IDEA VELOCITY. What I learned from SAC. SAC, the infamous hedge fund led b mer!urial, se!

reti"e, su#er art !olle!tor Ste"ie Cohen is legendar . The ha"e re!entl been a!!used of insider trading and it sure loo$s li$e the are guilt . %ut there are a lot of "er smart #eo#le that &or$ed there that had nothing to do &ith this s!andal. '(s and anal sts in )edgistan dream of toiling there and ma$ing obs!ene ri!hes. As an unabashed trading addi!t and #la er of The *ame, I &as li$e a moth to the flame. I had to !he!$ this #la!e out. I did. Although b dumb lu!$ and a &ell+!alibrated %S dete!tor, I &as able to a"oid ,oining them, I did meet &ith them o"er a do-en times. I learned some #rin!i#les that ha"e !hanged m &a of trading fore"er. .or the good. Out of a s#irit of e/uanimit and gratitude, I &ill share them &ith ou.

0. 12LE O3E4 IDEA VELOCITY. This is so im#ortant and it &ill seem so ob"ious after I tell ou that ou &ill &onder &h no one tal$s about it. Let5s do some math. Let5s sa ou5re a long+short '( and ou t #i!all ha"e 06 longs and 7 shorts at an gi"en time. Call it 86 #ositions. If our a"erage holding #eriod is 9 months be!ause our #ortfolio turns o"er t&i!e a ear, &hi!h is fairl t #i!al for an a!ti"el managed sto!$ fund, that means ou need 6: #ositions #er ear. That is one high !on"i!tion idea #er &ee$; That doesn5t sound li$e all that mu!h, but tell me, do ou reall ha"e a dis!i#line in #la!e to !ome u# &ith at least one, highl resear!hed, &ell+thought out, high !on"i!tion idea #er &ee$< I5m not tal$ing about being #it!hed a /ui!$ sto!$ #i!$ b the sell+side either. . In te!h, things !hange fast, and sitting on &inners that ha"e stalled out too long is a mista$e. It5s also !alled !om#la!en! . The onl &a to $no& these numbers, su!h as our a"erage holding #eriod, number of #ositions, is to anal -e our trading re!ords ruthlessl and honestl . This is the !on!e#t of IDEA VELOCITY. 8. 'OSITIO3 SI=I3*. When ou find an idea, a high !on"i!tion sto!$ idea, ho& do ou build our #osition< Do ou s!ale in< Do ou bu half and another half later after ou see ho& the sto!$ trades< This is &hat most in"estors do. TOTALLY W1O3*. That5s right. If ou ha"e a high !on"i!tion, &ell+ resear!hed idea, &hat is the #oint in #utting on onl a half #osition< If our original #osition dro#s b 06>, &hat do ou do, bu more< Does that ma$e an sense< Or if it goes u# after ou bu it, es, it ma$es sense to bu more, but didn5t ou ,ust lose the gains ou &ould ha"e had if ou had the !o,ones to bu the &hole #osition at on!e< .urthermore, &hat are ou doing #utting on a ?half #osition@ if ou don5t ha"e the !on"i!tion to #ut on a full #osition. So &hen ou #ut on a #osition, do it all, at on!e, one da . 'OSITIO3 SI=I3*+ the $e to good #erforman!e. A. CAS) I3 T)E 'O1T.OLIO. )o& mu!h !ash should ou !arr in our #ortfolio< (ost '(s &ill #la around &ith the amount of !ash in their fund. Some e"en brag about ho& their #erforman!e for is all of the SB' u#side &hile being onl 96> in"ested, be!ause the are holding A6> in !ash. What $ind of stu#id logi! is this< If I5m #a ing ou 8 and 8: to in"est m mone , then in"est it all; This is the $e !on!e#t+ I3VEST IT ALL; If ou are so good that ou !an get all of the SB' returns &ith A6> !ash, then ,ust gi"e me the !ash ba!$ so I don5t ha"e to #a 8> on the !ash. Let me ma$e m o&n asset allo!ation de!isions. So an e/uit long+short fund should be 0::> long and some #ortion short. In SAC !ase, the &ould #refer '(s be no more than 06> net long, so that meant the &ould be 0::> long and 76> short for eCam#le. I5m not ad"o!ating that. %ut I5m sa ing e/uit funds should not !arr more than a minimal amount of !ash. If ou don5t ha"e ideas for the mone ou5re managing, ou need to re+read rule number one, IDEA VELOCITY. D. S)O1TI3* I3DICES. (an fund managers thin$ the are great sto!$ #i!$ers. A!tuall , &e all do, b definition, be!ause &e are !harging #eo#le for our great s$ills+ other&ise the !ould !hea#l in"est in an unmanaged indeC. %ut these same managers de!ide the &ill #i!$ the longs in the fund and then use an

