How Steve Cohen Traded The Bursting Of The Dot Com Bubble
By Nick Colas of DataTrek Research
This week’s Story Time Thursday is about “Patience”, and I (Nick here …) will start with a brief anecdote from my time at SAC Capital back in 2000:
Just after the peak of the dot com bubble in March, it was not immediately clear which way the US equity market was headed.
Many thought the momentum would return soon enough. Others were more cautious, but most bears had been wrong for years. It was therefore hard to take them seriously.
Going into a Fed meeting day in mid-2000, Steve had set up his portfolio very short S&P futures.
Because every trader in the room was allowed to see his pad, we all followed suit. Everyone was max-out short, confident in Steve’s market call even though it wasn’t exactly clear what he saw.
Stocks opened up that morning, and then headed higher still.
The room was dead quiet, as every trading desk will be when experiencing sharp, sudden losses.
Then Steve did something I had never seen him do before: he left the desk and went downstairs to have lunch with his family. At the time, SAC shared space with GE Capital in a Stamford, CT office building. When I went down to the cafeteria to get lunch a little while later, I saw Steve chatting with his kids and wife while munching on some fish sticks. He didn’t really seem to have a care in the world.
At 2:00pm, with Steve back on the desk, we all waited for the Fed decision. It was another rate hike. But instead of selling off, the S&P just kept going up. The only sound in the room was Steve’s assistant calling out S&P levels, each one higher than the last, her voice growing more urgent with each number. Had Steve misread the tape?
After about 15 minutes, though, the S&P leveled out and started to drop.
First by just a little, but then it went into free fall. The whole firm’s P&L swung from dangerously in the red to deeply profitable.
At 4pm, with all his shorts covered, Steve stood up and addressed the room: “And that’s how you do it … I’m going home now”. We gave him a standing ovation.
I’ve thought a lot about that day in the last 20 years, and not just because it so neatly encapsulates the experience of equity day trading in its late 1990s – early 2000s heyday.
It taught me that:
#1) Conviction matters.
We used to have a debate on the desk at SAC: was Steve so good because he was already worth a billion dollars and could afford to take risk, or did his net worth come from his ability to only scale and stick with bets where he had the highest conviction? Days like the one I just described always made us realize it was the latter.
There is more to that point, though. Many years later, I met a data team that had done a deep diagnostic analysis of hundreds of hedge funds. They looked primarily at what separated top decile performing funds from the rest of the pack.
They found that much of the slippage in underperforming funds came from a myriad of small portfolio positions that collectively ate away at returns. Some were losers, yes, but many were winners that weren’t sized large enough to make a real difference in the portfolio. Top performing funds owned winners in size; lesser funds were involved as well, but only in a small way.
No prizes for guessing why that happened: conviction. Mediocre funds had enough of an investment process to unearth good ideas, but not enough to size them correctly. They weren’t willing to make a larger bet because they knew they would not be able to patiently sit out any volatility that might arise if it were 5 percent of the portfolio rather than 0.5 percent.
Takeaway: conviction and sizing are what separated Steve, and every other great investor I’ve ever met, from the merely “very good”. It’s not enough to find ideas that work. The real magic is in making them count.
#2: Use whatever mental hacks you need to foster patience.
Steve’s was getting off the desk for an hour. Other highly successful investors I’ve met over the years literally turned off their screens or took a symbol off their monitors.
This is not to say one can just blindly buy an asset and hold it whatever comes. Productive patience means following many rules. A few of my personal favorites:
Don’t buy new lows.
Don’t short new highs.
Always scale in and out of positions.
Set stop losses where you re-evaluate your point of view.
Always look for new ideas.
Admit when you’re wrong and move on.
Takeaway: the story about Steve on Fed Day is not meant to celebrate blind patience, but rather to show how patience fits in the context of a broader, disciplined approach. If Steve had been wrong on that day, he would have still stuck to his process the next day and the day after that. No one has a 100 percent hit rate in this business.
Final thought: the ability to be patient is, in the end, always a function of conviction and environment. Since we have little control over environment, especially with capital markets, the only effective way to cultivate patience is to build and follow a process that increases conviction in the context of prevailing circumstances.
Ironically, low volatility markets such as what we have now demand more patience and conviction than when prices are choppier. Even a 1 percent position in a spicy name can meaningfully help portfolio returns when the VIX is at 40. But when the VIX is below 20 (today’s close was 18), it’s an entirely different game. The current environment demands a focused investment approach, not a scattershot one.
Yes, this is hard, but as Steve said, “That’s how you do it”.
Mon, 06/21/2021 – 05:00