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Steve Cohen On Making Trading “Harder Than It Has To Be”

Courtesy of ZeroHedge View original post here.

Submitted By Nicholas Colas of DataTrek Research

This week’s Story Time is about keeping things simple. I (Nick) will begin with a story from my time at the old SAC Capital, run by legendary trader (and now Mets owner) Steve Cohen.

I sat opposite a two-trader team who were famous in the room for wild daily P&L swings. They once added up their daily gains and losses over the year and found that their winning days totaled $330 million dollars on $100 million of capital, but their losing days totaled $300 million. They netted $30 million on the year, which was awesome because they got to keep a third of the gains as their compensation, but the way they made that money was insanely stressful.

One morning, this duo found themselves unusually deep in the hole, even for them: down $30 million at the open. I glanced across the desk. One trader was pale as a cadaver, staring at his screens in horror. The other, who had been in the office since 3am trading Europe, was in the bathroom with what can most politely be described as an explosive case of stomach troubles.

Around 10am, Steve walked over and sat down next to the pair. He wasn’t visibly angry, and he didn’t tell them what to do.

He just looked at them and said, “You’re making this way harder than it has to be.” He paused to make sure they heard him. They nodded, and Steve got up and went back to his desk. In the next hour they cut back all their losers, regrouped, and concentrated the portfolio in their highest conviction names. Over the next week they clawed back all their losses and by month end they were profitable again.

This happened 20 years ago, but I’ve never heard a clearer observation about the craft of investing/trading. Mistakes most often come from making the job of allocating capital harder than it has to be. And … The harder one makes it, the harder it is to break the doom loop and get back on the right track.

Yes, I absolutely understand why this sounds like cliched, useless advice. Of course we don’t consciously self-sabotage by making the investment process needlessly complex. The problem is that investing is a profoundly fault-intolerant discipline. A few bad decisions can swamp scores of good ones.

Ask an elite trader about their win rate (percent of money-making trades) and, if they are honest, they will tell you it’s between 55 – 60 percent. Their positive returns come just as much from keeping losing positions to 40-45 percent of the book as they do from their (narrow) margin of victory. It is no different for every highly successful investor I’ve ever met. Their tolerance for holding on to large losing positions is very low; they know a handful of wins make their year and a few bad mistakes can quickly eat up those gains.

Here are my own 5 rules for “keeping things simple”:

1: Only outcomes matter. There is an old saying among traders: “The bank doesn’t ask about your win rate when they cash your paycheck”. It is all too easy to focus on issues that don’t influence stock prices. Social media and click-hungry online news outlets only amplify those distractions. At the end of the day, however, the prices on the screen are the only things that matter.

2: Three things – and only three things – drive stock prices. They are changes in expectations for:

  • future earnings/cash flows,
  • future interest rates used to discount those earnings streams,
  • and the timeframe over which investors have confidence in those earnings

This is equally true for individual companies and country/regional equity markets. For example, our highest conviction long term investment viewpoint is that US large cap stocks will outperform Europe and Asian equities. The American system of capitalism, from seed-round venture funding to its deep public capital markets, delivers better and more sustainable returns on capital than other regions’ approaches. Nothing we see tells us this will change any time soon.

3: Money has to go somewhere. Capital always moves to where it can earn the highest risk-adjusted return. Find those areas, and you’ve found the outperformers. This is why we have a momentum bias to some of our work. Price momentum reveals capital flows. The biggest rookie mistake out there is thinking “the market has it wrong”. Prices always lead fundamentals. There’s an old Wall Street saying that goes “Never listen to analysts. In a bull market you don’t need them, and in a bear market they’ll kill you.” That’s a hard message for a former analyst (me) to hear, but it’s more right than wrong.

4: Time management determines investment results. This is the unwritten reason successful traders and investors have so little tolerance for holding on to losing positions. Losses capture attention and soak up time, which is the one fixed constraint we all face. I think this is the core of what Steve was trying to tell the stressed-out traders: focus your time on what can make a difference and the results will follow.

5: Look back to look forward. History doesn’t predict the future, but it does offer a roadmap for considering what comes next. Simple example: I am no fan of technical analysis, but I look at dozens of asset price charts every day and across everything from 1-day to 20-year periods. Does the data trend or remain static across a cycle? What sorts of macro environments create the greatest change? The same goes for economic and market data graphs. Every picture tells a story, and profitably predicting future trends means accurately tracing out the next chapter of that story before it is actually written.

Summing up: trading and investing are hard enough already without making matters worse by overthinking the process. Simpler is better, if only because it is more efficient. Productive investors know they can always make more money, but they can never make more time.


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