Hello reader, welcome to the latest issue of HX Weekly!

Each week we bring you a new edition of HX Weekly that includes three distinct sections.

In the first section, Thoughts on the Market, we'll offer insights into current economic and market news or timeless insights.

In the second section, HX Daily Redux, we'll revisit investing concepts, tactics, and more from past issues of HX Daily.

And in the third section, Market Wizard’s Wisdom, we’ll share thoughts, quotes, and theories from the greatest investing minds of all time.

Now, let's dive in!

Thoughts on the Market

Lose to Win – Part II

Those readers who are familiar with my story know that I have a long history with Nevada and gambling.

Now, I have never lived in Nevada nor am I much of a gambler – ha ha!

My parents met in Reno, Nevada and my father then went on to live in Las Vegas and Reno for almost 30 years.

Over that time, he was a “professional gambler.”

I use quotations because it WAS his occupation. I don’t think it was a profitable one, but it was he something did every day…

On my end, I have never been much into gambling because my view is that working in the stock market gives me enough excitement every day.

The one game, though, that does interest me is BLACKJACK.

The reason is simple: it is the most mathematical of the bunch and offers the best odds.

The basics are that casino blackjack has set rules.

With those rules in place and the set nature of distribution of cards in a deck, a knowledgeable player will always know what is the BEST ACTION to take when the cards are dealt.

If you play “perfect” blackjack, then the house edge is about 0.5%.

Mathematically the casino wins 49.1% of the time, you win 42.4% of the time and 8.5% of the hands end up in a tie or “push.”

Now this doesn’t mean those odds play out every time.

The reality is that this is what would happen if you played blackjack across an infinite number of hands and played perfectly.

Across a shorter number of hands, the outcome can be much different.

A perfect example is what happens when you have one of the strongest hands out there – a “20” against a dealer “6”.

The proper strategy in this situation is to hold. Doing so gives you an 80% chance of winning.

Those are great odds!

Think about that, though – even with one of the BEST hands in the game, you STILL have a 20% chance of losing.

The analogy for trading and investing is important.

Our goal is to try to find the highest probability set ups in a trade.

The combination of technicals, psychology, fundamentals, and catalysts that give us the best chance to win.

Even when you have all of that lined up, though, you can still lose.

It might be because the market sells off. It might be because of an “exogenous” event like a war or anything Trump might do!

Or it might just be that you ended up being wrong in your analysis.

This concept of the possibility of losing is extremely hard for investors to handle.

Especially when you must accept that it is INEVITABLE across a big enough population of decisions.

We wrote a note about the psychology necessary to deal with this investing and we share it below.

You need to embrace the concept that even your BEST investment bets can fail, and be prepared to react.

Another concept is how to think of your portfolio as a number of hands of blackjack.

We recently sold roughly 40% of the PUT OPTIONS we had bought in one portfolio.

We bought those put options because we thought the underlying stocks were going to go down. We thought they were high probability bets.

They all were related to a belief that the enthusiasm about AI infrastructure had been excessive in the share prices.

The fundamentals remained good, but the stocks were ahead of themselves in a major way.

This created a high probability of a pullback and why we made the bets.

When we sold three of the eight positions, we chose the ones we thought had seen the most damage and had realized the most upside.

The reality, though, is we don’t know for sure.

In fact, we think that all the positions still have nice upside from current levels.

Why close out almost 40% of the positions then?

Let’s go back to blackjack.

Even if we are sitting on eight bets that were high probability, there was some still some possibility we would lose.

Here is a graphic showing these eight bets as “70% chance to win” blackjack bets…

The graphic goes through the math of the blackjack table.

The math of the stock bets is driven by distinct factors.

That probability is driven as much by what is going on with the markets and their industry as it is by what is happening with the individual companies. With this bet, we think it is even more driven by it.

Although we think the move has further to go (and is a high probability bet), we don’t know for sure.

So, we take profits on a portion of the bet to lock in some gains.

We honestly think that all eight of the bets will pay off, but prudent “money management” dictates we lock in some gains.

This is the same tactic that you do in blackjack.

“Gambling” isn’t what you want to be doing in the stock market, but the rules that make you a better gambler ALSO make you a better trader.

Building on the blackjack framework above, this second note digs into the emotional and practical reality that losses are not a sign of failure—they are an inevitable feature of any edge-driven process. Originally published December 13, 2024.

HX Weekly Redux

Lose to Win - Part I

As Warren Buffett once said, investing (and trading) is “simple but not easy.”

One of the most challenging skills for new traders is recognizing that losses are part of the process. They will happen in any strategy; a loss does not reflect your trading skill.

Losses – and taking them appropriately – are a good sign. Trying to avoid them at all costs is also a way to almost certainly NOT make money.

As many of you know, my parents met in Reno, Nevada. My mother, at one time, worked as a "cigarette girl" in a casino (that was a thing), and my dad was a professional gambler for many years. Since an early age, I have been surrounded by gambling and fascinated by probability.

My favorite game is blackjack. What I like about it is that there is a well-defined strategy. Depending on what cards you are dealt and what the dealer is showing, you know exactly what you should do next.

Play "perfect" blackjack, and you will still lose. Obviously, it is better to be the casino! But you know your odds, especially when looking at any particular hand.

Even when looking at a "can't lose" hand, you still CAN lose. This is what probability is all about. You want to bet – or bet more when you have a high chance of success, but that still signifies you have a chance of failure.

