"To others, being wrong is a source of shame; to me, recognizing my mistakes is a source of pride. Once we realize that imperfect understanding is the human condition, there is no shame in being wrong, only in failing to correct our mistakes." --Ă‚ George Soros (Trades, Portfolio)
"I learned that everyone makes mistakes and has weaknesses and that one of the most important things that differentiates people is their approach to handling them. I learned that there is an incredible beauty to mistakes, because embedded in each mistake is a puzzle, and a gem that I could get if I solved it, i.e. a principle that I could use to reduce my mistakes in the future." --Ă‚ Ray Dalio (Trades, Portfolio)
Every two quarters the Macro Ops team spends a week poring over our last six months of trading. We comb through our winners, losers and the trades we almost pulled the trigger on, but didn’t.
We keep detailed records of our reasons for taking trades and our thoughts on the market at the time (running a newsletter helps). When reviewing, we compare these notes to how things actually played out. Our goal is to see what we got right, what we got wrong and where we completely screwed the pooch.
This is the most valuable exercise we do. Nothing pays us higher returns than taking a step back and ruthlessly dissecting our process and execution. I’ve learned more from studying my trading journal than I have from reading any trading book.
Like Dalio says, “Embedded in each mistake is a puzzle, and a gem.”
Pain + Reflection = Progress.
One of the great things about trading is that mistakes are inevitable and constant. This game is dynamic and complex, and we’re all limited in our ability to understand the system of which we’re all an integral part — like the fish who know little of the water in which they swim. We all get things wrong — a lot. This gives us plenty of puzzles to solve, gems to uncover and truths to realize.
The Palindrome,Ă‚ George Soros (Trades, Portfolio), one of the best speculators to have played the game, had a win rate in the mid-30s. On average, two out of every three trades he made were losers. Yet, the guy was a perpetual money machine over three decades. He knew how to lose and still win. Being good at being wrong is the most important skill set a trader can develop.
One of my favorite market technicians, Ned Davis, put it like this: "We are in the business of making mistakes. The only difference between the winners and the losers is that the winners make small mistakes, while the losers make big mistakes."
Much of our job then, as speculators, is to learn how to make smaller and smaller mistakes by ruthlessly studying our bigones. This is how we uncover first principles that comprise the foundation from which the entirety of our process is built.
This is akin to Josh Waitzkin’s concept of “making smaller and smaller circles”.
He noted, "It’s rarely a mysterious technique that drives us to the top, but rather a profound mastery of what may well be a basic skill set."
I’ve spent years dissecting the habits and practices of the greatest traders, and I can tell you that there’s no secret to anything they do.
They are just incredibly efficient at executing the basics:
- Cutting losses short and protecting capital.
- Sitting on hands and letting winners run.
- Mental flexibility and strong opinions weakly held.
This is what we’ll be going over today. We will revisit the first principles of trading and see where we can make smaller circles and refine our thinking and process with the hopes of improving our performance going forward.
In this review, we will:
- Dissect our biggest winners and losers (focusing primarily on the losers).
- Cover lessons learned, the gems we can gleam from the mistakes we’ve made and how we can improve our process.
Enough with the fluff. Let’s to get to the goods.
Over the last six months, we’ve executed 54 trades. This number includes pyramiding trades, basket trades on a theme (which we view as a single position) and exiting trades from the prior year. In reality, the number of standalone trades we executed since the start of the year is closer to 25, which is around our sweet spot of averaging three to four trades per month.
Out of the 54 trades, 26 were winners and 28 were losers. This gives us a win rate of 48% year to date. This is above our long-term win rate, which typically hovers around 41%. On average, our losing trades lost 55 basis points on our total capital and our average profits on our winners was over twice the size of our losers.
Our biggest losing macro trades were:
- Long Purple Innovations (PRPL, Financial) where we lost 1.2% of our capital.
- Long Yatra Online (YTRA, Financial) where we lost 1.1% of our capital.
- Long Nikkei futures (NKD, Financial) where we lost 1% of our capital.
Our losses adhere to the same power laws as our profits; 10-20% of our losers will account for 80-90% of our total losses. This year has been no exception. The losses on the above trades are multiples larger than the capital lost on the remaining 23 losing trades. Finding ways to reduce the size of our biggest losers can dramatically improve our overall results.
And just looking at these trades above, I recognize that most of these losses were not due to market randomness — losses are unavoidable — but rather to sloppiness in execution on our part.
Take Purple (PRPL, Financial) for example.
I entered this trade back in March, and the stock quickly ran up more than 25%, only to gap down reverse on missed earnings. Because it’s an illiquid stock, we weren’t able to exit the full position at our risk point and took a loss that was 20% larger than what we had intended.
This was stupid.
Because it’s a relatively new SPAC and is illiquid, I should only have taken a position if I was willing to make it an investment, meaning size it smaller and widen the risk point by quite a bit. I still think the stock is an interesting value, especially now at current levels. But the mattress space is getting crowded, and my experience in investing in that type of consumer business is limited. My position size should have reflected this limited experience. So instead of taking what should have been a 35bps loss, it was instead four times larger. This is not a mistake I should make again.
