The Art of Risk Taking
What an ancient military treatise taught me about asymmetric investing.
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Most investors think risk management means avoiding risk. They think of it as the boring part.
Sun Tzu would disagree.
The Art of War is commonly perceived as a book about aggression. It is, after all, called The Art of War.
But its core message is the opposite.
It is a book about patience, preparation, and knowing when not to act. It is, in many ways, the greatest investing book ever written. It just happens to have been written 2,500 years before the stock market existed.
I recently read Tobias Carlisle’s book, Soldier of Fortune, which maps Sun Tzu’s principles onto Buffett’s career. It crystallized something I’d been thinking about for a while. I believe the principles in The Art of War, properly understood, describe the optimal framework for asymmetric investing.
The same framework that underpins this newsletter.
This post is an attempt to unpack why that is.
Via Negativa: Winning By Not Losing
The most surprising thing about The Art of War is how much of it is written in the negative. Don’t do this. Avoid that. Do not engage unless conditions are overwhelmingly favorable.
Sun Tzu’s central insight is what philosophers call “Via Negativa”: you get where you’re going by removing what doesn’t work, not by adding what might.
If you eliminate all of the obviously wrong paths, whatever remains is the only path you can take.
This is the most underrated concept in investing.
Most investors spend their time looking for reasons to buy something.
They hunt for catalysts, narratives, upside scenarios. But the best investors I’ve studied do the opposite.
They have a mental checklist of things that kill investments, and they refuse to engage unless none of those conditions are present.
Too much debt. Misaligned management. Cyclical business at peak earnings. Unquantifiable regulatory risk.
If any of these are present, they pass. They don’t care how exciting the story is.
I think about this every time I look at a new position.
The question is never “what could go right?” The question is “what would kill me?” If the answer is “nothing obvious,” then you start doing the real work.
If the answer involves three paragraphs of caveats and rationalizations, you move on.
The positions I’ve been most wrong on share a common trait: I talked myself past a clear disqualifying factor because the upside was too exciting. The positions that have worked best were the ones where I struggled to find reasons not to own them.
Via Negativa also applies to portfolio management. The months where I do the least tend to produce the best outcomes.
Not because inaction is inherently virtuous, but because action for its own sake is inherently destructive. Every unnecessary trade is a chance to introduce error.
Doing less, when you’ve already done the work, is a feature, not a bug.
I’ve written before about how “boring is a feature.” This is the Sun Tzu version of the same idea.
Defend First: The Ergodicity Problem
Sun Tzu says you must defend before you attack. You secure your own position before engaging.
The reason is simple: if you are destroyed, nothing else matters. There is no second chance.
In investing, this is the ergodicity problem.
If your portfolio goes to zero, it does not matter that your CAGR was 40% for the prior five years. Compounding works in both directions.
A single catastrophic mistake can undo years of correct decisions.
This is why position sizing matters more than stock selection.
You can be right on every thesis and still blow up if you’re sized incorrectly. Conversely, you can be wrong frequently and still compound well if your sizing protects you from ruin.
Sun Tzu actually understood probabilities.
He writes about “balancing the chances of life and death” and uses an archaic ratio, something like a grain to a pound, which is approximately 1 to 6,000.
His point: you should only act when the odds are overwhelmingly in your favor. Not slightly in your favor. Overwhelmingly.
This sounds extreme. But in practice it describes exactly how the best investors behave.
They wait.
They do nothing for extended periods.
And then, when the odds are truly lopsided, they act decisively and in size.
This is the margin of safety concept, but stated more aggressively.
It is not just about avoiding losses. It is about refusing to engage until the setup is so asymmetric that losing becomes very difficult.
This maps directly onto how I think about the positions I write about in this newsletter.
I am looking for situations where the downside is quantifiable and limited, and the upside is a multiple of the current price.
Not a 20% upside with 15% downside. That is not asymmetric.
That is a coin flip with a small edge.
I want setups where a reasonable downside scenario is a 30% correction, and a reasonable upside scenario is a 200%+ rerating.
These setups are rare. But they exist, and waiting for them is the entire game.
The Rabbit vs. The Hunter
I’ve written before about the Rabbit vs. Hunter framework.
It describes two instinctive responses to drawdowns.
The Rabbit freezes. It sits paralyzed, staring at the red on the screen, doing nothing.
The Hunter assesses conditions and, if the thesis is intact, adds to the position.
Sun Tzu would recognize this immediately. He writes extensively about emotional discipline. About understanding your own psychological state. About not reacting to conditions, but instead shaping them.
The problem is that the Rabbit response feels rational in the moment. The stock is down 15%.
The market is telling you something. Maybe you should wait for clarity. But waiting for clarity is often just a euphemism for doing nothing while the asymmetry improves in front of you.
The Rabbit watches the price fall further, never adding, and eventually the thesis plays out without them having capitalized on the dislocation.
The Hunter knows this.
The Hunter has done the work beforehand. The Hunter has a thesis with clearly defined assumptions and kill criteria.
