Trading and Portfolio Management, 10 Lessons of a Lifetime

“Our indicators tell us, we’re very close to a Lehman-like drawdown,” argues Larry McDonald, a former strategist at Société Générale who now runs The Bear Traps report.

Financial Times, February 20, 2020

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“Without owning something over an extended period time, where one has a chance to take responsibility for one’s recommendations; where one has to see one’s recommendations through all action stages and accumulate scar tissue along the way for the mistakes. Where one has to pick one’s self up off the ground, feel the pain, and dust one’s self off. Without that process, there is very little real learning.”

Steve Jobs on Research vs. Trading, on “Consultants”

A Weekend in Omaha

An icy cold breeze rolled in through an open window, early morning was coming out of deep sleep. I reached for the covers and tried to get some rest, but just couldn’t, the adrenaline was pumping. There were just two thoughts in mind; the Munger meeting and waking up in Omaha, Nebraska. It was our 3rd year in a row, but this journey was special. Charlie Munger invited us for a 1-1, private meeting. To many, Buffett’s right-hand man is the behind the scenes “gem” of
Berkshire. On this Saturday, we walked into the Quest Center, close to 20,000 were waiting for Buffett and Munger to sit down in two chairs positioned on center stage. There were another 10,000 investors in town for events and weekend activities that make up Berkshire Hathaway’s Annual Meeting. After a 45-minute kickoff presentation, Buffett and Munger opened up the gathering for Q&A. It was a sight to behold. There were over 70 different spots selected around the arena for shareholder questions, each with a microphone and an attendant. Over the next hour, inquiries poured in – it’s the ultimate live display of corporate transparency on earth. After two full hours, I could see my wife was a bit agitated. She leaned over, tapped a woman on the shoulder and said, “how long do these questions go on for?” It was her first time in Omaha and I had made the tragic mistake of not informing my better half of this vital piece of information. “Another 3 hours,” the lady in the next row said with a broad, Midwest smile. Then, I was on the receiving end of the “death stare” from the Mrs.

“Larry, always remember, human nature is your great enemy near market lows. At your absolute climax of fear, you must do the exact opposite of what you want to do.”

Charlie Munger

The next day we walked into the Marriott hotel in Omaha. Glancing across the foyer, in one room there was Bill Gates with pension fund investors. Around the next corner, there was Mr. Buffett himself with the sovereign wealth funds. We were escorted to a small private room. The first thing we could see was a sparsely accommodated conference table, complete with just pencils and paper – vintage Berkshire. The most memorable part of the conversation came down to how Charlie Munger looks at convexity, searching for the best upside, relative to the downside relationship in an investment. He spoke of “crowd folly” – a large collection of highly intelligent people, the “lemmings” acting like idiots. “Emotions have to be under control, you need patience and discipline and an ability to take losses, adding to positions where the real value is found. We find the best opportunities where emotional liquidity is driving price action. We look for the best risk-reward, asymmetric payoff driven returns. We buy businesses with sustainable competitive advantages at a low or even a fair price.” The bottom line, “across the investing playing field, nothing is guaranteed. There will be losses as well as profits, but “insisting upon proper compensation for the risk assumed is the only way to win in the long- term investing game.”

Lehman Lessons

As a trader at Lehman, I remember Mike Gelband coming by the desk and asking traders an important question, one I will never forget; “Are you long because you like it – Or do you like it because you’re long?” Being wrong doesn’t get you stuck. Not admitting that you are wrong gets you stuck in a bad position. Mike is one of the best risk managers on Wall St., one of the good guys, trying to stop the madness as the ill-fated bank was heading for that giant iceberg in 2008. In recent years, Mike founded the $8B hedge fund Exodus Point, the finest cream always rises to the top. Out of Lehman’s ashes are found some incredible success stories. 

Which brings to mind the ultimate focus of this blog post.

What makes a great risk trader?

