Today Steve Cohen is a multi-billionaire managing a $14 billion hedge fund, SAC Capital.
So it’s not surprising that he shies away from the media — especially now, as his firm is somewhat entangled in the latest insider trading scandal.
But in the interview below, from Cohen’s early days as a hedge fund manager, he reveals a lot, including some of his favourite trades, mistakes traders make, and how Wharton didn’t help him much.
The interview is an especially great read for anyone who’s interviewing with SAC.
“One of the questions I ask [potential employees] is: “Tell me some of the riskiest things you’ve ever done in your life.” I want guys who have the confidence to be out there; to be risk takers,” says Cohen.
An excerpt from the interview is below. Click here to download the full interview.
Did your economics education at Wharton help at all in your career as a stock trader?
Not much. A few things they taught you were helpful.
They taught you that 40 per cent of a stock’s price movement was due to the market, 30 per cent to the sector, and only 30 per cent to the stock itself, which is something that I believe is true. I don’t know if the percentages arc exactly correct, but conceptually the idea makes sense.
When you put on a trade arid it goes against you, how do you decide when you’re wrong?
Because of a catalyst, the first thing I check is whether The catalyst rule applies. For example, about a month ago, I expected that IBM would report disappointing earnings, and I went short ahead of (the report. I was bearish because a lot of computer and software companies were missing their numbers [reporting lower than expecled earnings] due to Y2K issues. Customers were delaying the installation of new systems because with the year 2000 just around the corner, they figured that they might as well stick with their existing systems. I went short the stock at $169. The earnings came out, and they were just: phenomenal—-a complete blowout! I got out sharply higher in alter-the close trading, buying back my position at $187. The trade just didn’t work. The next day the stock opened at $197. So thank God I covered that night in alter-hours trading.
Has that been something you were always able to do—that is, turn on a dime when you think you’re wrong?
You better be able to do that. This is not a perfect game. I compile statistics on my traders. My best trader makes money only 63 per cent or the time. Most traders make money only in the 50 to 55 per cent range. That means you’re going to he wrong a lot. If that’s the case, you better make sure your losses are as small as they can be, and that your winners are bigger.
Any trade stand out as being particularly emotional?
I held a 23 per cent position in a private company that was bought by XYZ.
XVZ had a subsidiary, which had an Internet Web site for financial commentary. They decided lo take this subsidiary public. XYZ stock started to run up in front of the scheduled offering, rallying to $13, which was higher than it had been at any lime I held it. I got out, and was happy to do so.
The public offering, which was originally scheduled for December, was delayed and the stock drifted down. A few weeks later, they announced a new offering date in January, and the stock skyrocketed as part of the Internet mania. In two weeks, XYZ went up from $ 10 to over $30.
I couldn’t stand the idea that after holding the stock for all those years, J got out just before it exploded on the upside. But I was really pissed off because I knew the company, and there was no way the stock was remotely worth more than $30. The subsidiary was going public at $15. If it traded at $100, it would be worth only about $10 to the company. If it traded at $200, it would add only about $20 to the company’s value. The rest of the company was worth maybe $5. So you had a stock, which under the most optimistic circumstances was worth only $15 to $25, trading at over $30.
I started shorting the hell out of the stock. I ended up selling 900,000 shares of stock and a198couple of thousand calls. My average sales price was around $35, and the stock went as high as $45. On Friday, the day of the offering, XYZ plummeted. On Friday afternoon I covered the stock at $22, $21, and $20. 1 bought back the calls, which I had sold at $ I 0 to $15, for $ 1.
This trade worked out phenomenally well. But when you go short, the risk is open- ended. Even here, you said your average price was around $35 and the stock did go as high as $45. What if it kept going higher? At what point would you throw in the towel? Or, if your assessment that the stock was tremendously overvalued remained unchanged, would you just hold it?
A basic principle in going short is that there has to be a catalyst. Flere, the catalyst was the offering. The offering was on Friday, and I started going short on Tuesday, so that I would be fully positioned by that time. If the offering took place, and the stock didn’t go down, then I probably would have covered. What had made me so angry was that I had sold out my original position.
So you got redemption.
I got redemption. That was cool.
What happens when you are short a stock that is moving against you, and there is no imminent catalyst? You sold it at $40, and it goes to $45, $50. When do you get out?
It a stock is moving against me, I’m probably buying in some every day.Even if there’s no change in the fundamentals? Oh sure. I always tell my traders, “If you think you’re wrong, or if the market is moving against you and you don’t know why, take in half. You can always put it on again.” If you do that twice, you’ve taken in threequarters of your position. Then what’s left is no longer a big deal. The thing is to start moving your feet. I find that too many traders just stand there and let the truck roll over them.