When the stock drops, the Hunter checks the kill criteria. If none have been triggered, the drawdown is information about the market, not information about the business.
And information about the market, for a long-term investor, is useful only insofar as it lets you buy more of something you already liked at a lower price.
Sun Tzu would say: “Know yourself, know your enemy.” In investing, “knowing yourself” means understanding your own emotional triggers, your tendency to freeze, your susceptibility to FOMO.
“Knowing your enemy” means understanding the market’s behavioral tendencies: its tendency to overreact, to extrapolate, to misprice duration, to ignore small and illiquid names.
The investor who knows both will rarely be caught off guard.
Wu Wei: Don’t Be a Great Farmer. Farm in Spring.
Wu Wei is a Daoist concept that roughly translates to “non-action” or “effortless action.” It does not mean doing nothing. It means aligning yourself with the natural flow of events rather than fighting against them.
There’s a line attributed to one of the Daoist philosophers that I think about often:
“It’s great to be a good farmer, but you don’t have to be a great farmer in the spring.”
In spring, the conditions do the heavy lifting. You just have to show up and plant.
Investing is the same.
There are periods where the conditions are doing the work for you: regulatory tailwinds, industry transitions, valuation dislocations, forced selling. In these periods, you do not need to be a genius stock picker.
You just need to be present and positioned.
Conversely, there are periods where conditions are hostile: everything is expensive, speculative fervor is peaking, and the easy money has been made. In these periods, even excellent stock picking may not save you.
Wu Wei says: flow with events, do not fight them.
This is counterintuitive for contrarian investors.
Part of what we do is bet against the crowd. But there is a difference between betting against the crowd on a specific mispriced situation, and fighting the entire direction of the market or the macro environment.
The former is good investing.
The latter is stubbornness disguised as conviction.
I try to find situations where the natural flow of events is working in the company’s favor. A regulatory change that creates a structural tailwind. A recurring revenue transition that the market is not yet pricing. A catalyst with a defined timeline.
These are “spring” conditions.
The thesis is not dependent on the company doing something extraordinary. It is dependent on the company executing on something that is already in motion.
When multiple “spring” conditions converge on a single name, that is what Charlie Munger called the Lollapalooza Effect.
Individual tailwinds add. Convergent tailwinds multiply. And the market, because it tends to think linearly, consistently underprices the multiplicative scenario.
This is my edge.
Coup d’oeil: Seeing What Others Cannot
Coup d’oeil is a French term meaning “stroke of the eye.” It refers to the ability of great military commanders to take in a complex situation, with its many variables and uncertainties, and instantly perceive the correct course of action.
Napoleon was said to have possessed it. Von Clausewitz wrote about it.
In investing, coup d’oeil is the ability to look at a company and see, in an instant, why the market is wrong.
Not because you’re smarter. But because you’ve done the pattern recognition work so many times that the signal cuts through the noise.
This is not mystical.
It is the product of method.
You do the analysis over and over. You study hundreds of situations. You develop an instinct for which factors matter and which are distractions. And then, one day, you look at a company and the thesis assembles itself almost automatically.
The misclassification. The hidden asset. The earnings power that the market is ignoring because it’s fixated on the wrong metric.
I think about this when I write about companies that I think the market has mislabeled.
A company classified as “insurance” that is actually a search fund platform.
A company labeled as “coal” that is actually transitioning into a power utility.
A monitoring business whose earnings are misread because the market is focused on a single quarter rather than the trajectory.
In each case, the thesis is not complicated. It is a simple observation that the label is wrong, and when the label changes, the multiple changes.
The hard part is not the observation. It is having done enough work, on enough situations, to recognize the pattern when it appears.
That is coup d’oeil.
Victory Without Battle
Sun Tzu’s most famous principle may be that the greatest victory is won without fighting.
The battle, if it comes to that, is already a sign that something went wrong.
The real victory was achieved beforehand, through positioning, preparation, and patience.
For investors, the “battle” is the period after you buy.
The volatility. The drawdowns. The noise. If you have done the work correctly, the battle is already won before you enter the position.
You’ve identified the mispricing. You’ve confirmed the thesis. You’ve sized the position appropriately. You’ve defined your kill criteria.
The outcome will be determined by whether the business executes, not by whether you can stomach the daily price action.
The investors who lose are the ones who enter the battle unprepared.
They buy on a tip, or a chart, or a feeling. They have no thesis and therefore no ability to distinguish between signal and noise. Every drawdown is existential because they have no framework for evaluating it. They are the army that arrived at the battlefield without a plan, and every army that arrives without a plan eventually loses.
Sun Tzu, writing 2,500 years ago, understood all of this. The principles have not changed.
They will not change.
Markets evolve, technology evolves, geopolitics evolve. But the way you win does not. You defend first. You wait for overwhelming odds. You flow with conditions rather than fighting them. You trust your preparation. And you act decisively, and only, when the moment is right.
That is the art of risk taking.
Thanks for reading.
Dom
Schwar Capital
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