In a winner's game the outcome is determined by the correct actions of the winner. In a loser's game, the outcome is determined by mistakes made by the loser.¹

—Charlie Ellis

Charlie Ellis wrote this in his 1998 classic, Winning the Loser's Game. In other words, professionals win points and amateurs lose points. “Professional tennis players stroke the ball hard, with laserlike precision, through long and often exciting rallies until one player is able to drive the ball just out of reach or force the other player to make an error.”² He contrasts this with how amateur games unfold. Instead of highly skilled shots and long volleys, amateur matches are full of faults, missed shots, and mistakes. It doesn't take much to draw the parallels between the way amateurs and professionals play tennis to the way amateurs and professionals play the market.

Amateur investors, and I'm painting with a broad brush, buy after stocks advance and sell after they decline. Cullen Roche said, “The stock market is the only market where things go on sale and all the customers run out of the store….”³ This type of behavior, the desire to run for cover after you've been burned causes investors not just to underperform the market, but even their own investments. The spread between investment returns and investor returns is known as the behavior gap, and it is a permanent feature in any markets where human beings transact. It exists because the collective behavior of millions can overwhelm our senses. Fear and greed do not respond well when they're under assault. The market is notorious for forcing unforced errors.

The behavior gap is pervasive because the amateur investor gets fooled by averages. They're bombarded with information and literature suggesting that they can or should expect average returns, and they mistake average return for expected return. We frequently hear “stocks typically return between eight and ten percent a year.” Well, over multiple decades, you could say they'll compound at between 8 and 10%, but the last time the Dow returned between 8 and 10% was 1952. There is a lot of space between what you expect the market to do and what it actually does, and this is where unforced errors lurk.

Stocks tend to swing in a wide range, spending a lot of time at the fringe and little time near the average, delivering maximum frustration. This sort of erratic behavior transfers money from the amateur's pocket and into the professional's.

US stocks have gained 30% or more 13 times annually. When this happens, the temptation is to look around at your friends and family to see how you stack up against other people. Bad things tend to happen when we compare our portfolios with others, especially if they possess a lesser IQ and extracted a higher return. On the flip side, and just as dangerous, there have been seven years where US stocks fell at least 30%. Big down years are massively disruptive to investor's long‐term wealth, because people tend to run away from risk after it takes a bite out of their portfolio, which is like buying home insurance after a hurricane blows the roof off your house.

The amateur investor is most likely to make unforced errors at market tops and bottoms because, at the point of maximum optimism or pessimism, the story will have permeated throughout every corner of popular culture. When stocks are crashing and reverse crashing, the story will seem so compelling, that not making a change almost seems irresponsible.

Great investors do things differently than the rest of us. They buy what others don't want and sell what others crave. They're intimately familiar with the similarities between buying stocks and betting on the ponies. Michael Mauboussin says, “Fundamentals are how fast the horse runs and expectations are the odds.”⁴ This is what Howard Marks refers to as second‐level thinking, and it escapes most of us. The casual investor thinks a good company makes for a good stock, without giving consideration to the fact that the majority of investors share a similar opinion. Perhaps, like‐minded investors have pushed the price of a good company into that of a great company, making it less than it appears at first blush.

At a conference in 2015, the audience was introduced to one of the most successful investors of all time. In the introduction, he was compared to Warren Buffett, underscoring the speaker's tremendous success:

Probably the poster child of investors, Warren Buffett in the last thirty years has compounded at just under 20%; $1,000 30 years ago would be $177,000 today, 24 up years and 6 down years…3 of the 6 were [down] more than 20%. Our speaker tonight, $1,000 invested with him 30 years ago, today it would be $2.6 million…Thirty years, no losses.⁵

Stanley Druckenmiller is famous for taking the reins from George Soros and running his Quantum Fund for over a decade. He is one of the best global macro investors of all time. This game involves measuring economic sea changes and figuring out how they'll move stocks, bonds, and currencies around the globe. A colleague said, “Druckenmiller understood the stock market better than economists and understood economics better than stock pickers.”⁶ This was a unique combination. Add to this his affinity for risk management, and you've got a cocktail strong enough to knock his opponents on their behind. For three decades, he played the winner's game: “It's my philosophy, which has been reinforced by Mr. Soros, that when you earn the right to be aggressive, you should be aggressive. The years that you start off with a large gain are the times that you should go for it.”⁷

Druckenmiller reportedly earned 30% a year for 30 years by throwing conventional wisdom in the trash can:

The first thing I heard when I got in the business, not from my mentor, was bulls make money, bears make money, and pigs get slaughtered. I'm here to tell you I was a pig. And I strongly believe the only way to make long‐term returns in our business that are superior is by being a pig.⁸

The most important lesson we can learn from one of the best to ever do it, one who earned billions by being a pig, is that even winners sometimes play the loser's game.

