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05-May-2006
Letter to a Newborn Son, from Victor Niederhoffer

The occasion of a birth is always a good time to take stock of the important things in life that a father would like to share. In your case, it's even more important, because at 62, I am the oldest father that the big Pennsylvania hospital that you were born in had ever discharged, and I am going to have to compress much of my hopes and knowledge and love for you into a few short years. Here are some of the main lessons for you that I hope to set in motion so clearly and firmly by my own example and also with practical direct applications for you while I'm alive that it will become second nature to you, and these guidelines will be useful merely for a review, but it's too late to lock the stable after the horse has been stolen, so here goes.

The Mouse with One Hole

You will soon learn to love the memory of your grandmother Elaine. She gave of herself selflessly so that her family could excel and prosper. Nothing for her three kids and 10 grandchildren and her many good friends was too unimportant for her to attend to. She led an exemplary life, with nary an enemy. Hardly anyone who knew her who didn't love her. One thing she really wanted was to see you before she died. But, regrettably, things don't usually happen the way you hope, and she died one week before you were born. Okay, a tragedy, but at least she had many a smile thinking and hearing about you while she was waning, and you will through her teachings, her books, her progeny, her eulogies, and her bios have many opportunities to learn from her. Nevertheless, let this be a lesson for you.

Your investments, your romances, your aspirations will never be realized the way you planned. There is much uncertainty and risk in the world. Even when the outcomes are known, it's largely chance what's going to occur. Do account for risk and uncertainty in what you do. Never leave yourself with just one exit on any important pursuit. Constantly plan for the contingencies that are not at the peak of your hopes, or most likely outcome. Follow the wisdom of many animals, and the proverbial "the mouse with one hole is quickly cornered".

Listen and Learn

While we're on the subject of your grandparents, you'll soon find out your paternal grandfather was a king among men, whose spirit lives in thousands of others still living. My book Education of a Speculator is a love story about him, and you'll get the main ideas from that. Regrettably, he never thought he was going to die young, so he never wrote down guidelines like these, but he did read me and Diane and Roy a story every night for 18 years, and he drove us to and attended all our 10,000 lessons and tournaments, so we got a good dose of what he would have told his kids. One of his most important mottoes was "Listen and Learn." In its most exact sense it means that you should always be ready to find wisdom in what other people say, and try very hard to absorb it without injecting your own preconditions into the fray. But at a more general level, it means to be humble, to always be wary of your own liability to error, to always give the other person the benefit of the doubt.

When you're investing, there is one super person that you must always listen to, and that's the market. To fight the market without humility is the cause of certain death. You see, all that has to happen is for you to be wrong enough for you to lose all your chips. And it doesn't take long for that to happen, especially if the market or anyone else, senses they can make a killing by doing you in. Regrettably, there are some people who, like the vultures and maggots and hyenas, specialize in waiting for you to be near the death point, and they always can tell when you're near death, so the market usually will take that last move just to suck your life blood away when you're not humble.

Give Others the Benefit of the Doubt

The world is full of great people and small people. You'll find they all think they're well-meaning and good. There is good and bad in everyone, but if you treat everyone as if he's a good person, you'll tend to bring out the good. That will augment your life immensely. Conversely, if you treat people like they're bad, not only will they clash with you but you'll help them to become bad. People never give you more than you expect of them. Artie was a master at giving the other person the benefit of the doubt. There was a joke in our family that we all hated to play ball when Dad was on our side, because every ball we hit was out and every ball they hit was in, according to him. But he taught us the value of sportsmanship. He taught us that if you needed to win so badly that you had to bring out the worst in other people then you'd bring out the worst in yourself also.

When you're doing business with someone, remember that all profits come from recurring relations with the other side. If you're the kind of person who's always trying to get the edge by assuming the other side is trying to put one over one you, no one will want to do business with you twice because it will be so unpleasant for them. Sure, you'll get gypped a few times by giving the other person the benefit of the doubt, but you'll make up for it on the many occasions when someone says, as they sometimes say to me, "You know - you've never asked anything from me and you've brought out the best in me, and here's something meaningful for you." As for the applicability of this to investing, remember that your counterparts, brokers and agents are going to have to benefit from doing business with you, or else they can't continue in business. So you have to give the other person the benefit of the doubt; otherwise, you won't be able to continue.

