How To Trade Like A Samurai

This past weekend, we began watching a new series on Hulu based on the 1975 James Clavell book “Shogun”. We remembered the original TV series from back in 1980 and have to say this new one doesn’t disappoint.

It got us thinking about one of the first notes we published when we joined Empire Financial Research a half-decade ago. That note is still just as relevant today.

Here it is…

For those of you who have followed me for years know, we spend a lot of time thinking about human behavior and psychology and how these relate to investing.

One of the most influential things I ever learned about psychology came from a book I read about Japan while studying as an undergraduate student at the University of Pennsylvania.

Growing up as a teenager in the late 1980s, Japan was the place to be. The country's economy was booming, and people bought every piece of real estate they could.

Japan even began to seep into U.S. pop culture... For instance, legendary comic book writer and film director Frank Miller incorporated many elements of Japanese culture in his Daredevil comic book series.

As a 17-year-old, I became enamored with everything related to Japan – from ninjas to comics to sushi and everything in between.

Naturally, this played a significant role in my choice of college majors... So, in addition to majoring in finance at the Wharton School of Business, I decided to double-major in Japanese.

The Japanese major required the most credits of any major at Penn. In addition to the language classes, it immersed us in the country's culture and literature.

Of everything we read, the work that resonated most with me was Yamamoto Tsunetomo's classic book from the late 1600s, Hagakure: The Book of the Samurai.

The book is somewhat controversial because it was considered one of the underpinnings of the fascist regime of Japanese army general Hideki Tojo and Japanese imperialism.

Tsunetomo wrote the book when traditional samurai culture was being suppressed. Critics argued that the book represented a nostalgic view of samurai culture rather than a realistic one. Despite the controversy, it's still a fascinating read that distills the psychology of intensely violent periods in human history and how we deal with the psychological stress of conflict.

The most important concept from Hagakure is the idea of "living as though one was already dead." In short, this meant that being an effective warrior required a mindset where you believed you were already dead – and therefore, you wouldn't fear death.

This allowed samurai warriors to act freely and rationally during combat, which improved their mental clarity and reduced their chances of dying.

You can use This compelling idea to become a much better investor. Let me explain...

As you go to buy a stock, you decide how much of your portfolio to put into it, based on several factors (liquidity, earnings growth, potential catalysts, etc.).

But as I've written before, as investors, we buy stocks, not companies. Stocks have far more volatility than their underlying businesses do. In other words, while the value of the business may not fluctuate a lot, the stock can.

It stands to reason that if the stock you buy goes lower – assuming there's no real change in the business fundamentals – you should make it a more significant position. (This is the reasoning behind the principle of "buy low, sell high.")

Do you usually buy more of a stock in your portfolio when it goes lower? Tell us more about your strategy in the comments section at the bottom of this post.

"What the heck do samurais have to do with all of this?" you might be wondering.

If you go into buying a stock with the mindset that you've already lost money on it – in other words, that you're living as though you're already dead – then if it falls, it won't feel nearly as bad.

This type of thinking is essential when it comes to volatile stocks. Remember, volatility cuts both ways: Seldom will a stock have the potential to go up 100% (or 1,000%) without falling 30% (or more) at some point. That's why it's critical to make speculations like these with a more minor position in your portfolio rather than with big, stable blue-chip stocks... It helps you manage your emotions.

You can make better investment decisions by accepting the possibility of failure and thinking like a samurai.

Check out Enrique Abeyta’s conversation with Whitney Tilson on the HX Podcast.