Five Market Insights from Scott Bessent

Scott Bessent is probably the only one in the world who worked with investing legends like Jim Rogers, Jim Chanos, George Soros, and Stanley Druckenmiller in different stages of his career. He oversaw Soros’s $30-billion fortune between 2011 and 2015. Last year, he launched his own fund. Here are some of his more interesting market insights:

Short-selling is a unique and specific mindset

I went to work with Jim Chanos, who just did short selling. Jim was always trying to go against the crowd. He constantly picked things apart and looked for what the market had wrong.
One thing Jim was never great at was figuring out why it would end. He never really looked for the catalyst that would change the market’s focus. He was usually right, but what I’ve learned since is that it’s more important to be there when a mania ends, that spotting it early.
What I came away with from my time with Chanos was that you don’t have to be skeptical about everything.
There are also other problems with shorting. There’s a difference between investing or buying stocks and shorting. If you are a long/short player and one of your longs goes down 10 or 20 percent, you’ll buy more. If one of your shorts goes up 10 or 20%, you’ll get out.

On how Soros and Druckenmiller “broke” the Bank of England

The breaking of the pound was a combination of Stan Druckenmiller’s gamesmanship – Stan really understands risk and reward — and George’s ability to size trades. Make no mistake about it, shorting the pound was Stan’s idea. Soros’s contribution was pushing him to take a gigantic position.
With the pound, we realized that we could push the Bank of England up against the trading band where they had to buy an unlimited amount of pounds from us. The plan was to trade the fund’s profits and leverage up at the band’s boundary. The fund was up about 12 percent for the year at the time, so we levered the trade up to the point where if they pushed us back up against the other side of the trading band, we would lose the year’s P&L but not more.
The UK economy was already weak, so when they raised interest rates to defend the currency, the average person’s mortgage went up. They basically squeezed everyone in the UK with a mortgage. When they raised rates from 7% to 12% with the stated goal of defending the pound, we knew it was unsustainable and they were finished.

On his worst trade

Being short Internet stocks too early in 1999. Right trade, wrong time. It taught me the lesson that you can be right and lose all your money. Also, if a stock is going to zero it doesn’t matter where you short it, you’re still going to make 100% because you can short on the way down. You made just as much money shorting $100 million in Enron at $25 as you did shorting $100m at $50. it ‘s better to have more conviction and do twice as much.

Stock Picking is full of macro bets

Recently, I was at a money manager roundtable dinner where everyone was talking about “my stock this” and “my stock that”. Their attitude was that it doesn’t matter what is going to happen in the world because their favorite stock is generating free cash flow, buying back shares, and doing XYZ. People always forget that 50% of a stock’s move in the overall market, 30% is the industry group, and then maybe 20% is the extra alpha from stock picking. And stock picking is full of macro bets. When an equity guy is playing airlines, he’s making an embedded macro call on oil.

In trading, when there’s nothing to do, the best thing to do is nothing

Soros used to give out a lot of money for other people to manage. George wasn’t bothered when people started losing money, but he was always worried that they weren’t feeling the pain properly because it was his money and not theirs. If people managing his money were down in November or December and he saw their trades getting bigger, he’d pull the money immediately. Also, if the manager was down and their trading volume picked up dramatically, he’d pull it. The worst thing you can do when you are having a hard time is flail. In trading, when there’s nothing to do, the best thing to do is nothing.

Source: Inside the House of Money, Steven Drobny

Five Market Insights from Jim Leitner

The right trading mindset

I was absolutely unemotional about 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 markets the next day. To this day, my wife never knows if I’ve had a bad day or a good day in the markets.

Learning never stops

I am really humble about my ignorance. I truly feel that I am ignorant despite having made enormous amounts of money. I calculated the other day that I have taken over $2 billion out of the market for my investors and employees so far. That seems like a lot of money and yes, I am relatively wealthy and happy to be independent, but there’s never a day when I feel a lot smarter than everybody else.

An advice to aspiring traders

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.

On the benefits of using options

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. Meanwhile, 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 and you never know what can happen.

I once owned a one-year option on the euro swap rate that became worthless soon after I bought it. Then, with two weeks to go to expiry, the swap rate came back my way and blew through my strike. After being worthless for 11 months, I ended up selling it for five times what I paid for it.

Short-dated volatility is too high because of an insurance premium component in short-dated options. Longer-dated options are priced expensively versus future daily volatility, but cheaply versus the drift in the future spot price.

Every Friday, we go out and buy one-year straddles. We admit that we’re ignorant but we expect that sometimes, over a year, there will be enough trend that we will make money. So, yes, we overpay for options but that doesn’t mean that we don’t make money. If the option maturity is long enough, trends can take us far enough away from the strike that it’s okay to overpay.

