Jack Dreyfus was a successful investor from the 1950s to the 1960s and, according to Barron's, he was considered the second most significant money manager of the last century. He was so successful financially that he could afford to develop his interests in many other fields. For example, after selling his fund in the 1970s, he wrote a book on a medicine called phenytoin and became a major proponent of it as a cure for nervousness and depression. He was also a champion bridge player, as well as a breeder and trainer of racehorses.
His fund, the Dreyfus Fund, was the best performer in the late 1950s and it sometimes had performances twice as good as the competitors. What are the secrets with which he made his fund so successful? Here are three of them:
Secret 1: Buy Strength, Not Bargain.
William O’Neil, the renowned stocks expert, was an avid student of Dreyfus when he was young. He used to study the quarterly reports of the Dreyfus fund and examine how the stocks were purchased. He would mark the new positions the fund made during the quarter in red ink on the price charts in order to see if there were any hidden buying strategies of the fund.
After looking into the purchases of Dreyfus for several years, O’Neil had a stunning discovery that all stocks were purchased at new highs, i.e. if a stock had been trading between $20 and $25, then Dreyfus would have bought it when the price broke into a new high at about $25.5. In addition, O’Neil also found that almost all the stocks bought by the fund had strong increases in their quarterly earnings reports. By following this strategy, Dreyfus was conquering every one of his competitors who followed a “traditional” approach of fundamental analysis and “buy low, sell high”.
It is clear that Dreyfus had a simple belief: he only wanted to buy strong stocks with momentum. He did not want to “buy-and-hold” by buying lackluster stocks and hoping that they would suddenly increase tenfold to make him a fortune. As famous commodities trader Ed Seykota joked:
“One evening, while having dinner with a fundamentalist, I accidentally knocked a sharp knife off the edge of the table. He watched the knife twirl through the air, as it came to rest with the pointed end sticking into his shoe. ‘Why didn’t you move your foot?’ I exclaimed. ‘I was waiting for it to come back up,’ he replied.”
No, you would be much better off if you catch the knife on the way “up”.
Secret 2: The Chart Matters.
Here is another secret: Jack Dreyfus was a chartist. In those days without computers and internets, his research department used to have three young assistants who are responsible for posting oversized charts of hundreds of stocks with the day's price and volume actions inside the office. He was also such an avid tape reader that he had tapes put in every corner of his office, because if he happened to leave his desk, he didn't want to miss any trade.
Dreyfus bought all his stocks based on price actions: not just that he only bought a stock at new high, but also only when it forms certain kinds of technical patterns. In other words, he believed in technical analysis. In the words of famous trader Richard Dennis: “I agree with the metaphysics of technical analysis that the fundamentals are discounted. You don't get any profits from fundamental analysis; you get profit from buying and selling. So why stick with the appearance when you can go right to the reality of price and analyze it better?”
It is certainly beyond the scope of this article to go into how a chartist might spot a preeminent stock from studying the charts, for the amount of information
is surely enough to fill a book, but here are two conventional concepts that are popularly employed. This first one is relative strength. During a bull market correction, the strongest stocks are usually those which persistently resist selling off along with the general market, and are the first to rally once the correction is over. Conversely, the stocks that are late to rally or with light volume are usually the languid ones.
Another key factor is volume. A good chartist pays particular attention to volume because real winners usually jump with huge transactions. Unusual transaction activities, like a sudden pickup in volume and activity in a quiet stock, are very strong signals. Strong volume indicates strong interests from professional investors, whose deep pockets are usually enough to drive the price even higher, and provide the necessary liquidity when you want to get out.
Secret 3: Euphoric Optimism is Fatal.
Dreyfus believed in a contrarian approach when it comes to ridding your holdings. He said, “Sell when there is an overabundance of optimism. When everyone is bubbling optimism and running around trying to get everyone else to buy, they are fully invested. At this point, all they can do is talk. They can't push the market up anymore. It takes buying power to do that.”
Here is a little story recounted by Stanley Druckenmiller, a fund manager who worked for the Dreyfus fund after Dreyfus retired: “In early August of that year [of the 1987 crash], I had received a call from a woman who was about to leave for a vacation to France. She said, ‘My brother says that the market is getting out of hand. I have to go away for three weeks. Do you think the market will be all right until I get back?’” Druckenmiller reassured her that it was fine, but then the woman asked, “Do you know who my brother is?” Druckenmiller had no idea. “‘He’s Jack Dreyfus,” the woman informed him.
Later Jack Dreyfus visited Druckenmiller and told him, “I’ve been very concerned about the conversations I’ve been hearing lately when I play bridge. Everyone seems to be bragging about all the money he’s making in the market. It reminds me of everything I read about the 1929 market.” Dreyfus wanted Druckenmiller to perform a research on the market to confirm his conjecture. Ironically, by the time the study was finished, it was the Friday afternoon of October 16, 1987, and basically, the study confirmed Dreyfus’s concern. Dreyfus looked at the study and said, “I guess were a bit too late to capitalize on my fears.”
Druckenmiller was convinced that he was on the wrong side of the market, and decidedly sold everything and went short on Monday. That same afternoon, five minutes to four, Dreyfus came by. He said, “Forgive me for not telling you before, but I had already sold S&P futures to hedge my exposure in the stock market.” “When did you go short?” Druckenmiller asked. “Oh, about two months ago.” In other words, Dreyfus had gone short at exactly the top, right around the time his sister was told not to worry about an imminent top in the stock market.
Victor Chan Wai-To is an active trader in Hong Kong.