Here are some of his brilliant quotes and my comments on them:

1. “If you are shopping for common stocks, choose them the way you would buy groceries, not the way you would buy perfume.”   –  It is true that perfumes come and go out of popularity, but no trend lasts forever. There are trends that last 3 months; there are trends that last 3 years.

2. “Obvious prospects for physical growth in a business do not translate into obvious profits for investors.” – it depends on to what level has the expected growth been already discounted. The truth is that it is really hard to forecast growth in quickly developing businesses. The market always overdiscounts at some point, but in the meantime trend followers could make a killing. You never know how long or how fast a trend could go.

3. The only constants in the markets are change and uncertainty. Not only business environment changes, but also people’s perceptions of stocks change. Look at $GMCR for example. It went from making a new all-time high at $10 back in March 2009 to $115 in September 2011 to $25 today.

Most businesses change in character and quality over the years, sometimes for the better, perhaps more often for the worse. The investor need not watch his companies’ performance like a hawk; but he should give it a good, hard look from time to time.

4. Different catalysts matter for the different time frames:

Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies.

5. The difference between a trader and investor

The most realistic distinction between the investor and the speculator is found in their attitude toward stock-market movements. The speculator’s primary interest lies in anticipating and profiting from market fluctuations. The investor’s primary interest lies in acquiring and holding suitable securities at suitable prices. Market movements are important to him in a practical sense, because they alternately create low price levels at which he would be wise to buy and high price levels at which he certainly should refrain from buying and probably would be wise to sell.

6. How to think about risk

The risk of paying too high a price for good-quality stocks – while a real one – is not the chief hazard confronting the average buyer of securities. Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions. The purchasers view the current good earnings as equivalent to “earning power” and assume that prosperity is synonymous with safety.

7. There is nothing guaranteed. The market doesn’t owe you anything. There are no sure things. Equity selection process is important, but risk management discipline should always trump conviction:

Even with a margin [of safety] in the investor’s favor, an individual security may work out badly. For the margin guarantees only that he has a better chance for profit than for loss – not that loss is impossible.

8. “To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks.”

9. “Wall Street people learn nothing and forget everything.”

10. “Most of the time stocks are subject to irrational and excessive price fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or gamble … to give way to hope, fear and greed.”

There is a saying that the market reflects the price of everything and the value of nothing. Wall Street is such a house of mirrors. There are very few original thinkers. If you have a good track record (read you were right at least once big time) and you sound and act confident, not only no one is going to question you, but also you are likely to have tremendous impact on the market.

Are there way too many “second level” thinkers in this market, who prefer to take the short cuts and let’s say look only at charts and follow established names? Everyone is taking the path of least resistance, not only because it takes less efforts, but because it has worked most of the time. Who is left to do the real homework? I am certainly guilty of charge.

I am sure that even David Einhorn was pleasantly surprised by the reaction his comments caused during Herbal Life’s conference call. Here is what one of the StockTwits’s users rightfully pointed out earlier today:

ronbo811: $HLF stock went from $6 in 2009 to $73 and today everyone just realized the comp is a scam after a couple questions at a meeting?…Really?    May. 1 at 11:18 AM

He makes a really good point. Benjamin Graham liked to say that “Price is what you pay. Value is what you get”. The reality is that value is what you think you get. Price is what the market is willing to pay for it. Value could be very subjective, even in the stock market. What is worth zero to you, is worth $1 billion to Facebook, for example.

 
And another comment:
 

KidDynamiteBlog: $HLF funny thing is that if I hadn’t come to the conclusion that I was wrong I would have bought even more stock and made a killing!  May. 1 at 1:07 PM

Everything looks so clear and easy in hindsight, but it is never so in real time.

The market has become so short-sighted, impulsive and reflective. Or maybe it has always been like that.

Prices change when expectations change and the latter change under the influence of outside factors. In short-term perspective, price could go anywhere and the major catalyst that impacts expectations is price action itself.

Disclosure: I traded $HLF during the day. I didn’t mention it on my StockTwits stream, because it was a short-term trade that was hard to follow.

When two amateurs play tennis, the one that makes the least amount of mistakes usually wins. The same rule often applies to investing except that what matters more is not the number of mistakes, but their size. While Tadas Vishkanta doesn’t necessarily teach his readers what to do in his first book – Abnormal Returns; he does an even more important job by highlighting what not to do.