Hedge fund money is not the smart money

The big thing that distinguishes the real money world from the hedge fund world is redemptions. Universities don’t have redemptions, nor do family offices. Both are going to be around for years so they invest for the long-term. Meanwhile, the hedge fund world industry invests for the one to three-month time horizon, which subjects managers to taking inefficiency risk and missing out on opportunities that are longer term in nature.

Source: Inside the house of money, Steven Drobny

Jesse Livermore on Why You Don’t Have to be Active Every Day in the Stock Market

First, do not be invested in the market all the time. There are many times when I have been completely in cash, especially when I was unsure of the direction of the market and waiting for a confirmation of the next move….Second, it is the change in the major trend that hurts most speculators.

Always remember; you can win a horse race, but you can’t beat the races. You can win on a stock, but you cannot beat Wall Street all the time. Nobody can.

There is the plain fool, who does the wrong thing at all times everywhere, but there is also the Wall Street fool, who thinks he must trade all the time. No man can have adequate reasons for buying or selling stocks daily– or sufficient knowledge to make his play an intelligent play.

Remember this: When you are doing nothing, those speculators who feel they must trade day in and day out, are laying the foundation for your next venture. You will reap benefits from their mistakes.

The Biggest Winners Are Usually A Pleasant Surprise

Peter Lynch has given the investment world a lot of market wisdom. Here is one of his most insightful thoughts:

The point is, there’s no arbitrary limit to how high a stock can go, and if the story is still good, the earnings continue to improve, and the fundamentals haven’t changed, “can’t go much higher” is a terrible reason to snub a stock. Shame on all those experts who advise clients to sell automatically after they double their money. You’ll never get a ten-bagger doing that.

Frankly, I’ve never been able to predict which stocks will go up tenfold, or which will go up fivefold. I try to stick with them as long as the story’s intact, hoping to be pleasantly surprised. The success of a company isn’t the surprise, but what the shares bring often is.

I am not a long-term investor like Peter Lynch. I am a swing and position trader and yet I agree with his statement. This is why I have never been a fan of hard price targets. I believe in having a time stop for swing trades – giving a stock a certain number of days to prove that it deserves to be held. I believe in having exit strategies in both, my swing and position trades. Those exit strategies are never based on a hard price level. They are based on price cycles and invalidation of trends on different time frames. My reasoning is simple:

  1. I don’t know which particular trade will end up being a winner. I know that I’ll be right at least 50% of the time and my average winner is bigger than my average loser.
  2. I don’t know what profit will a particular winner deliver. It could be 5% or 50%. I know the average size of my winners, but never what the individual return will be in advance.

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3 Questions Every Trader Should Ask

Preparation is the key to success in any field of life. Trading is not different. Here are three major questions every active trader should ask him/herself every morning/week.

1. Is it time to be short, long or on the sidelines and how aggressive should I be?

Are indexes overbought or oversold, do we see any momentum divergences, is there a good number of long setups.

What is the market reaction to earnings reports – do we see stocks selling off after strong reports or stocks rallying after weaker than expected reports. Nothing reveals the true market sentiment better than market reaction to earnings reports.

How aggressive should I be will define our risk per trade, the types of setups we will trade, how tight our stops will be and what our exit tactic will be.

What percentage of capital should I risk: for me it between 0.5% and 1% depending on the market environment. 0.5% in faster markets that change directions frequently. 1% in trending markets, up or down.

2. What type of setups should I focus on and why?

Do we buy strength (breakouts), do we buy weakness in established uptrends (pullbacks to rising moving averages), do we focus on recent IPOs, do we play a certain industry, should we look for mean-reversion setups, should we primarily look for short setups? Should we buy breakouts or could we afford to front-run and buy in anticipation of a breakout?

Holding period – should we be taking profits quickly (in 1-3 days) or let them run longer. How much room should we leave to our stocks? Where should we put our stops – make them tighter or leave them more room so we don’t get shaken out from normal pullbacks or rips.

Should we focus on intra-day trades or swing and position trades? For example, during deep market corrections volatility rises significantly and moves that typically happen in a month could happen in a day or two. This is the perfect trading environment for intra-day trades, because they allow us to risk very little to make a lot and we don’t risk to be on the other side of an overnight gap. During trending markets, we trading a market of stocks environment. Volatility is low and declining. The big moves happen over a period of multiple days and weeks. It makes a lot more sense to ride trends – be it with swing trades, which aim to capture 2 to 10% moves or position trades, which goal is to ride multi-week trends.

What industries are currently hot, if any? In a bull market, industry momentum accounts for half of a stock’s move. A crappy stock in a hot industry will outperform a great stock in an out of favor industry.

3. What are the three-four priority setups that we have lined up for the next day/week?