Stuart Walton – Back from the Abyss – Investor Profile

---

This article is part of our ‘Guru’ series – investor profiles of those who have succeeded in the markets, with takeaways for the private investor in the UK.

You can find the rest of the series here.

---

Stuart Walton

Stuart Walton features in Jack Schwager’s book Stock Market Wizards. Apart from that interview, I haven’t been able to find out much about him. I don’t even have a photo.

Walton wound up his $150M hedge fund in 1999, under the strain of a marriage breakup. Over the previous 8 years, he returned an average 115% annual compounded return (92% net to his clients).

Before that, he had quit once before and had almost gone bankrupt.

Walton is from Canada and originally wanted to be a cartoonist, and then a journalist. He became disillusioned and took an MBA, planning to work in advertising.

But he graduated in a recession and had to take a job in banking. By chance, he was assigned to an FX trading team while training in New York. He didn’t initially take to either trading or to Americans.

---

Equities

Hearing he was about to be transferred home, and not wanting to leave his future wife, Walton transferred to another job which offered a green card. He was placed on the equities desk.

He borrowed money from his father to place his first trade in the stock of the company his wife worked for. It went up, which in retrospect was not good, and he sold.

The worst thing you can do as a beginning trader is to have your first trade work.

Three weeks later, he had lost all of the money his father gave him, by acting on tips from others.

It took him five years to pay his father back. His wife’s company’s stock quadrupled in the meantime.

---

Bonds

Attracted to the civility of the bond desk – and the large size of the trades – he switched. He didn’t so much like trading overseas illiquid issues in the middle of the night (Japanese hours).

At this point, Walton had no system and went on gut instinct. He was bailed out by a bull market in bonds and was promoted.

But he became frustrated with the lack of liquidity in the bond markets, feeling that he was investing rather than trading.

---

Canada and San Francisco

He moved back to Canada to trade liquid Canadian government bonds. But by now he couldn’t take the country club atmosphere in his home country.

After seven months he quit, by coincidence on the same day that his wife quit her job. They took six months off to travel the US together.

They next moved to San Francisco on the promise of jobs that fell through. Over the next six months, they ran out of money before Walton’s wife got a junior position in retail sales.

Finally, Walton got a job at a regional brokerage firm as an institutional stockbroker, but with no existing accounts. So it was cold-calling third-rate institutions to push lousy stock ideas.

He didn’t have a single account or make a single trade for eight months.

---

The low point

Bored, he took out a home-equity loan and began trading on his own account. He told his wife the money would be in dividend stocks returning more than the loan interest.

Within three weeks he had lost 75% of the loan shorting winning stocks and buying losers. Again he was listening to tips from others.

Eventually, he put everything he had left, leveraged at 200%, into Commodore Computer – another tip from a buddy. The stock went from $10 to $17 and Walton got out. He was back in business.

The stock went to $24 before falling to $0 as the company went bust.

---

No more tips

Walton admits it was luck and feels that all the pivotal points in his life have just worked out somehow, perhaps because of luck.

But he knew it was luck, and slowly weaned himself from tips. He still has the gambling urge and the vulnerability to tips, so he copes by keeping a small separate fund for speculative trades.

Schwager notes that Walton has no assistants apart from a part-time secretary. Because he feels that he had often gone wrong by listening to the tips and opinions of others, he now prefers isolation.

He became determined to find out why stocks really went up. He started to buy good companies – ones with good relative strength to the market – and sell bad ones, the reverse of his previous approach.

The hardest thing to do is to buy a high-flying stock or to sell a stock that has gone down a lot, but … the hardest thing to do is the right thing to do.

---

Blessed stocks

Walton believes that some stocks are “blessed” by the market, and he looks for those.