On another level, giving the person the benefit of the doubt assumes he is very intelligent and knowledgeable. That's part of being humble and preventing yourself from assuming that you know more than others. The importance of humility as a requisite to success in investments cannot be overemphasized. That is why it crops up in many of my points as a corollary or condition to success. You'll learn this best sometimes by falling victim to the contrary. Eventually, you'll see people who are always boasting about their own success and how much smarter they are than everyone else. They're obviously not giving the other person the benefit of the doubt. You'll find a lot of these arrogant blowhards around, but you may overestimate the number doing business at one time, because they're sure to go out of business. So the only ones who are left are the newbies who have not gone under but soon will.

People are Able

The one observation that I can make from my own experience that has the most explanatory power is that almost everyone you meet will have some aptitude, know-how, taste or expertise that's highly effectual and interesting. When you go through life, try to elicit those unique qualities in the people you meet. Assume that the average Joe on the street has much to teach you, and be ready to drink it in. One of the most effective ways that I've found to bring out the these know-hows in people is to sit down with them sometime over lunch or take a walk, and just say, "Tell me a story," or "Teach me something." You'll be surprised at how those simple words open vast vistas of erudition and knowledge that were completely undreamed of.

You'll discover that every investor has a different method of applying his trade. That's one of the beauties of an enterprise system like we have in our country. The process of providing a product is divided up into many parts. Because of these many parts, people can pick and choose those they are most interested in or most able at. This is called specialization and niche-building in the animal and plant worlds. The process of finding your own niche, the area that you have the greatest edge, in as well as figuring out what the niches that others specialize in, is a grand goal in life but also a crucial aspect of the process of investing.

The Importance of Small Things

Little strokes fell great oaks. No matter what great goals you have for yourself, and I hope they'll be very high, you have to start somewhere. The best place to start is with something little, something you are accustomed to doing well, maybe from your mastery of games or music. For example, you might want to become the world's greatest trader. To do so you have to start by trading something with someone. Try it with someone in the family, trade a tennis lesson for a piano lesson, or a set of plate blocks, for a penny black. Once you start, you'll find it easier to get to the next step.

The best lessons in doing small things come from music. Every day you have to start by doing some very simple exercises. Then you have to practice over and over again until you can meet anything written in music with great aplomb. Once the technical difficulties are mastered, in music or anything else, you can concentrate on the things that make for greatness, the rhythms, the content of the main themes, what the composer has in mind, the dynamics, and the pedals.

Time and again I've applied the lessons I learned from practicing the piano and violin, which, among other instruments, I'm sure you'll be playing. I found it normal to practice by myself in squash, just by hitting each shot for 10 minutes at a time alone on the court. That's really how I got good, once I received the proper instructions, foundations and guidelines from Jack Barnaby. Amazingly, to this day, hardly anyone else did that, and people used to look at me like I was an oddity for practicing by myself in all my racket sports, and it was much harder in tennis in the old days before they had machines.

When you want to start investing, make a little trade. Wait until there's been a long run without a success in some field like the stock market, and then take the other side with a very small quantity. Do it so small that you can afford to hold for more than a day. Remember the mouse with one hole. If it's up the first day, then get out. If not, wait for two or three days to close out. After that, call it a day. The markets will always be there.

Because of the wide applicability of the value of learning by doing small things, you'll find it applicable to every pursuit. I like to apply it to problem solving. Whenever you have a problem, start by doing the problem as if there were just one or two things or persons involved. Count out the possibilities. Then see how you solved it and apply it to more things. If it worked for one, then did it have to work for two? Not only will you know the way to solve more complex problems that way, but you may have within you a generalized proof by induction.

Incentives Matter

Actions happen as the result of individuals' making choices about based on a comparison of the benefits and the costs. If you want certain actions to happen, or if you wish to know why they did not happen, compare the benefits that were available to the costs for the individual. When they increase you'll find more of the action and when they decrease there will be less.

The best incentives you'll find are the ones that involve money. That's because people can use money to get more of the things they want and the things that have the most value to them. Sometimes the best way to see the importance of something is to assume you had none of it, or a googol of it. Often when there are no money incentives you see the craziest things. In my day, there was a book about the lack of money incentives in Russia, written by G. Warren Nutter, titled The Strange World of Ivan Ivanov. He said that because they had no incentives in Russia, no one worked hard, and they never produced what people wanted. He and Mises and Hayek predicted that the system would break down, but no one believed him at the time. Indeed, they used to teach at Harvard and all the other good schools that the Russian system was as good for producing goods and grew as fast as ours. But then the truth came out. There was uniform poverty in Russia, except among government officials, and no one was there to take care of the sick cow because there was no benefit from doing so.

