According to Jim Leitner, that is the key thing that can differentiate who would make big money in the market. Leitner, an eminent macro trader, says an investor must not let emotions get the better of them while investing and should accept the fact that she is bound to incur losses from time to time in the investment journey.
He says investors should not let bad days impact the way they would approach market in the future.
“I was absolutely unemotional about the numbers. Losses did not have an effect on me, because I viewed them as purely probability-driven, which meant sometimes you came up with a loss. Bad days, bad weeks, bad months never impacted the way I approached the market the next day. To this day, my wife never knows if I’ve had a bad day or a good day in the market,” he said in an interview toSteven Drobny, which was published in Drobny’s bestseller
Inside the House of Money.
Jim Leitner is the head of Falcon Investment Management, and was previously a member of Yale Endowment’s Investment Committee.
He is famous for amassing spectacular returns by using an investment approach that helped him make money across asset classes. His trading principles are based on finding the right price and structure in a company, not losing money and remaining humble.
His vision and clear thought process about hedging, risk management, cash and a number of other investment topics are well appreciated and respected in the investment industry.
In his interview to Drobny, Leitner reveals a few tips for investors to build the right trading approach, which he says can help them achieve success in their investing career.
Never stop learning
An investor should not stop learning and should be open to new ideas and opportunities. If one makes the mistake of thinking she is a lot smarter than everybody else, that’s when the market teaches her a lesson.
“Many traders I’ve met over the years approach the market as if they’re smarter than other people until somebody or something proves them wrong. I have found this approach eventually leads to disaster when the market proves them wrong,” says he.
He says one should remain humble and down to earth, no matter how well she may be doing in the market. “I am really humble about my ignorance. I truly feel that I am ignorant despite having made enormous amounts of money. I am relatively wealthy and happy to be independent, but there’s never a day when I feel a lot smarter than everybody else,” Leitner says.
Don’t get restricted to one investment style
Young investors should be open to trying different investing styles in different geographical locations, as one never knows where they might find a great investment opportunity.
Leitner also feels one should not try to become too much of an expert in only one specific area and should constantly broaden her horizon and look for newer and better investment opportunities.
“Aspiring traders should be open to the entire spectrum of market experiences. I never locked myself down to investing in one style or in one country, because the greatest trade in the world could be happening somewhere else. My advice would be to make sure that you do not become too much of an expert in one area. Even if you see an area that is inefficient today, it’s likely that it won’t be inefficient tomorrow. Expertise is overrated,” says he.
Invest in options to hedge risk
Leitner feels one should include investing in options in a trading strategy, as it is a great way of managing the risk involved in investing.
“Options take away the whole aspect of having to worry about precise risk management. It’s like paying for someone else to be your risk manager. I know I am long XYZ for the next six months. Even if the option goes down a lot in the beginning to the point that it is worth nothing, I will still own it. You never know what can happen,” he says.
Investors should not become overconfident and stay humble when they start getting some amount of success in the investment world.
Leitner says investors sometimes become so overconfident that they feel they have cracked the secret to success in the market, but that’s when they witness the hardest fall.
“It’s not possible to ‘crack’ the market. You’re guaranteed to eventually be proven wrong no matter how smart you are. When that time comes, you have to stop the bleeding before death occurs. The trading graveyard is littered with ‘smart guys’ who thought they solved the market puzzle… don’t be one of them,” Leitner says.
Be wary of compelling narratives
A compelling story about a company in a market can both be a blessing and a curse.
On one hand, understanding the dominant market story can keep investors on the right side of a powerful trend, while on the other hand, it can also lure one into some dumb trades as not all stories are fundamentally sound.
Leitner feels it often happens that a false trend gets formed and leads to a boom/bust in the market.
“We need to quantify things and understand why some things are cheap or expensive by using some hard measure of what cheap or expensive means. Then there has to be a combination of story and value. A story is still required because it will appeal to other people and appeal is what drives markets. If there’s no story and something’s cheap, it might just stay cheap forever. But if there’s a story involved, make sure that you first look at the numbers before you get involved to be sure there is some quantitative backing to the idea,” says he.
Leitner insists that before investing, one should do proper quantitative research on companies they are looking to invest in. If the quant research doesn’t give favourable results, then there’s a higher risk of falling into the trap of an overhyped narrative, says he.
“In equities, we start by looking at various valuation measurements like price to book, price to earnings and price to cash flow. It’s very important to not be too story-driven. A way to avoid that is by using quantitative screens to determine what is cheap. Once you find things that are cheap, then look for stories that argue why it shouldn’t be cheap. Maybe a stock is cheap but it’ll stay cheap forever, because there’s no good story attached to the cheapness,” he says.
Have a good reason for going short
There is always an incentive in the form of premium that investors get for investing in stocks and bonds for moving out of cash and taking risk.
Leitner feels being long on financial assets has a positive expected value over time and, hence, investors should have twice the normal conviction to go short.
He believes the investment system is designed to move higher over time. So, investors really need a good reason to fight that drift.
“Owning assets, or being long, is easier and also more correct in the long term in that you get paid a premium for taking risk. You should only give your money to somebody if you expect to get more back. Net-net, it is easier to go long because over long periods of time, you’re assured of getting more money back. Owning risk premia pays you a return if you wait long enough. So it’s a lot easier to be right when you’re going with the flow, which means being long. To fight risk premia, you have to be doubly right,” he says.
Follow a multi-strategy approach
Leitner says in trading he has adapted his strategy away from traditional global macros, in which he used trend following and gut feel to a multi-strategy approach.
According to him, investors should combine various system-based strategies across five main asset classes: equities, fixed income, currencies, commodities and real estate with the goal of earning the risk premium present in each category.
He says investors should reserve a certain amount of cash for special situations and big bets that only come a few times in a year.
“We start off by acknowledging that we are ignorant. So we need to be systematic, clip some coupons and earn some risk premia. It doesn’t matter if it is in currencies, bonds, commodities, real estate or equities. Of course we have to be smart about it by reading a lot, talking to smart people, and being on top of it all, while acknowledging that we’re not that much smarter than the rest of the world. Then, every once in a while, we’re going to stumble upon an exciting idea that’s going to give us some extra alpha and the ability to outperform,” says he.
Leitner believes investors should keep a last category which he calls absolute return where they should keep those great, out-of-the-box ideas that come across rarely.
This category, he feels, should be there to leave a portfolio open to making unsystematic money.
“Sometimes we’re lucky and find major mispricing once or twice a year, and sometimes we’re unlucky and it takes 18 months before the next one comes along. When we find these fantastic ideas, we’re willing to bet up to 10 per cent of our fund on one idea. One that we think will double or triple, earning an extra 10 or 20 per cent return for the entire portfolio,” Leitner says.
These tips, Leitner feels, can help investors withstand the boom and bust cycles of markets and achieve investing success.
(Disclaimer: This article is based on Jim Leitner’s interview with Steven Drobny for his book Inside the House of Money