Thursday, November 29, 2012

Lessons from Hedge Fund Market Wizards: Ray Dalio

Ray Dalio Bridgewater Associates
In our second installment of "Lessons from Hedge Fund Market Wizards", we'll offer up some trading and macroeconomic insights pulled from Jack Schwager's interview with Ray Dalio of Bridgewater Associates. 

You've probably heard of Ray Dalio if you have even a cursory knowledge of the hedge fund industry (or the Forbes billionaires list), so let's get right to it. These notes will fill in the rest of the story. 

1). Dalio is the founder and former CEO (now "mentor") of Bridgewater Associates, a fund that has returned more money ($50 billion) for investors than any hedge fund in history.  

2). Bridgewater still manages to achieve excellent returns on a huge base of capital and has done so over a long period of time. It is among the few hedge funds with a 20-year track record. 

3). Dalio believes that mistakes are a good thing, as they provide an opportunity for learning. If he could figure out what he (or someone else) was doing wrong, he could use that as a lesson and learn to be more effective.

4). His life's philosophy and management concepts are set down in a 111 page document called, Principles, which drives the firm's culture and daily operations. Identifying and learning from mistakes is a key theme. It also advocates "radical transparency" within the firm; meetings are taped and employees are encouraged to criticize each other openly.

5). "The type of thinking that is necessary to succeed in the markets is entirely different from the type of thinking required to succeed in school". Ray notes that school education emphasizes instructions, rote learning, and regurgitation. It also teaches students that "mistakes are bad", instead of teaching the importance of learning from mistakes. 

6). If you are involved in the markets, you must learn to deal with what you don't know. Anyone involved in markets knows you can never be absolutely confident. You can't approach trading by saying, "I know I'm right on this one." Dalio likes to put his ideas in front of other people so they can shoot them down and tell him where he may be wrong. 

7). "The markets teach you that you have to be an independent thinker. And any time you are an independent thinker, there is a reasonable chance you are going to be wrong."

8). Ray learned in his early working years that currency depreciation and money printing are good for stocks. He was surprised to see US stocks rise after Nixon closed the gold exchange window in 1971 (effectively ending the gold standard). The lesson was reinforced when the Fed eased massively in 1982 during the Latin American debt crisis. Stocks rallied, and of course, this marked the beginning of an 18-year bull market.

9). From these earlier experiences, Dalio learned not to trust what policy makers say. He has learned these lessons repeatedly over the years (much like our previous "Market Wizard", Colm O'Shea).  

10). Dalio vividly recalls a time when he was nearly ruined trading pork bellies in the early 1970s. He was long at a time when bellies were trading limit down every day. He didn't know when the losses would end, and every morning he'd hear the price board click down 200 points (the daily limit) and stay there. The experience taught him the importance of risk management - "I never wanted to experience that pain again".

11). "In trading you have to be defensive and aggressive at the same time. If you are not aggressive, you're not going to make money, and if you are not defensive, you are not going to keep money.". 

12). Bridgewater views diversification and asset correlation differently than most. As Dalio puts it, "People think that a thing called correlation exists. That's wrong.". Instead, he describes a world in which assets behave a certain way in response to environmental determinants. Correlations between say, stocks and bonds, are not static, but are changing in response to "drivers" (catalysts) that can cause assets to move together or inversely.

13). By studying how asset prices move in response to certain drivers, Bridgewater looks to build portfolios of truly uncorrelated assets. By combining assets that have very slight correlations, they are able to diversify among 15 assets (instead of 100 or 1000 more closely linked assets). This helps them cut volatility and greatly improve their return/risk ratio. 

14). We are currently in the midst of a "broad global deleveraging" that is negative for growth. Since the United States can print its own money, it will do so to alleviate the pressures of deflation and depression. The effectiveness of quantitative easing will be limited, since owners of bonds purchased by the Fed will use the money to buy similar assets. Dalio elaborates on our future economic course and possible policy approaches to these problems throughout the interview.

There's a lot more in Schwager's chapter with Ray Dalio. These notes just scratch the surface on Bridgewater's process and their quest for the Holy Grail of investing

There is also an addendum to the chapter containing Dalio's big picture view of long-term economic cycles and a historical "stage analysis" of the economic rise and fall of nations.

Be sure to check out this latest Market Wizards book (a very worthwhile read) and look for our upcoming posts for more "Lessons from Hedge Fund Market Wizards". In the meantime, you'll find more lessons and interviews in our related posts below. 

If you're enjoying these posts and would like to see more, please subscribe to our free RSS updates and follow Finance Trends in real-time on Twitter and StockTwits. You can also check out our related posts below for more market wisdom and trading insights.  


Related posts:

1. Lessons from Hedge Fund Market Wizards: Colm O'Shea.

2. Jack Schwager interviews on Hedge Fund Market Wizards.

3. Ray Dalio in Barron's: "It's a D-Process"

4. Ray Dalio's 'Principles'.

*Photo credit: Ray Dalio Blog.