Worse yet is what happens to people's character when they don't have incentives. They must constantly fight against their inmost tendencies to improve themselves, which they think about almost every waking minute. If the system doesn't provide for a way to make those incentives to improve themselves easy -- or worse yet, the Russian system made the money incentives to improve yourself illegal, since all economic goods belong to the state and to start a business or trade in Russia was a capital crime -- it makes people crazy and deceptive and suspicious. Almost all the Russians I've met have a strong tinge of dishonesty within them, developed in their communistic upbringing as a prerequisite for survival. The terrible influence of lack of incentives on character is usually present whenever you see people doing consistently bad things.

I hate it when someone who wasn't brought up in an incentive system comes to me. He's always thinking, what can he take from me, what can I give him without a trade. Worse yet is what he thinks about me. He sees me as an enemy, and thinks "What the H am I trying to get?"

I love to buy investments where incentives are changing. Some of the best opportunities arise when governments or associations privatize their activities. All the sudden, the sick cows get milked, people start working long hours, the customer becomes the king rather than a problem. When you were born there was a movement for all the exchanges to become private profit making entities, and the importance of incentives in improving their operations and making them fight harder to get business led to many profit opportunities. Always make sure there are incentives in the people you invest with for them to make money for themselves while they're making money for you. If the incentives are not in balance, then you're going to have big problems unless you or someone else changes them quick.

Counting

I've discussed many areas that are crucial to success. How can you keep track of them? There is only one way, and that's to count. Now, counting is best learned by doing. In your family Francis Galton reigns supreme. Your eldest half-sibling Galt was named after him. He is often referred to as the king of counting. Galton kept an index card and pen in his pocket at all times so that he could classify relations between two things into the times they moved together and opposite from each other. This is what the call the process of co-movement and countermovement, or contingency tables, in technical terms. The best way to become a good counter is to do it often. My first memories are of Artie sitting in 90-degree heat at Dodger Stadium and counting the number of hooks and errors in handball. In my mom's book with Artie The Police Family they give a beautiful example of counting, by classifying all the books ever written by police families -- by kind of favorability, style, content, happiness of the characters, and many other variables.

Count often and practice at it, and it will become second nature to you. You'll make many discoveries. Even more important, you'll learn to be skeptical of the kind of things that are going to come down the road that are based on superstition and myth, magic and cult wisdom.

Read good books on counting. I like the classic statistical books on counting like Statistical Methods by Snedecor and Cochran. Also good is Statistics Without Tears by Derek Rowntree. But any book that gets you to take out the pencil and paper and teaches you good examples from many different fields is good. The third aspect of counting nowadays is that it's important for you to develop a tool above and beyond the pencil and paper to do your counting. For that purpose, it's essential to learn a good programming language so that you can count systematically and extensively. The programming languages that I learned on were based on FORTRAN and BASIC. Nowadays, many people find that using the statistical programming environments R and Matlab is an excellent way to round out counting in practice. When you've mastered these three steps to counting, you'll have to gone a long way toward becoming a good speculator. You'll not only have a proper basis for making statements about the relations that matter in markets, but even more important, you'll have a basis for rejecting those that don't. There's a mantra that all the people associated with me follow that has been very helpful in their investments and, indeed, in their lives. When someone suggests a trade or procedure, always ask the question, "Er, have you counted and tested that?"

Aubrey, one of the first jobs that you have is to cry, to let us know what gives you happiness and pain, and to get your body functioning properly. I know this is very important for you but right now it's been keeping your mother and me up for the first two days that you've been alive. And before I tell you the other important lessons, based upon such things as the important of games, the importance of books, or music, the overriding significance of compound interest, the importance of taking a proactive approach, I'm going to have to get some sleep. Then, I'll talk about the importance of having proper mentors, of choosing a path where you have the wind at your back, the lessons about diminishing marginal return, the key significance of trade, and the lessons from examples of heroic men. But, before I tell you about all this, I'm going to have to get a little rest.

 

 

 

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