Lessons From Dorsey Wright’s Thomas Dorsey

“Investment philosophy is really about temperament, not raw intellect. In fact, proper temperament will beat high IQ all day.” – Michael Mauboussin

Last week the Wall Street Journal ran a profile of Thomas Dorsey, the president of Dorsey Wright & Associates, an investment firm that focuses on momentum and trend following strategies.

I had a few people send me this story asking for my thoughts.

Early in my career, when I thought I knew everything, it was easy to dismiss an investment philosophy that differed from my own because I thought I had it all figured out.

At this point I’ve been involved in just about every investment style, strategy, market and product you could imagine. I now understand that it makes no sense to completely dismiss an investment discipline because you can always incorporate aspects of different strategies into your approach.

Why not have an open mind? Everyone is different and personality-type has a lot to do with the style certain investors use. Even if you don’t use the strategy in question, you can always learn from other investors, both good and bad, even if you don’t utilize their same philosophy.

In this case, having an understanding of trends is very important because they can last longer than most assume and can move very swiftly in the other direction, as we’ve seen in the past couple of weeks.

Here are a some of the other lessons I took away from this profile:

Mr. Dorsey, 66, whose company is tucked away in a wooded office park outside Richmond, Va., has an approach that he says separates him from many market technicians: “I always strive for simplicity,” he says. Degree of difficulty has never been a prerequisite for investment success. You don’t have to be clever or blessed with superior intelligence to make money in the markets. Complexity doesn’t guarantee profits.

And there are no complicated formulas to generate trading ideas. In a nutshell, Mr. Dorsey ranks investments based on how well they have been performing relative to each other. Many investors would thumb their nose at such a simplistic approach, but maybe that’s why it works. Also, simple doesn’t mean easy. You still have to execute any strategy in real-time while dealing with all of the noise, differing opinions, emotions and market movements.

The calculations are so simple, Mr. Dorsey says, that after he demonstrated them to students at Gates Elementary School in Chesterfield, Va., it took them less than 40 minutes to duplicate his stock-picking method. I think this is great. A quote I have on the about page of this website from Einstein is one of my all-time favorites: “If you can’t explain it to a six year old, you don’t understand it yourself.”

Discipline is critical, though: Once a favored investment starts falling behind the pack, he swaps it for the one that took its place, no questions asked. “I don’t make judgment calls, ever,” Mr. Dorsey said. “We’re purely rules-based.” Automating good behavior is one of the smartest things an investor can do to reduce unforced errors. It doesn’t mean you won’t be wrong, but it can lower your chances of making egregious mistakes.

He acknowledges the formula doesn’t always work when the market is moving in a narrow range, failing to generate the trends that feed his calculations. And he admits that he won’t buy at the bottom or sell at the top with this method. But, he says, he’ll catch the big moves. Nothing works forever. The investors that assume they’re infallible are usually the ones that blow-up from leaning too far in one direction because they’re absolutely certain they’re right and the market is wrong. Strong opinions and stubbornness can cloud your judgment when making investment decisions. Overconfidence in any approach will usually lead to large losses eventually.

Fund manager’s formula for finding a winner: Look for a winner (WSJ)

Further Reading:
Universal lessons from every investment discipline

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    […] Ben Carlson has a nice post about Thomas Dorsey and how his firm has been successful, and this contains one of the other keys to financial success:  Find a strategy that has been working in the long term (typically over long time periods and in separate countries, markets, and even types of assets) and makes sense.  Be sure you understand your strategy’s strengths and weaknesses, and then stick with it!  Thomas Dorsey uses a rules based momentum strategy, and it works.  I’m not endorsing his firm or strategy as ideal, or even necessarily efficient or appropriate.  And of course it could quit working at any time.  But if he had not done his homework, and most importantly, stuck to the discipline, he would definitely not be as successful. […]