Yatra Online (YTRA, Financial) is a similar case study. It’s also a relatively new and illiquid stock. We entered our initial position with too much size and too close of a stop. We have long-term conviction on the stock and our positioning and risk points should have better reflected this.
We have since reentered the stock with a smaller size and much wider stop. But we should have done this on the first attempt. My position sizing needs to better reflect the volatility and liquidity conditions of the underlying.
Our Nikkei loser is a combo of a number of sloppy mistakes.
The overall trade setup was decent, though not great. I don’t regret putting it on. But where I screwed up was getting too aggressive with the pyramid and failing to move my risk point up after the move, especially considering the flashing warning signs that sentiment indicators were giving at the time of the trade.
I was too aggressive at a time when I should have been reducing my holdings, and I was too loose with my risk point at a time when I should have been pulling them close.
Going forward I need to be more diligent in continuously assessing the Marcus trifecta of macro, technical and sentiment and adjusting fire accordingly. I was sloppy here and that cost me.
Overall, we’ve done a decent job of protecting our capital these last six months. Especially when considering the volatility at the start of the year. Even our drawdown of 11.3% from NAV highs — which is our largest drawdown from peak to trough to date — was exaggerated by the number of long-term DOTM calls we held on our books. Many of these temporarily fell to near zero during February’s sell-off, which didn’t at all reflect their true value.
But we did make a number of mistakes — mistakes from which we can tease valuable lessons and improve our performance going forward. These are:
- Position sizing and risk points need to better reflect the volatility and liquidity conditions of the underlying (i.e., size smaller and stop wider in smaller cap stocks).
- Always reassess broader market conditions (macro, sentiment, technicals) before executing a trade. It’s easy to get tunnel vision when you get excited about something, but it pays to step back and objectively reassess the environment. When the market is greedy, be fearful, and when the market is fearful, be greedy.
Now let’s take a quick look at our largest winners.
Our biggest macro winners so far this year have been (this percentage gain is on our portfolio’s total capital. The actual underlying trades advanced much more):
- Long TripAdvisor (TRIP, Financial) where we’ve made 6+% on our total capital.
- Long W&T Offshore (WTI, Financial) where we made 3.2% on our total capital.
- Long USD (DXY futures) where we’ve made 2.5% on our total capital (position is still open).
- Long United Health (UIHC, Financial) where we’ve made 1.7% on our total capital (position is still open).
- Long Interactive Brokers (IBKR, Financial) where we made 1.5% on our total capital.
Tripadvisor (TRIP)
I started digging into Tripadvisor last fall. What we found was a very compelling value stock with a number of positive catalysts on the horizon. The more I dug into the company, the more I liked the stock due to its moat, the consensus negative sentiment on the company and the broader macro tailwinds for the OTA market in general. Tripadvisor checked the right boxes, and that gave us high conviction in the asymmetry of the trade.
We took our first swing at Tripadvisor in early October but were stopped out a few weeks later for a small loss. This gives us a good opportunity to study the pros and cons of two different styles and approaches to speculating.
If we bought Tripadvisor as an investment and not a trade, then we would have had to sit through large volatility over the ensuing months, including a 30% or greater drawdown at one point. The fundamentals never changed, but the market was doing what markets do and was washing out the weak hands.
This would have ended up working out because the stock ultimately ran higher than our original entry point. But sitting on the position would have been extremely taxing mentally and even more importantly, there’s the chance that we could have been wrong in our thesis and the stock. In that case, the stock would have continued to sell off, and we would have eventually cried uncle and taken a large loss.
Instead of doing that, we’ll just take multiple swings on a high-conviction trade like we did here with Tripadvisor. By doing this, we only have to risk small amounts of capital each time and never expose ourselves to a large drawdown. I think of this approach as insurance against my own ignorance. There’s always the chance that I'm wrong, very wrong, when taking a highly contrarian position. And I’d rather pay a small premium than risk a huge loss in protecting myself from myself.
The downside is that there’s the possibility that the stock gets away from us and we end up buying at a higher price than our original entry. This is a worthwhile trade off as I’d much rather have a poorer entry than risk a large drawdown. So when we’re dealing with liquid stocks, we’ll always treat them as trades and not buy and holds.
W&T Offshore was a homerun for us. Almost everything went right on this trade. We nailed the macro call on being bullish oil last year. We bought W&T Offshore on textbook technical breakout, and held onto the stock through its wild ups and downs, while it embarked on a monstrous trend over the subsequent eight months that we held onto the position.
All in all, we got a 30x return on our initial risk. Not too shabby.
But, here’s what we could’ve done better.
We know that returns follow power laws. The majority of our returns will come from just a handful of our trades. The trading greats like Stanley Druckenmiller and David Tepper are great because they fully exploit this power law and size up their positions when the stars align and a fat pitch comes their way.
Bullish oil was a high conviction theme for us. We played the trade by buying a basket of energy names. We eventually cut the other stocks because they failed to follow through, unlike W&T Offshore. As W&T Offshore’s trend progressed, we should’ve added on technical inflection points and built our position size to match our confidence level.
