Lessons from Colm O’She’s interview in the Hedgefund Wizards.

There are traders with divergent techniques but I think we can draw a few lessons from O’shea’s trading style. Have added my own commentary

Money management

Money management could be counter-productive if it’s inconsistent with underlying trade analysis. Many traders have the discipline to set exits and stick with them but make the critical mistake of determining the exit points as pain thresholds rather than price levels that disapprove their original trade premise. When they get out of a market position, they still believe the original idea was correct. As a result, there will be strong temptation to get back into the trade, leading to multiple losses on the same idea. First decide at what point your hypothesis will be wrong, then set exit.

 

I think it applies for fundamental traders as well, instead of buying more shares solely because the share is dropping it would be better checking whether the reasons that made you buy in the first place still hold before deciding on the next move.

Bubbles

You need to be early, the worst thing is being stubborn and late to convert. The best way to trade a bubble is to participate on the long side to profit from the excessive euphoria, not to try and pick tops, which is nearly impossible and an approach vulnerable to large losses if one is too early. Its easier to trade from the long side because its often relatively smooth. Two components necessary in trading a bubble. 1. Initiate a trade early in the bubble 2. Bubbles are prone to abrupt sharp downside reversals. Its critical that the long biased position is structured such that with worst case scenario is limited. If possible, hedge.

Fundamentals

Although macro trades are based on fundamental market view, there does not always need to be a reason for the trade. Sometimes price action itself can reveal that something important is going on, even if the fundamental is not apparent. He cites a situation in the course of LTCM’s demise, an event that strongly impacted the market. He didn’t know the reason for the market action at the time, he reasoned that the magnitude of the move implied that there was an important fundamental development He quotes George Soros: Invest first, investigate later.

I think an example would be CiC, when it broke out, there was some skepticism at first from some traders, then rumors started surfacing as it rallied higher and by the time it was starting to get clear as to what the real reason was, it turned around and corrected lower. As long as price behavior is bullish and the company is good, might as well ride the move higher.

It’s important to not get attached to an idea and to always be willing to get out of a market position if price action is inconsistent with the trade hypothesis. He sites Soro’s master of flexibility who has no attachment to his trade and shows the least regret about getting out of a position of anyone he has ever met.

(Colm O’Shea is a macro trader and has never had a losing year. Majority of his track records spanning years at Citigroup and Soros Fund is not available to the public)