In this series, we’ve asked Covestor managers: “What is the single most important lesson you’ve learned about being a successful investor, and how do you try to apply that today?”

Manager: Timothy Sykes
Covestor model: Contra Hype

A wise fund-of-funds manager once told me “I love your strategy, work ethic and determination, but I’m not going to invest in you because you haven’t been scarred by the market yet.”

As a cocky 23-year-old who had never experienced a big loss, I thought he was crazy. Less than two years later when I got away from my core strategy of shorting smallcaps in search of a more scalable strategy, he was proven 100% correct.

Large losses create scars that help you learn what not to do. In my case, it was straying from my strategy.

How do you apply that lesson in your current investing? What are the challenges to applying it?

Because I short sell hyped up smallcap and microcap equities, the number one problem I face is locating shares to short, which is why I a) teach instead of run a hedge fund, and b) have multiple brokers who are always on the lookout for more shares of blatant pumps.

For a recent example, there’s LEXG, which on the back of a promotional mailing campaign rose from just pennies per share  to over $10/share in the month of April 2011. At its peak, the company was valued at over $500 million, despite having no  revenues. The CEO Alexander Walsh gave himself 25 million shares in February 2011.

That’s my kind of play and the stock dropped dramatically in late April 2011 on no news just because it was due… as all pumps are inevitably doomed to fail.

LEXG sources:

Financials: Google Finance http://www.google.com/finance?q=OTC:LEXG&fstype=ii
Walsh share grant:  Yahoo Finance/EDGAR  http://biz.yahoo.com/t/01/8517.html