Successful players aren't happy to lose, but they understand it is part of the process. They don't get upset or take it personally. They simply move on to the next hand.

You can always identify the novice player at the table as the one who throws their hands up when they lose. They also blame other players for “taking their cards” if they hit and get a card that wouldn’t help.

They are emotional and don’t understand the fundamental math behind the game. They also are never sustainably successful.

We recently read a fascinating insight. Few traders or investors talk about how they handle losing, but we see plenty bragging about their successes—especially younger investors.

Now there are a few out there – like Steven Burns and Mark Minervini – that do a great job of talking about handling losses. Most of the “noise,” however, is coming from braggarts showing off their winnings.

This isn’t helpful for your own process or future success.

It is the very nature of trading that you will have losses—many of them.

If you have a strategy targeting very high returns, you will likely have significant losses. You can't have one without the other.

It hurts our ego to focus on our losses. It doesn’t make us feel good. Remember that we feel negative feedback at a ratio of eight times greater than positive feedback. Dissecting our losses is one of the most complex parts of improving as a trader. It is also one of the most important.

The key to losing is figuring out how to manage your losses. Keep them small. Know which ones to take and when to take them. Managing your losses is much more important than managing your gains.

Newer traders often will not pull the trigger because they are waiting for the "perfect" situation. They aren't willing to take a loss. Most often, this results in them failing to make any gains.

Remember the old NY Lotto slogan – “You can’t win if you don’t play!”

One of the greatest traders of all time – Jesse Livermore – would often start a trade with a small amount of capital. Then, if the idea worked out, he would put more money into the trade.

This is the strategy that powers the capital allocation process of the largest and most successful multi-strategy hedge funds. Funds you have heard of like Citadel and Millenium.

We think this is a strategy that can also work for novice traders. Start small and see if it works. If it does, add more; if not, take the loss and move on. The loss will be small.

The purpose of investing is to make the gains, but the key to success is learning how to take the losses.

In 1949 one man quietly invented the modern hedge fund—and a multi-trillion-dollar industry.

Alfred Winslow Jones’s radical ideas on shorting, risk, and incentives still shape how professionals manage probability today. His story is the perfect historical bookend to the risk-and-position-sizing lessons in the two notes above.

Market Wizard’s Wisdom

The Story of the FIRST Hedge Fund

Our readers are a mixture of a broad spectrum of investors.

Some of you are experienced money managers who manage (or have managed) billions of dollars, while others are just beginning their investing and trading careers.

At HX Research, we try to write our publications in a way that is educational and informative for all readers.

No matter where you are on the spectrum, we are sure you have heard the term "hedge fund."

The term initially referred to funds that could use a variety of instruments to help "hedge" their investments. This means they might try to remove some of the risk from their portfolio by using other securities.

Today, the term has expanded to refer to many different types of funds that employ many strategies. For the most part, it simply refers to funds that have flexible strategies.

Do you know the story of the FIRST hedge fund?

That fund was established in 1949 by Alfred Winslow Jones or A.W. Jones.

After graduating from Harvard and Columbia and serving as an editor at Fortune magazine, Jones became convinced that he could do as well as the professional investors he wrote about. He established his fund with initial capital of $100,000, including $40,000 of his own money.

Jones decided to do something entirely different from his contemporaries when establishing this fund.

In his strategy, he decided that his fund would also go “short” stocks. This would allow him to take advantage of share price declines.

It would also allow him to be “hedged” and remove some stock market risks from his portfolio. That would allow him to focus on the specific idea that he owned and not have to worry as much about the market.

This all sounds very ordinary today, but back then, it was revolutionary.

While short-selling strategies were associated with some speculation (and stock manipulation), respectable professional investors did NOT employ them.

The view was that a short was too risky a strategy because there was an infinite risk to the downside (a stock could go up an unlimited amount).

Jones had the novel idea that if stocks were shorted intelligently and in a diversified manner, he could REDUCE the risk of his strategy.

Jones also revolutionized several other concepts. He began to examine a stock's volatility to understand how it might impact his portfolio. He called this “velocity,” and his staff charted it by hand.

He also began to look at how a stock traded relative to the overall stock market. He called this relationship the “relative velocity.”  We now call it the “beta” of the stock relative to the stock market.

There were many other innovations beyond these.

He understood that having information before other investors could be an advantage. He would have his staff physically go to the offices of the Securities and Exchange Commission (SEC) to read new filings right as they were released.

As a private partnership, he pioneered a novel fee structure. He structured his fund so that it avoided the Investment Company Act of 1940, which allowed him to be paid out of his profits.

This structure more closely aligned the manager's success with that of his clients. It was also relatively expensive for investors, but it attracted the best and brightest to the strategy.

By thinking independently, Jones could utilize strategies that gave him an advantage over his competitors. In doing so, he established a tremendous track record. A $10,000 investment in his fund at its inception in 1949 was worth $480,000 two decades later. He lost money in only three of his thirty-four years managing money.

After thirty-five years of managing money, Jones turned his fund into a "fund of funds.”  This is a structure where instead of investing directly into stocks and other assets, they invest in other hedge funds.

I am proud to say that his fund invested in several of my hedge funds over the years.

You may not be familiar with A.W. Jones, but his novel approach helped change the face of investing and created a trillion-dollar industry.

We hope that you’ve enjoyed this week’s issue of HX Weekly…

Do you have any thoughts, questions, or feedback? Tell us more in the comment section or at [email protected].