This is of course easier to say in hindsight, and it’s just a constant fact of trading that we’ll always have too little in our winners and too much in our losers. But I do feel I could have done a better job managing this trade over the life of its fantastic trend.
US Dollar (DXY)
We made the majority of our discretionary returns last year shorting the dollar. This year we’ve made them on the long side.
If I could only trade one market, it’d be currencies. I’ve made the majority of my returns throughout my trading career trading forex. It’s the ultimate macro market and there are numerous false beliefs and bad pervasive mental models used by players in the FX space that create a lot of edge for those who objectively and independently study it.
I’m overall pleased with the way we’ve executed our FX trades this year. We’ve been lucky in catching the trends at exactly the right times. I’m still very bullish the dollar and believe there is plenty more upside in left for this move. This will likely end up being a bottom liner for us on the year.
United Insurance Holdings (UIHC, Financial)
United Insurance Holdings was a simple setup. The great chart setup and large amounts of insider buying are what originally drew my attention to the stock. It’s also an under-the-radar company with solid management and strong fundamentals.
The excellent inflection point in the technical setup gave us a great point at which to buy and allowed us to buy in size.
I’m still holding the stock and I think there’s a good chance it will take out its all-time highs of $28 before the end of the year.
Interactive Brokers (IBKR, Financial)
Interactive Brokers is a great example of a great trade poorly executed.
We pitched the bullish case for Interactive Brokers in our August MIR from last year. This was a high conviction call, and I believed the trade had a lot of positive asymmetry.
I screwed up because I missed the original inflection point in the technical breakout at the time we released our bullish call. I then waited for a pullback because I was disappointed in myself for missing the initial entry. This is bad trading. When you have high conviction on the asymmetry of a trade, you don’t try and pinch pennies and wait for it to come back. You will almost always end up buying at much higher prices.
I then compounded this initial mistake by putting too little size into the trade. My position size was nowhere near my conviction level. This is largely due to the fact that I was pissed that I missed the original entry.
The stock then ran straight up, nearly doubling over the following six months, and I never added to the position. Another big mistake.
Even though this was a bottom-line trade for us, our returns should have been more than twice what they were. But my poor execution and poor trade management kept me from fully exploiting the trend.Ă‚
Our biggest miss: Gaia Inc. (GAIA)
If any single trade epitomizes my failure in trade execution over the last year, it’s Gaia Inc. I did everything wrong on this trade and turned what should have been a monster winner into a small one. Let’s go through the mistakes I made.
We first pitched Gaia Inc. in our March 2017 MIR. This was a high-conviction, high-asymmetry trade with a loooong runway.
But, similar to Interactive Brokers Group, we waited over a month to buy into the stock after missing its technical breakout and seeing it run up over 20%. I was annoyed that I missed our initial entry point and then waited for a pullback. The pullback never came, so I finally put the trade on in much smaller size — just like in Interactive Brokers Group.
I then allowed myself to get shaken out of the stock after it rose over 30% from my entry point. This exit made no sense. I was fundamentally very bullish on the company. Management was executing flawlessly, and I continued to put out bullish updates on the stock all the way up. I did then, and still do, believe that Gaia Inc. is a $60 or higher stock within a few years.
It’s now up over 150% since our initial call. But I lost my position in the stock because I failed to be patient enough and give it the room it needed to run. My trade management didn’t match my fundamental conviction. I turned what should be a monster gain into a tiny winner.
This tendency to compound my mistakes is something I need to really work on. I need to look at trades with fresh eyes and not let mistakes and poor execution of the past affect what I should do in the present. The market doesn’t care if I missed my original entry, so I shouldn’t either. I need to just judge the trade on its merits in that very moment and then manage accordingly.
To sum up, the lessons we can take away from our winners is:
- High conviction fat pitches only come around a few times a year.
- Our performance hinges on our ability to fully exploit these.
- This means we need to size and manage our trades so that they’re in alignment with our conviction and perceived asymmetry of the trade.
- Portfolio concentration is also needed if we want to vastly outperform the market. Druckenmiller and Tepper typically have 60% or more of their long portfolio in just five trades.
- We can accomplish this by being patient and trading less but being aggressive when a great trade comes along.
It all goes back to the basics of:
- Cutting losses short and protecting capital.
- Sitting on hands and letting winners run.
- Mental flexibility and strong opinions weakly held.
Conclusion
All in all it’s been a good year for us in the markets. I’m loving the macro game right now. These volatile markets are my bread and butter, and I think the second half of this year will be even better for the Macro Ops portfolio than the first half. I’m seeing the beginnings of some powerful trends developing.
With that said, there’s obviously a lot that I can improve upon in my trading. I don’t view this as a negative but rather a positive. My mistakes and shortcomings as a trader are just opportunities for me to learn from and grow.
I’m on a path of continuous evolution, and the only way to walk this path is by continuously and ruthlessly studying my failures. Doing so has become my favorite and most fruitful exercise. I look forward to dissecting my future mistakes again six months from now. I just hope they’re not the same ones I’ve recently made — hopefully I’m making smaller circles then.
Macro Ops is now 30-months old. It’s a young operation. We’ve come a long way since we started, but we still have a long ways to go.