Druckenmiller dropped out of business school after just one semester and began his career at Pittsburgh National Bank. At 23 years old, he was by far the youngest in a group of eight other people. And then in 1978, not even two years after being hired, he was promoted to director of equity research. It wasn't apparent at the time that he would go on to become one of the best money managers ever. Instead, it was his youth, his clean slate that his boss found so appealing. He asked why he leapfrogged his peers, who had much more experience than he did. “For the same reason they send 18‐year‐olds to war. You're too dumb, too young, and too inexperienced not to know to charge. We around here have been in a bear market since 1968. I think a big secular bull market's coming. We've all got scars. We're not going to be able to pull the trigger. So I need a young, inexperienced guy to go in there and lead the charge.” And lead the charge he did: Here's where my inexperience really paid off. When the Shah was deposed, I decided that we should put 70 percent of our money in oil stocks and the rest in defense stocks…. At the time, I didn't yet understand diversification.”⁹

A few years later, Druckenmiller gave a presentation at a conference, and somebody in the audience came up to him after he was finished and said, “You're at a bank! What the hell are you doing at a bank? I'll pay you ten thousand dollars a month just to speak to you.”¹⁰

With that, in February 1981, just 28 years old, Druckenmiller left the bank and launched Duquesne Capital Management. He started with $1 million under management and caught the upswing in small cap stocks in 1981. In just the first five months of the year, the Russell 2000 gained 14.92% while the S&P 500 fell 0.23%. He turned very bearish after the sharp advance, but he still managed to lose 12% in the third quarter, even though half of his portfolio was in cash. That led him to change his strategy. Druckenmiller was evolving. He was playing a winner's game.

Druckenmiller has one of the most interesting investing stories I've ever come across. In the first half of 1987, he was bullish while stocks were going straight up. The Dow Jones Industrial Average made 33 new highs in just the first four months of that year. It was up 45% at its highs in August, and after such a steep advance, Druckenmiller turned bearish in the summer. Sure enough, the market pulled back 17% from its August highs, and thinking there would be support at 2,200, he went from net short to 130% net long on October 16.¹¹ If you're familiar with “Black Monday,” you already know 2,200 did not act as support.

The Dow closed at 2,246 on Friday and 1,738 on Monday. The 22.6% crash remains the single worst day ever for the US stock market. Stocks plunged at the open and subsequently bounced, and by lunchtime, Druckenmiller sold everything and went short! He covered his positions, and after a strong two‐day bounce following Black Monday, Druckenmiller was again short the market. When stocks cratered on Thursday morning, he had made 25% in less than 24 hours. Druckenmiller was 130% net long going into the worst day in the history of the US stock market, and still made money in October 1987. He played the game at a level few ever have.

Druckenmiller was so talented that Dreyfus hired him in 1987 and let him continue running Duquesne. He ran the Strategic Aggressive Investing Fund, which was the best‐performing fund in the industry from its inception (March 1987) until he left in 1988. He was soon managing seven different funds for Dreyfus¹² and quit to pursue his dream job, working for George Soros.

Druckenmiller was on the way to greatness on his own, but partnering with an iconic investor would eventually give him legendary status. In 1989, soon after his arrival, he shorted the Japanese stock market in a trade he described as “just about the best risk/reward trade I had ever seen.”¹³ Nearly 30 years later, with the Nikkei still 50% below its 1989 peak, this turned out to be a prescient call.

In August 1992, Druckenmiller was looking to short the British pound. At the time, Quantum had $7 billion in assets under management and, inspired by his mentor Soros, Druckenmiller looked at selling $5.5 billion in pounds and putting the money in Deutsche marks. It seemed risky to have almost the entire fund invested in a single trade, but Druckenmiller had worked the numbers and was confident it was a winner. Before taking action, he decided to run his idea past Soros. As he described his plan, Soros got a pained expression on his face. Just as Druckenmiller started to second guess his plan, Soros surprised him by saying, “That is the most ridiculous use of money management I have ever heard. What you described is an incredible one‐way bet. We should have 200 percent of our net worth in this trade, not 100 percent.”¹⁴

Druckenmiller and Soros put the equivalent of $2 for every $1 they had invested in the fund, and shorted the pound. The Bank of England spent $27 billion in an effort to defend their currency,¹⁵ but it could not stand up to the onslaught of selling out of the Quantum Fund and others. When the levee broke and the pound crashed, Druckenmiller and Soros made a billion dollars.

Druckenmiller returned 31.5% in 1989, followed by 29.6%, 53.4%, 68.8%, and 63.2% in the next four years.¹⁶ He put together one of the most remarkable investment records of all time, with huge sums of money, but not everything he touched turned to gold. Sooner or later, everybody hits the ball into the net.