Walton believes that identifying  a good stock is:

• 25% fundamental
• 25% technical – he likes a linear price movement, and smooth progress through round numbers (eg. $10, $20 stock price)
• 25% about reactions to news – moving higher on good news, coping well with negative news
• 25% market direction, which for Walton is partly gut feel, based on how the market is reacting to the news

---

Trading style

1. Walton holds a stock usually for just a few weeks. This may be a weakness since many of the good stocks continue to go up. Often he will buy back in at a higher price.
2. He sells when a stock has gone up a lot in a short time, or if a stock seems to be running out of steam.
3. He is happy to use momentum or value, depending on what is working in the markets at the time.
4. He feels that the big opportunities are often obvious. But they don’t happen very often, so you have to not lose money while you wait for the next one.
5. Walton handles a losing streak by trading smaller.
6. He doesn’t believe in visiting or talking to companies.
   • He did this a lot when he was working for the investment advisory firm.
   • Either they told him what they had told everyone else, and it was already factored into the price, or else they lied.

Buy on extreme weakness and sell on extreme strength. Get a feel for the sentiment, whether it is euphoria or pessimism.

---

Selling to managing

Walton became a successful stockbroker by learning to tailor his sales pitch to the optimistic story that clients were looking for.

He began pitching ideas from his own account to his clients and was eventually hired by one of them to manage money for them.

He was constrained by the firm’s investment criteria:

• PE below 15
• earnings growth of 20% pa
• balance sheet and liquidity conditions

Walton felt these requirements were a “huge impediment”. He couldn’t buy “expensive” market leaders like Microsoft or Cisco.

This means that his corporate account grew at only 15% to 20% a year, while his personal account grew at more than 100% pa.

When he had enough capital – around $650K – he found a matching amount through word of mouth and set up his own hedge fund. At the time of Schwager’s interview, the $1.3M had grown to $150M.

Walton had no intention of growing the fund faster than its organic gains. More assets to manage would be a burden.

Any stock can go to zero, and you need to realize that.

Someone who has never made a mistake is dangerous, because mistakes will happen.

---

Trading rules

Walton thinks that most successful traders are unemotional, hardworking, and disciplined, but that he is none of these.

He puts his success down to conviction about gut feelings and the ability to act on them.

That said, he has a long list of trading rules:

1. Be patient–wait for the opportunity; never trade impulsively, especially on other people’s advice.
2. Trade on your own ideas and style.
3. Don’t risk too much on one event or company.
4. Stay focused, especially when the markets are moving.
5. Anticipate, don’t react.
6. Listen to the market, not outside opinions.
7. Think trades through, including profit/loss exit points, before you put them on.
8. If you are unsure about a position, just get out.
9. Force yourself to trade against the consensus.
10. Trade pattern recognition.
11. Look past tomorrow; develop a six-month and one-year outlook.
12. Prices move before fundamentals.
13. It is a warning flag if the market is not responding to data correctly.
14. Be totally flexible; be able to admit when you are wrong. You will be wrong often; recognize winners and losers fast.
15. Start each day from last night’s close, not your original cost.
16. Adding to losers is easy but usually wrong.
17. Force yourself to buy on extreme weakness and sell on extreme strength.
18. Get rid of all distractions.
19. Remain confident — the opportunities never stop.

Lessons

Walton’s story is an unusual one. He seems to have a gambling problem or at least a susceptibility to other people’s ideas, that almost bankrupted him.

But finally, he learned to control this and developed his own system. He describes this as including a lot of gut feel, but from the outside, it looks a lot more systematic.

Schwager identifies five key lessons:

1. Persistence – Walton did not let multiple failures stop him.
2. Self-awareness – he realized his weakness and fixed it.
3. Methodology – he became successful when he developed his own market philosophy and methodology.
4. Flexibility –
   • he switched from selling strong companies and buying weak ones to the opposite;
   • he’s also willing to use either value or momentum depending on what is working;
   • he will buy back into a stock at a higher price if he thinks that its prospects have improved;
   • he’s happy to sell below his buying price
5. Diagnostic capability – Schwager sees this as Walton’s talent
   • using the same information as everyone else, Walton has a clearer insight into the market’s probable direction

The first four of these are “easily” adapted by the private investor, the last one less so.

In addition, I would highlight a few of Walton’s trading rules:

1. Trade on your own ideas and style.
2. Don’t risk too much on one event or company.
3. Think trades through, including profit/loss exit points, before you put them on.
4. If you are unsure about a position, just get out.
5. It is a warning flag if the market is not responding to data correctly.
6. Get rid of all distractions.

These are rules we can all benefit from.

• Until next time.

---