BookWatch: Here’s the stock-market trade this hedge-fund star is most excited about right now

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Who’s got a subscription?

Larry Hite is a long-time successful hedge-fund manager who doesn’t believe he — or really anyone — can predict what the stock market (and other markets) will do next, or which seemingly successful companies will suddenly crash. (Just remember Enron, he says.)

Nor does he care much for Wall Street’s standard buy-and-hold advice for small investors.

Rather, the 78-year-old has become fabulously wealthy using computer programs to detect and follow price trends — and by following one simple rule: cutting his losses early. He founded Mint Investment Management Co., and the composite of funds achieved a compounded annual rate of return above 30% before fees during his 13-year run there. He now runs Hite Capital, a family wealth management firm.

“I love making money,” he says.

Hite expounded on his approach to investing in his new book, “The Rule: How I Beat the Odds in the Markets and in Life―and How You Can Too.” He discussed his investment style, a current trade and some of his best and worst trades in an email interview with MarketWatch.

Question: Which of your current trades are you most excited about?

Answer: I’m interested in stocks that went from selling software to subscription models. Companies with a recurring subscription model like Apple AAPL, +1.75%, Netflix NFLX, -0.03%   or Amazon AMZN, +0.83%  have not only a recurring revenue, but also a captive revenue.

Q.: Why did you make it? And when?

A.: Within the last few years because we are all electronically hooked up and companies like Apple are the amplifiers. Subscription models are a revolution in retail because the monthly or annual revenue generates a steady stream of cash.

Q.: What would make you get out of it?

A.: If the share price hits my stop-loss threshold of 2%. I’m always measuring the risk and move quickly. If it drops, I get out and preserve my capital and look forward to the next opportunity.

Q.: How many trades do you have on at a time, on average? And, on average, how many others are you monitoring for an entry point?

A.: We are technical traders and the number of trades we have could have at any given time is driven by numbers: price, volume, averages, etc. As for monitoring for trades, that is driven by the methodology we trade on and the universe of stock and commodities that we have defined. Currently in our systems we are monitoring 600 stocks, and we could have a maximum of 30 in active trades.

Q.: On average, how long are you in a trade?

A.: I go trade by trade and really focus on the price and the trend. I watch the markets and ride the momentum. To quote David Ricardo who had three golden rules ‘’Never refuse an option when you can get it; cut short your losses and let your profits run on.”

Q.: What’s been your best trade ever, and why did you make it? And you got out because..?

A.: In the mid 70’s, the coffee market’s prices were extremely low; there was a glut of supply and farmers were getting hurt. I researched 50 years of weather patterns and supply/demand data and saw that coffee consumption had been rising for a long time but prices hadn’t yet responded. I bought calls on coffee options futures betting their value would rise and I rode the trend from 60 cents to $3.10. My initial $500,000 investment went up to $15 million. When the trend reversed and went down, I got out with $12 million.

Q.: Can you talk about a big trading mistake and what you learned from it?

A.: I was trading orange juice years ago and my computer showed me a price, but when I went to sell I wasn’t able to get the same price. I got very angry and stubborn which was really stupid. After I lost enough money, I stopped being stubborn and learned a valuable lesson.

Q.: You’ve made lots of money as a trend trader, and you write in your book that you make money because you do what the market tells you do. If only it were that easy! Why, in your opinion, is this not a more crowded strategy?

A.: A lot of people adhere to Wall Street’s conventional advice, which tells investors to buy and hold with a passive approach to their portfolio. In this school of thought, you should do nothing when prices drop and not to pay attention to fluctuations in the market, but rather wait it out, because over time they believe the stock market always rises and you will always do well. Trend following is my bible and I feel it’s the safest thing you can do and the best way to make money.

Q.: What advice would you offer a small investor looking to emulate you? What’s your No. 1 rule?

A: I always have a stop-loss order in place which will automate a sell-off once an asset declines by an amount that you predetermined based on what you have decided you can lose.

Q.: Jim Cramer said earlier this month that you have to be out of your mind to have any conviction about this stock market right now. Do you agree? Is today’s market that different than those of the past?

A.: No, it’s not. I respect the intelligence and devotion of economists and historians who have tried to understand global markets and develop a theory of human behavior and market dynamics. But when you start believing you have remarkable market-predicting powers, you get into trouble every time.

Q.: How has your own approach to trend following evolved over the years? Have you shifted over the year in what you trade, say commodities vs individual stocks vs the broader market? Are trades generally longer now? Or shorter?

A.: My approach hasn’t changed significantly. Risk management and a diversified portfolio remain important factors in my overall strategy.

Q.: Do you take into account a company’s fundamentals like earnings forecasts and how fast it is growing vs. its sector, valuation measures like P/E ratios, and other factors, or is that all irrelevant as a trend follower?

A.: I look at the price and the other factors are irrelevant. I continue doing whatever is making me the most money. I have done research and run thousands of simulations over the years and what I see convinces me that people’s emotions don’t change. It’s not intellect that moves the markets, it’s emotions.

Q.: Why do you prefer trend-following over other strategies, including buy and hold? Is it just better suited to your personality, or is there a deeper reason?

A.: I believe in adaptive systems. Trend following empowers you to see clearly that you can make the right choice for right now. It gives any motivated person a chance to invest in the markets with managed risk.

Q.: Now for some questions away from trading. What’s the best thing you’ve bought recently?

A.: I was very happy to give my daughter a really beautiful wedding recently and I am looking forward to more grandchildren. Family is everything.

Q.: And what do you hate spending money on?

A.: Jewelry. I would much rather invest the money.

Q.: If you weren’t trading the markets, what would you be doing?

A.: Studying history.

Q.: And what’s your retirement plan?

A.: I will keep doing this 20 years after I’m dead. I enjoy what I do and I love making money.