Monday, November 26, 2012

Lessons from Hedge Fund Market Wizards: Colm O'Shea

Colm O' Shea Hedge Fund Market WizardsIn our first installment of "Lessons from Hedge Fund Market Wizards", we examine the lessons offered in Jack Schwager's interview with noted global macro trader and hedge fund manager, Colm O'Shea of COMAC Capital. 

Last week we brought you a brief overview of Hedge Fund Market Wizards, including several interviews with author Jack Schwager sharing trading insights found within this new Market Wizards volume. 

We'll expand on those ideas throughout this series by zeroing in on our favorite interviews and highlighting some key lessons and quotes. Of course, our notes are just a sample of what readers will find in these interview chapters - we don't want to give away the store!  

Today, we'll look closely at some key insights offered in the book's opening chapter. Here are our notes on Schwager's interview with Colm O'Shea

1). Colm O'Shea began his career as a young economic forecaster. He was kept behind closed doors by his firm, who did not want clients to know their research reports and forecasts were written by a 19-year old who had landed the job before starting at university. 

2). Colm realized he did not want to continue publishing consensus-hugging forecasts, and he landed his first job as a trader at Citigroup after graduating from Cambridge. He went on to work for George Soros' Quantum Fund before founding his own firm, COMAC Capital.

3). O'Shea view his trading ideas as hypotheses. Moves counter to the expected direction are proof that his trade hypothesis is wrong. O'Shea is quick to liquidate these positions when they reach a pre-defined price (a level at which his trade hypothesis is invalidated). He risks a small percentage of his assets on each trade - position sizing. 

4). Received early lessons in trading and macro thinking by reading Edwin Lefevre's classic, Reminiscences of a Stock Operator. Colm points out that the character, Mr. Partridge teaches the protagonist (a thinly-veiled Jesse Livermore) to size up general conditions - "it's a bull market, you know!". 

5). Price movements take place in the context of a larger fundamental landscape. O'Shea believes one must pay attention to both the fundamentals and the technicals (price as seen through technical analysis) to make sense of the picture.
 
6). In his first week as a trader, the British pound was kicked out of the ERM (the famous Soros trade), much to his surprise. Recalls Colm, "I had absolutely no comprehension of the power of markets vs. politics. Policy makers [often] don't understand that they are not in control...it's the fundamentals that actually matter."

7). You can't be short just because you think something is fundamentally overpriced. In the example of the Nasdaq bubble, you should have been selling Nasdaq at 4,000 on the way down, not on the way up. Wait until the market turns over, or until you can see a turning point (a la George Soros shorting the pound).

8). Being short credit in 2006-2007 was the same as being short Nasdaq in 1999. Bubble pricing was evident and the problems were obvious. However, being short was a negative carry trade (in which one must pay a certain cost to maintain a speculative position through instruments such as credit default swaps) and credit spreads went lower (the trade went against you) before a turning point was reached. 

9). All markets look liquid in a bubble. It's liquidity afterwards that matters. Can you get out?

10). There does not have to be an identifiable reason for every trade. O'Shea cites the LTCM blowup in '98 as an example. At the start of the '98 crisis, there was no LTCM story in the press, but T-bond futures were limit up every day. "Once you realize something is happening, you can trade accordingly.". Trade hypothesis = something big is happening. I will participate, but do so in a way that I can get out quickly if wrong.

11). Most great trades are incredibly obvious to everyone after the fact. O'Shea points to his bearish turn at the start of the financial crisis in August 2007, when money markets seized up and LIBOR spiked. To this day, equity people wrongly point to March 2008 (Bear Stearns collapse) as the start of the crisis. The great trades don't require predictions, but you must see what other market participants won't.

12). Big price changes occur when people are forced to reevaluate their prejudices. Crisis (such as the inflationary threat from growing U.S. debt) may hit in the future when people notice and start to care. Bond yields will only signal there's a problem when it's too late. Fundamentals underlying the trade/event exist all along.

Hope you enjoyed the first in our series of "Lessons from Hedge Fund Market Wizards". Look for our next post, featuring hedge fund titan Ray Dalio, later in the week. 

If you're enjoying these posts and would like to see more, please subscribe to our free RSS updates and follow Finance Trends in real-time on Twitter and StockTwits. You can also check out our related posts below for more market wisdom and trading insights

Related posts:

1. Lessons from Hedge Fund Market Wizards: Steve Clark.

2. Lessons from Hedge Fund Market Wizards: Ray Dalio.

Tuesday, November 20, 2012

Jack Schwager on Hedge Fund Market Wizards

If you're a fan of the Market Wizards books by Jack Schwager, then you've probably read (or are looking forward to reading) the latest in the series, Hedge Fund Market Wizards.