Tadas looks at investing from all perspectives imaginable and paints a rich portrait of the market reality, without saving the uncomfortable truth. While Abnormal Returns reads like a textbook at times, it provides deep market understanding of the common hurdles each market participant faces in this enormously challenging field. Unbiased, with no issue that could blind his objectiveness, Vishkanta summarizes and explains a ton of practical investment wisdom from some of the best financial minds of our time.

Abnormal Returns is really informative reading that will enrich your understanding of financial markets. Certainly a worthwhile addition to your investing library.

Here are ten insights I was reminded of by reading the book:

1. Opportunity cost is often overlooked, not only in terms of return, but also in terms of time:

The time and effort spent in trying to become an accomplished trader, by definition, come at the expense of other activities. The biggest cost to the 90% or so of traders who fail is not necessarily the financial costs, but rather the time lost to other opportunities. Money can be made in a number ways, trading only being one of them. However, time is not something any of us can get back.

2. Know your limits:

Great investors recognize that once they make an investment decision, the results are largely out of their control. They can have a plan about when to sell, but the market will ultimately dictate how that investment works out over time.

3. The worst forecasters are often the most confident. Once in a while, they hit the jackpot like a blind squirrel finds an acorn sometimes.

Analysts who correctly called the market crash of 1987 have been living off that call ever since then. The irony is that research shows that those forecasters who get these “big calls” correct turn out to have the worst overall track records.

4. Finding skilled money managers is one of the hardest endeavors on earth

First, we should recognize that investing is a field in which both skill and luck do play a role. Investing is often compared to gambling and most often to poker, and for good reason. Recent research also shows, contrary to what the authorities say, that poker on the whole is a game of skill. Unfortunately for investors, our ability to identify skilled investment managers is much more difficult than identifying skilled poker players.

5. Distinguish between skill and chance

Fama and French examine the performance of mutual fund managers and find that before expenses the top 5% or so of managers demonstrate some skill compared with chance.9 The performance picture worsens dramatically once you take into account expenses, which largely wipe out the benefit of skill in the best managers. You can guess what it does for the rest of the mutual fund manager crowd. Anyone looking for skilled managers needs to recognize that identifying skill isn’t enough. The challenge is identifying managers whose skill outweighs whatever fees they charge investors.

6. Different catalysts rule the market in the short-term vs the long-term

Howard Marks says it well: “In the long run, there’s no reasonable alternative to believing that good decisions will lead to investment profits. In the short run, however, we must be stoic when they don’t.” We live in a world filled with randomness, and recognizing this is an important step in dealing with our investments in a more measured and mature fashion.

7. Confirmation bias hurts us more than we could imagine. “On a subconscious level, we simply never perceive information that may not fit with our worldview.”

8. “You may think you’re able to filter the noise. You cannot; it overwhelms you. So don’t fight the noise—block it.”

9. Momentum investing works because it is psychologically hard to apply

Momentum works because it calls on investors to do things that do not come naturally. Momentum strategies require investors to buy things that have already increased in value and are trading near their highs, not their lows. Successful momentum strategies also have strict and well-defined selling, or switching, strategies. Both these pieces of the momentum puzzle are difficult for investors to master.

10. Value investing works because it is also psychologically uncomfortable to practice:

This is a more challenging task than simply buying stocks that are statistically cheap. Swensen writes, “In many instances, value investing proves fundamentally uncomfortable, as the most attractive opportunities frequently lurk in unattractive or even frightening areas.”

Howard Marks writes: “To boil it all down to just one sentence, I’d say the necessary condition for the existence of bargains is that perception has to be considerably worse than reality. That means the best opportunities are usually found among things most others won’t do.”

Source: Viskanta, Tadas (2012-03-30). Abnormal Returns: Winning Strategies from the Frontlines of the Investment Blogosphere,  McGraw-Hill. Kindle Edition.

Back in January this year, most people disbelieved the rally and were very cautious. The second half of 2011 was the definition of a trendless, high-volatility, choppy environment and over time it conditioned most of us to be very nimble and take profits quickly. Most breakouts failed, mean-reversion from overbought and oversold reading worked almost flawlessly.

As the bull market climbed a wall of worry, more and more people started to figure out that breakouts are actually working and delivering solid results.

In bull markets, corrections happen under the surface and take the form of  sector rotation. When financials and tech took a breather, biotech and consumer discretionary took the leading role and the indexes barely budged. All dips were a great buying opportunity in hindsight. Somewhere along the way, people realized that instead of jumping from a setup to setup, they might be much better off just riding three or four strong stocks.