ET. to short against the longs, as a ?hedge.@ WT. $ind of ba!$&ard thin$ing is this< So ou !an #i!$ &hat sto!$s &ill go u#, and not the sto!$s that !an go do&n< Does this ma$e an sense< Then the !le"er among this grou# &ill argue &ith ou that be!ause the mar$et goes u# o"er time, it5s im#ortant to s#end time on longs and ?hedges al&a s lose mone .@ 3O3SE3SE. E"en in a bull mar$et there are sto!$s that are going do&n. EDo ou need eCam#les< I%(, ?%ig %lue,@ the bluest of the blue !hi# te!hs, is do&n 7.6> as I &rite this, "ersus the 3ASDAF u# AA> for the ear.G I5ll tell ou &hat+ if ou &ant to #la &ith indi!es, and ou tell me the mar$et goes u# most of the time, I &ill suggest that ou LO3* the indeC and s#end all our time finding indi"idual name shorts instead. Did our brain ,ust blo& a fuse< Let me suggest the best a##roa!h and that is #i!$ longs and shorts and ne"er short an indeC. If ou don5t ha"e enough shorts, be!ause ?Shorting is hard@ and all that, then go re+read 12LE 32(%E1 O3E. 6. COLD ST1EAHS. SAC is ruthless, be!ause the em#lo a lot of le"erage. When one of their '( has a big dra&do&n, the tell them to slo& do&n. This is the one !ase in &hi!h a '( &ill !arr more !ash. Or /uite sim#l get some of their assets #ulled from them. So let5s sa ou5re !old, our strateg and dis!i#line is not !urrentl &or$ing, and ou need to !ut ba!$ our #ositions. What do ou do< T1ADE S(ALLE1. So that means $ee# ma$ing ne& trades. Don5t free-e u#. Did Iordan /uit shooting &hen he got !old< So if ou are going to !ut our #ortfolio in half, sa , to /uell the bleeding, ho& do ou do it< (ost #eo#le &ill sa , ?&ell, I5ll !ut m lo&est !on"i!tion #ositions and $ee# the ones I reall li$e.@ Wait a minute+ more stu#id logi!. What business do ou ha"e holding A3Y lo& !on"i!tion #ositions< The right ans&er is ou !ut our entire #ortfolio in half, e/uall , a!ross the board. If ou ha"e lo& !on"i!tion #ositions, ou ha"en5t been follo&ing 12LE O3E+ IDEA VELOCITY. So #erha#s it5s ob"ious to ou no& ho& im#ortant the idea of IDEA VELOCITY is to a traderJin"estor. It5s the under#inning of e"er thing in The *ame. You ha"e to &or$ VE1Y )A1D to !ome u# &ith high !on"i!tion ideas e"er single &ee$. The hours ou ha"e to #ut into this *ame and the mental horse#o&er and the emotional toll are all mu!h, mu!h greater than most #eo#le reali-e. You !an see &h some of them &anted to !heat, to !ut !orners. This is a tough game. You $no& &hat< SAC didn5t need to !heat. If the all &ould ha"e stu!$ &ith these #rin!i#les, the &ould be thri"ing toda . You !an ado#t these #rin!i#les into our trading regimen and im#ro"e our #erforman!e.