Hedge Fund Market Wizards book Jack Schwager
The review copy Wiley was kind enough to send me this summer. I've taken my sweet time re-reading it...

We'll be taking an in-depth look at this book and the insights of the "Hedge Fund Wizards" in an upcoming series of posts, but for now I'd like to share some key interviews and webinars with author Jack Schwager. 

These videos will give you a great inside look at Schwager's writing process, as well as offering some key lessons found in this new collection of interviews with leading traders and hedge fund managers. 

First, an Opelesque interview with Schwager in Manhattan: "15 Hedge Fund Market Wizard trading secrets and insights".



This discussion opens by noting that while markets have changed since the first Wizards books were published, the main principles behind the various traders' successes have not. Certain strategies and opportunities may have gone by the wayside, but successful traders have continued to hone in on what works for them as they strive for superior risk adjusted returns.  

Of supreme importance, Schwager finds, is the need to find a trading method that suits your personality. He cautions young traders from trying to emulate their trading heroes, since top traders may have an approach or strengths that differ from those of the would-be apprentice. You need to develop your own approach. 

If you enjoyed this interview and would like to dig further, check out Michael Martin's interview with Jack Schwager, as well as this Q+A webinar on the behaviors of Hedge Fund Market Wizards

One recurring theme that runs through these discussions is the quote, "There is no single true path". The Market Wizards profiled in this book, and throughout the series, have all found success by managing risk and pursuing the methods that suit their personalities and strengths. 

Join us next week, as we examine some key "Lessons from Hedge Fund Market Wizards" in our upcoming post series of the same name. See you then.

Update: Find the latest "Lessons from Hedge Fund Market Wizards" posts here.        

If you're enjoying these posts and would like to see more, please subscribe to our free RSS updates and follow Finance Trends in real-time on Twitter and StockTwits 

Wednesday, November 14, 2012

Dell: a '90s market leader digests its prior gains

Happened to glance at the daily chart of DELL today. 

While I wouldn't be surprised if the stock caught a bit of a bounce into 2013 (once year-end tax loss selling is exhausted), I'm not exactly bullish on the longer-term picture for DELL. 

Here's why, from a purely technical (price) view. Backing up to the weekly chart, we see DELL approaching its early 2009 lows near the $7.85 - $9 levels. If it can hold above those lows and rebound higher after a dismal 2012, that would provide a cyclical respite from what has been an overall bearish trend since early 2000.  However, even a months-long rebound and a 50%-60% rise wouldn't negate the longer-term bearish trend. 




Zooming out to the monthly chart, we see the secular bullish trend that took DELL from an adjusted price of $0.09 in 1990 to a high of over $50 (a 600-fold increase) by the bull market peak of early 2000. 


During this nearly-unprecedented boom, DELL was a market leader among US stocks. The company reached a peak market cap. of $100 billion in March 2000 and its stock gained over 60,000 percent in the 10 years prior. 

After the dot-com bubble crashed in 2000-2001, the stock made a valiant effort to regain its old highs, climbing back to the low $40s in the bull move of 2004-2005. It was not enough, as the secular bear trend and an ever-changing tech environment continue to take their toll on DELL.  We can see the ensuing decline on the monthly chart above.

When I look at DELL's 23-year chart, I see a fallen leader slowly digesting the monster gains of a secular bull move. In fact, it reminds me of a python digesting a very large meal - lots of time and rest are required to complete the process. 

If you are squeamish, please don't click the python link. Nature, like the markets, can appear to be very cruel at times.

Thursday, November 01, 2012

Sayonara Panasonic, hello Samsung and Apple?

Taking a look at the charts of Panasonic and Sony today, in light of Panasonic's $9.6 billion loss for the year ($25 billion in losses over five years) and the steadily eroding Japanese consumer electronics business.  



While Panasonic, Sony, and Sharp have been getting killed in the TV and electronics marketplace (and in the share market) over the past few years, others have prospered. 

Apple, which is increasingly seen as more of a design-focused electronics maker, as opposed to a computer company, has seen its stock price quadruple in price over the last five years. 



The US design-meets-Chinese manufacturing combo has helped Apple out-innovate its competitors and undercut their cost structure. A strong yen has also hindered exports of Japanese electronics. 

Samsung has been rising to the top and is now dominating the smartphone market along with Apple. In fact, the two now account for 106 percent of handset profits. That's right, the total is greater than 100% when offsetting losses of the other handset makers. 

 

So while the Japanese firms (who ate everybody's lunch in the '70s and '80s) struggle, Apple, Samsung, and US-based Vizio are making hay. Look no further than the charts above; they clearly show the shift towards the dominance of Korean and US firms (aided by low-cost foreign manufacturing) in electronics. 

So if you're trading or investing in an industry, and you see a trend unfold like this, be sure to go long or short along the line of least resistance - that's with the trend and not against it.