The market has been really accommodating in the first 3 months of the year, to a point that it created complacency. Naturally, when a shift in a character came, most people were slow to react.

We entered a choppy, high volatile environment, where many breakouts will be short-lived. We will see stretches of several red days followed by a pocket of green days that will continue long enough to confuse everyone.

Recency or our tendency to  pay enormous attention to the most recent price action has huge influence on our psychology. A few red days in a row and everyone turns bearish and give up positions bought on a dip, just before the market is ready to bounce. A few green days and everyone thinks that all is well and new highs are on the horizon. Don’t judge the market based on one day of market action.

Trednless markets could be very stressful to those who don’t notice the change of market character and rethink their tactics.  Stress leads to overtrading and the latter is a really dangerous endeavor in a choppy market environment. Overtrading leads to losses and losses lead to a loss of confidence, which is the last thing you want to happen to you, because your decisions will be ruled by fear and not rules.

Greed and fear often trump experience. The choices we make every day define the quality of our  lives. We are in the business to make money, not to make trades.

Choose wisely. Do less.

The trading world is different. It is an environment, where last impression is often the strongest and has the biggest impact on decision making. We put tremendous weight on the short-term price action, while it often represents just noise. Because it’s easier, we’re inclined to use our recent experience as the baseline for what will happen in the future. We project the most recent events into eternity and make unwise decisions.

We strive to know everything about everything and make sense out of every move, even when it is a garden variety of noise. Sometimes we forget to take a step back and see the big picture. Zooming out helps to curb the frustration and clear the head.

If you intend to be in this business long time, you have to find a hassle-free way to manage your portfolio. Howard Lindzon has found it by focusing on longer-term social and business trends that are confirmed by price action. Brian Shannon has found it by focusing on day trade setups and being 100% in cash at the end of the day. Joe Fahmy has found it by timing his market exposure and swing-trading stocks with solid technicals and fundamentals. There are different paths to achieve the same goal.

Not everyone is willing to put the time and the efforts needed to define himself and focus on a specific approach. One of the lines from the original Market Wizards book that has remained vividly in my head comes from Ed Seycota. On the question, what would you recommend to the average trader, he replies: “Find a superior trader to manage his money for him and then find something he loves to do.” The trouble is that it is much harder to find a superior trader who will want to manage your money than to learn how to be consistently profitable yourself. Just because someone sounds confident, doesn”t meant that he will be able to deliver.

The U.S. stock market is oversold on various measures, which doesn’t mean that it can’t become more oversold as nothing brings fear as fast declining prices. The silver lining of this correction is that we are entering earnings season with reduced expectations, which has usually been a good predisposition for positive surprises.

Even if there is a short-term bounce coming, we have entered a period of choppiness, where mean-reversion trades are likely to work better than breakouts.

$GLD rallying with $TLT is bearish for stocks. Once you see gold selling off along with the equity market, then we would be much closer to a “forced liquidation” period, which has historically provided great entries for long-term investors.

JPMorgan ($JPM) and Wells Fargo($WFC) report this Friday and the reaction to their earnings will reveal a lot about the near-term future of the stock market.

For example:

- I want to grab that stock on a pullback to its rising 50-day moving average and then do nothing when the moment comes;

- I will buy this stock when it breaks out of this range on volume and when the time comes you don’t buy it, because the stock jumps 5% the minute it breaks to new high. You wanted to pay $50.25 and at $52 suddenly seems expensive. Then you watch it go to $60;

- I will short the crap of that stock when it loses that $100 support, but when it does, you don’t do anything;

- I am not going to chase that stock here. It is too extended and the risk to reward is not worth it and yet you still buy it because everyone you know is making tons of money in it;

- I will stick to my hard stops next time…

Most market participants have incredibly short-term memory. Greed and fear have the power to erase even the most well thought out plan and make the smartest people behave silly.

Ignorance is not the main hurdle. A lot of people have excellent understanding of how market works and what their biases are, but yet very few are able to put that knowledge into practice. It is the difference between knowing how to lose weight and doing it, but 10 times harder. This is why so many successful people are not afraid to share everything they know – the “secret” to their success. Most people will never put the efforts and the time to consistently apply that knowledge in their everyday trading/investing process. It is human nature.

Markets could be as complicated as you want them to be. There are some ways to make sense out of the insanity:

1) Bull markets are markets of stocks. Most stocks will appreciate in a bull market, but some will go up much more than the average. Stock-picking skills matter a lot under such circumstances.

2) Bear markets are stock markets. Correlation is very high and most stocks move together up and down, disregarding of fundamentals. Stock picking is irrelevant here.