A common mistake traders make in shorting is that they take on too big of a position relative to their portfolio. Then when the stock moves against them, the pain becomes too great to handle, and they end up panicking or freezing.
What other mistakes do people make?
They make trades without a good reason. They step in front of freight trains. They short stocks because they are up, as if that were a reason. They’ll say, “1 can’t believe the stock is so high,” and that’s their total research. That makes no sense to me. My response is: “You have to do better than that.” I have friends who get emotional about the market. They fight it. Why put yourself in that position?
But the XYZ trade that you told me about, wasn’t that fighting the market?
The difference is that there was a catalyst. I knew the offering was scheduled for Friday. I knew what was going on. I also knew what I expected to happen. It was actually a well- planned trade, even though I was pissed off at having liquidated my stock position so much lower.
What else do people do wrong?
You have to know what you are, and not try to be what you’re not. If you are a day trader, daytrade. If you are an investor, then be an investor. It’s like a comedian who gets up on stage and starts singing. What’s he singing for? He’s a comedian. Here’s one I really don’t understand: I know these guys who set up a hedge fund that was part trading and part small cap. Small caps are incredibly illiquid, and you have to hold them forever—it’s the exact opposite of trading!
How do you interact with the traders who work for you?
I have different traders covering different sectors for a number of reasons. There are a lot of people in the room, and it would be cumbersome to have different traders trading the same names. Also, since we’re trading over one billion dollars now, we want to cover as many situations as we can. This firm is very horizontal in nature, and I’m sort of orchestrating the whole thing. You could say I’m the hub and the traders are the spokes.
How do you handle a situation when a trader wants to put on a trade that you disagree with? I don’t want to tell my traders what to do. I don’t have a corner on what’s right. All I want to do is make sure they have the same facts that I do, and if they still want to do the trade, then they can. Iencourage my guys to play. I have to. I’m running over one billion dollars. I can’t do it all myself.
How do you pick your traders?
A lot of the traders who work here were referred to me. I have also trained people who have grown up within the system. I’ve had people who began as clerks and are now trading tens of millions or dollars, and doing it very well.
One thing I like to do is pair up traders. You need a soundingboard. You need someone who will say, “Why are we in this position?” There is a check and balance, as opposed to being in your own world. We also have teams where the trader is teamed up with an analyst of the same industry. I like that idea because it helps the trader learn the subtleties of the industry and understand what factors really move the stocks in that sector.
Are these trading teams informal or are they literally pooling their trading capital?
No, they’re working together. Their livelihood depends on each other.
Have you seen improvements in the trading performance by using this team approach?
The results speak for themselves.
Was the team approach your idea?
It was an evolutionary process. Most traders want to trade everything. One minute they are trading Yahoo, the next Exxon. They’re traders! My place operates very differently. I want my traders to be highly focused. I want them to know a lot about something, instead of a little about everything.
That means they can’t diversify.
They can’t, but the firm is diversified. As long as they can trade the short side as well as the long side, I don’t think anyone in this room thinks being focused on a single sector is a negative.
Are you looking for any special skills when you hire potential traders?
I’m looking for people who are not afraid to take risks. One of the questions I ask is: “Tell me some of the riskiest things you’ve ever done in your life.” I want guys who have the confidence to be out there; to be risk takers.
What would make you wary about a trader?
I’m concerned about traders who wait for someone else to tell themwhat to do. I know someone who could be a great trader. He has only one problem: He refuses to make his own decisions. He wants everyone else to tell him what to buy and sell. And then when he’s wrong, he doesn’t know when to get out. I’ve known him for a long time, and he’s done this all along.
Do you give him advice?
Yeah! It doesn’t matter. He still does it. He finds a new way to make it look like he’s making his own decisions, but he really isn’t. Ironically, if he just made his own decisions, he would do great. Obviously, on some level he’s afraid. Maybe he is afraid of looking stupid.
Of the tens of thousands of trades that you have done, do any stand out?
One time, I shorted a million shares of a stock and it dropped $10 the next day. That was pretty good.
What was the story there?
Without naming any names—or else the company will never speak to me again—there were a number of other stocks in the sector that were under pressure, but this stock was going up because it was being added to the S&P index. I figured that once the index fund buying was completed, the stock would sell off. The day after I went short, the company reported disappointing earnings, and the trade turned into a home run.
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