My Philosophy


Order Flow

Before I discuss my two methods of analysis I want to discuss order flow. Order flow is simply the net buying or selling pressure on a particular security. Or better said, who has control(buyer or seller) on the time frame you are trading on.

In order to win, you have to be on the right side of the order flow. That may sound obvious but it is quite different than most people think. It has nothing to do with how well you analyze a business. 

Here is an example:


In the example above, the sellers could not maintain control below the $180 level. In other words, the ORDER FLOW went from offer to bid below the $180 level.

I believe a common mistake for individuals and professionals alike is to wait for confirmation. 

If you wait for the fundamentals to improve you will likely have to pay up. In this instance, the "good news" came when the stock was trading above $280, over a hundred dollars from the $180 level.

I'm not saying fundamentals aren't important, but this newsletter will focus on getting on the right side of the order flow, regardless of how the fundamentals look at that moment in time.

My ability to forecast the future earnings of a business, especially in the tech space or sectors where technology is disrupting, will not provide you with a sustainable edge.

There are generally two methods of analysis that investors use to judge the attractiveness of an investment.

One is fundamental, which involves analyzing revenues, earnings, return on equity, future growth prospects, etc to determine a company’s underlying value and upside potential.

The second method is technical analysis. This usually involves some form of analyzing chart patterns, supply and demand levels, oscillators, and a dozen other tools that varies with each investor.

There are proponents of both methods who feel strongly that one is better than the other, but I won’t get into that right now.

I think both are valid and useful. My primary method when scouting for ideas is to look at charts. Charts are my first filter, as I can scan a chart quickly and within a second know if an idea is worth pursuing. 

Let me state. I do not think charts or chart patterns predict the future, as some say. They are just a tool. They are a pictorial representation of the price of a financial security over a certain period of time, that’s it. 

The ability to to use them and gain an advantage by using them is an art. Some are better than others, just as some are better at analyzing financial statements than others.

I don’t do deep dives on fundamentals. I keep it simple. I am not going to gain an advantage by doing a thorough analysis of financial statements.

I do, however, like to think about the qualitative factors of an investment, because occasionally you can have an insight.

In the end, I will go with the chart as long as the probability of loosing my entire investment is close to zero.

When thinking about fundamentals, I use three frameworks. I borrowed these from Warren Buffett, Peter Thiel, and Howard Marks.

Warren Buffett wrote in his 1991 shareholder letter the characteristics of an economic franchise. He stated the following:

An economic franchise arises from a product or service that:
1. Is needed or desired.
2. Is thought by its customers to have no close substitute.
3. Is not subject to price regulation.
The existence of all three conditions will be demonstrated by a company’s ability to regularly price its product or service aggressively and thereby to earn high rates of return on capital. 
Moreover, franchises can tolerate mis-management. Inept managers may diminish a franchise’s profitability, but they cannot inflict mortal damage.
In contrast, “a business” earns exceptional profits only if it is the low-cost operator or if supply of its product or service is tight. Tightness in supply usually does not last long. 
With superior management, a company may maintain its status as a low-cost operator for a much longer time, but even then unceasingly faces the possibility of competitive attack. And a business, unlike a franchise, can be killed by poor management.

Thinking about an investment through Buffets ‘s framework is helpful in framing the qualitative aspects of a business.

I made a google sheet to help you walk through these qualitative considerations. I used Under Armour as an example.

Click here to access. Preview below.

Peter Thiel wrote a book- “Zero to One”. In the book he discusses the 4 characteristics of a monopoly.

1. Proprietary Technology–Is your product or service difficult or impossible to replicate? How hard would it be to build a better search engine than Google? Or offer more products at lower prices with faster delivery than Amazon?

2. Network Effects–Does your product or service become more useful as more people use it? If all your friends are on Facebook, does it make sense to choose another social network?

3. Economies of Scale–Does your business get stronger the bigger it gets? The fixed costs of creating a product can be spread out over greater quantities of sales. 

4. Branding–Built overtime by the ability of a company to deliver a product or service that, in the customer’s mind, is special and consistent. 

Most businesses will not have all these characteristics if any, however, the ultimate winners in a given vertical will likely have multiple.

Those are the companies you want to own and more importantly, hold onto[the hard part].

Howard Marks wrote this diagram that explains how to achieve above average returns.

What most people don't realize is that being in the "right, consensus" box will lead to average returns. You can own Apple, Amazon, and Facebook, but if everybody else owns them, you will do no better than them.

In this box all the returns are arbitraged away.

To do better than average you must assemble a portfolio that is d/f than other market participants.

BTW, owning Apple, Amazon, and Facebook were all non-consensus at one point in time.

It is easy to understand the concepts above, but executing them is an art. Investing is not an exact science.

The world changes, new technologies arrive and destroy old business models, people’s preferences change, and a dozen other variables can affect an investment’s competitive advantage.

As an investor, you must be willing to adapt and change your mind. It is one of the great skills you can learn. I don’t believe it can be taught. I think it is an experience an investor must go through and hopefully learn from.

I won’t have all the answers, as new information comes in, I will have to re-evaluate, and sometimes, I will be wrong. That, however, is part of investing.

For leveraged products, such as futures and forex, I strictly use technical analysis. I have found that trying to predict macro trends is a fool’s errand, at least for me. 

They key to investing in any asset class is to wait for the right pitch. I believe you can gain an advantage over others just by lengthening your time horizon.

There won’t be good ideas every day or every week. Most of the time they come around once a month and when they come you have to act aggressively.

I leave you with a quote from Charlie Munger. This quote is at the core of my investment philosophy.

It’s not given to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it — who look and sift the world for a mispriced bet — that they can occasionally find one.

And the wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time they don’t. It’s just that simple.
— Charlie Munger

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Caleb Dismuke

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