3) Bear markets make long-term investors a lot of money. Forced liquidation brings down prices to drastically low levels, to a point that some reasonably sound businesses are priced for default. Those are the type of stocks that become the best performers once the market turns north. Look at the Sleep Index, which is up 7000% for the past 3 years.

4) Mean-reversion works, but what is your time-frame of operation. We all suffer from recency bias. This is why when an asset goes from $100 to 70$ in a month, it suddenly seems “cheap”. When an asset goes from $20 to $30 in a month, it suddenly seems too expensive. Our brains are wired to think in terms of mean-reversion, but the trouble is that we also expect instant gratification for our actions and mean-reversion works best in long-term time frames. What seems too “cheap” could easily become “cheaper”. What seems expensive could easily become “more expensive”. Irrationality often trumps patience and solvency.

5) Only price pays. No matter how smart you are, how sophisticated your market approach is and how great your investment thesis is, unless the rest of the market agrees with you, you won’t make a cent.

6) Trading is like dating. You should only keep the stocks that make you happy.

7) Never Say Never. Being wrong is not a choice, staying wrong is.

8)  You are your own biggest enemy. Intelligence helps to realize what  needs to be done to be successful in the market, but it doesn’t guarantee that you will be able to apply that knowledge in practice.

9) The press will never run out of negative headlines. Fear sells best. There is always something to worry about, but you should never worry about something that doesn’t depend on you.

10) Sometimes, short-term price moves are just nonsensical noise, designed to make you second-guess yourself and shake you out of well-thought out, reasonable positions. Stick to your plan.

The S & P 500 has doubled for the past 3 years, but there are stocks that have done decisively better. Boring companies, selling mattreses, reclining chairs and sofas. I like to group them under the hood of “The World Looks for a Better Sleep” label.

In spirit of the immortal words of Gordon Gekko: Sleep is Good

The point is, ladies and gentleman, that sleep, for lack of a better word, is good. Sleep is right, sleep works. Sleep clarifies, cuts through, and captures the essence of the evolutionary spirit. Sleep, in all of its forms has marked the upward surge of mankind. And sleep, you mark my words, will not only save Teldar Paper, but that other malfunctioning corporation called the USA. Thank you very much.

The five stocks in the group: $SCSS, $TPX, $CPWM, $PIR, $LZB have returned on average 7000% for the past 3 years. $10,000 invested in an equal weighted Sleep Index in March 2009, would be worth $700,000 today.

Sleep sounds great as a concept, but it doesn’t represent the whole story behind the gigantic moves. Rising expectations for home improvement spending  and housing recovery are also big catalysts behind the move. As long as expectations rise, prices rise.

Sometimes, the most boring stocks, no one is talking about become the best performers.

Keep in mind that those stocks are highly cyclical and every 6-7 years tend to go from a boom to bust mode.

There are varisous ways to gauge the health of the market and get prepared for its next move:

- breadth (number of stocks on the 52week high list, percentage of stocks above their 200dma…);

- leading sectors (tech and financials and consumer discretionary have led this rally. Probably they will be the ones to go first too, when the market benchmarks turn south);

- asset classes correlations (is money flowing to the perceived safety of treasury bills and notes or to equities and high-yield bonds);

- sentiment (extremes are contrarian indicators).

These are all valid and potentially useful approaches, but there is one that I put first at this point of time. The price action in liquid, high-ticket stocks. Here is why.

$XLK (technology) is already up 19% YTD, $XLF (financials) is up 22%, $XLY (consumer discretionary) is up 15%. If you haven’t been at least 70% invested in U.S. equities, the odds are that you are underperforming. By mid March, many money managers realized that they were exactly in that precarious situation. As usual, there was only one cure for their ills – high-ticket stocks. Stocks like $AAPL $PCLN $GOOG $ISRG $CMG. Only they provided the needed liquidity to get meaningful quick exposure to equities. And they were bought.

Many of the mentioned names are extended for sure, but it is never wise to guess a top and jump in front of a freight train during a bull market. Irrationality (aka good mood and liquidity) often trumps the patience of even the most stubborn ones. Sometimes unnecessary sophistication leads to overthinking and underperformance as often being early means being wrong.

At this point, almost any institution owns some if not all of the above mentioned high-ticket stocks. They are my leading indicators. If I see any signs of churning (high volume and little price progress) or distribution (several negative big-range, high-volume days) in them, I will seriously reconsider my current view of the market.