There are 10 qualities and key ingredients. To start, a very creative nature, a high sense of urgency, very aggressive, highly skeptical, and not accommodative. And now, the rest of the best:

1) You need to think about forward price fluctuation differently than everyone else. Great traders aren’t copycats.

2) You have to move immediately before the opportunity is lost. You aren’t the only creative one out there. Paralysis by analysis is the state of over-analyzing (or over-thinking) a situation so that a decision or action is never taken, in effect paralyzing the outcome. NFL legend Tom Brady always reminds us, you must have your homework done BEFORE the game begins. Having enough experience to ride an opportunity when it shows up at your door is the key.

3) In traditional high yield bond trading, you have to go to the mat to get the trade done. No one and nothing can stand in your way. Ever. If that involves yelling at people, so be it.

4) You can’t be sucked in by everyone else’s bullshit or you are doomed. Doubt everything all the time. Take nothing for granted, especially your favorite trades. Every line item in your account is sitting there, waiting to destroy you. You must have HIGH conviction if the trade is still on your pad (in your books), if NOT exit, and move on.

“Higher prices bring out buyers. Lower prices bring out sellers – size opens eyes. Time kills ALL trades. When they’re cryin’ you should be buyin’. When they’re yellin’ you should be sellin’. It takes years for people to learn those basics – if they ever learn them at all.”

Larry McCarthy, Former Head of Distressed Fixed Income trading at Lehman Brothers

5) Risk decisions aren’t compromises. They are definitive. They don’t reconcile different people’s opinions. The trade is put on one way or the other. This whole hold-your-hands-together-to-build-consensus-and-team-cohesion thing is simply ridiculous when you have 20 seconds to launch $50 million of risk one way or another. This ain’t day camp to get in touch with people’s feelings. If people on your team have emotional problems with how a trade went down, they can always become social workers.

6) There’s nothing more dangerous on Wall St. than a bored trader with an unused capital line. As the great Seth Klarman says, “buying right, NEVER feels good.” Complacency is a capital killer. Over the years, one of our most important lessons is; trade LESS and make each trade count. On waiting and waiting to pounce (buy), Charlie Munger said; “the toughest thing to do is stare at a screen all day and do nothing.” The 2nd hardest thing for a trader to understand is that you don’t always have to make the bet. Sometimes the best position is no position. Not long. Not short. Just out.

7) Our friend Eric Peters used to say, “there are only a few times in a year to make a lot of money. When those times occur, you need to be involved, aggressive, big. The rest of the year it’s best to do as little as possible.” This is one of my all-time favorite quotes when it comes to trading.

8) The market is always wrong at the open, and always right at the close. Only buy on the open if you have the HIGHEST conviction that stocks will rip all-day long. Lessons learned, you’re much better off waiting and putting long or short positions on later in the day.

9) Made a mistake once? That is ignorance. Made the same mistake twice? That is stupidity. Made the same mistake a third time? That is neurosis. Made that same mistake a fourth time? Congratulations! You are an analyst, economist or strategist. The trend is your friend, when improving and with moves lower here and there, you are far more likely to notice the dips than the overall improvement.

10) High self-awareness is key. Great traders are very aware of their own feelings. Measuring your fear is key, the more you feel, the closer you are to a good entry point on the long side. Self-awareness allows for the understanding of others. Why? Because that understanding is a misnomer. It is really ascription to others what one feels oneself. Why does that work? Because we are all more or less the same. One self-consciousness is like another. As Kant puts it in the Paralogisms of Pure Reason in his Critique of Pure Reason: “Now I cannot have the least representation of thinking being through an external experience, but only through self-consciousness. Thus such objects are nothing further than the transference of this consciousness of mine to other things, which can be represented as thinking beings only in this way.”

Sound tough? It is.

Larry McDonald ran a highly successful distressed bond trading business at Lehman Brothers, was considered one of the firm’s most profitable traders.



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