Every macro investor will experience being flat‐out wrong at some point in their career. In 1994, Druckenmiller had an $8 billion bet against the yen, nearly as large as his bet against the pound two years earlier. But when it rose 7% against the dollar, he lost $650 million in just two days.¹⁷ Macro traders were wrecked; Paul Tudor Jones, Bruce Kovner, and Louis Bacon also got caught in the crossfire. Goldman Sachs had its worst year in a decade.¹⁸ The Quantum Fund returned just 4% in 1994. This was better than the Dow, which gained 2%, or the S&P 500, which fell 1.5%, but the 4% return was much less than he and his investors were accustomed to.

In 1998, Quantum lost $2 billion in Russia. But this did not define his career or even his year. They still gained 12.4% for the year¹⁹ and sidestepped the calamity that carried out Long‐Term Capital Management feet first.

But just a year later, Druckenmiller would be carried out, and it wasn't because he misunderstood what a central bank was doing, or what the bond market was telling him. This time he committed the type of unforced error that is prevalent among amateur investors. He didn't just hit the ball into the net; he hit it onto another court.

In 1999, Druckenmiller made a $200 million bet against “overvalued” Internet stocks. In just a few weeks, the expensive stocks that he was betting would come back down to earth got more expensive. These early bets cost the fund $600 million and by May, he was down 18% for the year. Druckenmiller was out of touch with the market and that same month, he hired a young trader, not dissimilar to what his boss had done 20 years earlier. He attended the annual media and technology conference in Sun Valley, Idaho, where anyone who was anyone attended. Having drunk the Kool‐Aid, when he came back to work, he gave his new hire more capital and brought in a second trader who was equally committed to the new investing paradigm. They were invested “in all this radioactive [stuff] that I don't know how to spell.”²⁰ They righted the ship and finished the year up 35%.

An investor who made his living for 20 years by judging liquidity and which way the economic winds were blowing had no business investing in technology that he didn't understand. He knew this and quickly grew uncomfortable with his positions, so he took his gains and went back to where his bread was buttered, global macro. He was bullish on the newly created currency, the euro, but it went the opposite direction he thought it would. To add insult to injury, he watched in agony as the tech stocks he sold continued to soar while his two new employees were making money hand over fist. Druckenmiller's pride got in the way of his fear of the tech bubble. He didn't want to be upstaged by these young new traders, so he plowed his money back into tech.

Prior to the bubble bursting, Druckenmiller told the Wall Street Journal, “I don't like this market. I think we should probably lighten up. I don't want to go out like Steinhardt.” But he didn't lighten up, and in fact, he backed up the truck. He bought VeriSign at $50, and at $240 a share, he doubled his bet to $600 million. As the tech sector began to wobble, VeriSign dropped to $135 and Soros wanted to reduce Quantum's holdings, but Druckenmiller wanted to stick it out. He was convinced VeriSign would remain steady and stand apart from the bubble.²¹

The NASDAQ peaked on March 10 and by April 14, just 25 days later, it had crashed 34%. VeriSign was no different from the rest of the floundering tech stocks. When the bubble burst, it was worth just 1.5% of what it was at its strongest point. “It would have been nice to go out on top, like Michael Jordan,” Druckenmiller said at a news conference in late April. “But I overplayed my hand.”²² The Quantum Fund was down 21% for the year, and assets at Soros Fund Management fell by $7.6 billion since their peak in August 1998, of $22 billion.

Despite being the owner of one of the most impressive long‐term track records, Druckenmiller remains humble and lighthearted. At the 2017 Ira Sohn conference he said, “Last year, I thought you should get out of equities and buy gold. That's why I'm introducing today and not presenting.”²³

There is a big difference between a lousy investment and an unforced error. Your thesis was wrong, or what you thought was already in the price; things like this are all part of the game. But oftentimes, we'll act impulsively, even when we “know” what we're doing is a mistake. Few people are spared from unforced errors, and the way they usually manifest themselves is because we can't handle people making money while we aren't. Munger once said:

The idea of caring that someone is making money faster [than you] is one of the deadly sins. Envy is a really stupid sin because it's the only one you could never possibly have any fun at. There's a lot of pain and no fun. Why would you want to get on that trolley?²⁴

Druckenmiller got on that trolley. He couldn't bear to see Quantum grinding its gears as a bunch of small‐potato upstarts were racking up huge returns. Firms that were heavily into tech stocks were up as much as 50% for the year, while Quantum was stuck in single digits.

Druckenmiller knew exactly what he was doing – he just couldn't stop himself. “I bought $6 billion worth of tech stocks, and in six weeks I had lost $3 billion in that one play. You asked me what I learned. I didn't learn anything. I already knew that I wasn't supposed to do that. I was just an emotional basketcase and couldn't help myself. So maybe I learned not to do it again, but I already knew that.”²⁵

Maybe we all need to have this happen once or twice. Some things can't be taught, they have to be learned the hard way, even if we don't learn anything at all.