why someone took the opposite side of your trade. For every buyer there is a seller who is making the opposite decision. “The major advice I would give to anybody is to recognize that this is a very competitive business, and that when you decide to buy or sell a stock, you are competing with people who have devoted a good portion of their lives to the same endeavor. In many instances, these professionals are on the opposite side of your trades, and on balance, they are going to beat you.”

I also think this quote about the competitiveness of investing emphasizes my views about small cap investing. For small investors buying individual stocks, I believe it is generally more wise to purchase smaller capitalization stocks that are covered by less professionals. Competing in a small pond is easier than fighting in an ocean full of sharks.

The Importance of Dynamic and Adaptable Investing Strategies
Steinhardt also emphasizes the need for flexible investment strategies. Successful investors normally do not exploit one market inefficiency for the long term. Overtime, a persistent inefficiency will attract more traders who subsequently eliminate the inefficiency. ”As soon a formula is right for any length of time, its own success carries the weight of its inevitable failure.”One of Steinhardt’s keys to success was employing a dynamic investing and trading strategy that capitalized on changing market conditions.

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