Paul Tudor Jones is the founder of the hedge fund Tudor Investment Corporation. The New York Times reported in March of 2014: Mr. Jones can “claim long-term annual returns of close to 19.5 percent in his $10.3 billion flagship fund, Tudor BVI Global.”
1. “Certain people have a greater proclivity for [macro trading] because they don’t have the need to feel intellectually superior to the crowd. It’s a personality thing. But a lot of it is environmental. Many of the successful macro guys today, they’re all kind of in my age range. They came from that period of crazy volatility, of the late ’70s and early ’80s, when the amount of fundamental information available on assets was so limited and the volatility so extreme that one had to be a technician. It’s very hard to find a pure fundamentalist who’s also a very successful macro trader because it is so hard to have a hit rate north of 50 percent. The exceptions are in trading the very front end of interest rate curves or in specializing in just a few commodities or assets.”
There are many ways to make a profit by trading and investing. For example, venture capitalists buy mispriced optionality and traders buy mispriced assets based on factors like momentum. Comparing value investing with what Paul Tudor Jones does for a living is interesting. What could be more anti-Ben Graham and value investing than a statement like: “We learned just to go with the chart. Why work when Mr. Market can do it for you?”
“While I spend a significant amount of my time on analytics and collecting fundamental information, at the end of the day, I am a slave to the tape and proud of it.”
Set out below are some statements by Paul Tudor Jones that reveal a bit about his trading style:
“When I think of long/short business, to me there’s 5 ways to make money: 2 of those are you either play mean reversion, which is what a lot of long/short strategies do, or you can play momentum/trend, and that’s typically what I do. We’ve seen cheap companies get cheaper many, many times. If something’s going down, I want to be short it, and if something’s going up, I want to be long it. The sweet spot is when you find something with a compelling valuation that is also just beginning to move up. That’s every investor’s dream.”
“I love trading macro. If trading is like chess, then macro is like three-dimensional chess. It is just hard to find a great macro trader. When trading macro, you never have a complete information set or information edge the way analysts can have when trading individual securities. It’s a hell of a lot easier to get an information edge on one stock than it is on the S&P 500. When it comes to trading macro, you cannot rely solely on fundamentals; you have to be a tape reader, which is something of a lost art form. The inability to read a tape and spot trends is also why so many in the relative-value space who rely solely on fundamentals have been annihilated in the past decade. Markets have consistently experienced “100-year events” every five years. “
“These days, there are many more deep intellectuals in the business, and that, coupled with the explosion of information on the Internet, creates the illusion that there is an explanation for everything and that the primary task is simply to find that explanation. As a result, technical analysis is at the bottom of the study list for many of the younger generation, particularly since the skill often requires them to close their eyes and trust the price action. The pain of gain is just too overwhelming for all of us to bear!”
“I believe the very best money is made at the market turns. Everyone says you get killed trying to pick tops and bottoms and you make all your money by playing the trend in the middle. Well for twelve years I have been missing the meat in the middle but I have made a lot of money at tops and bottoms.”
“One principle for sure would be: get out of anything that falls below the 200-day moving average.”
“I teach an undergrad class at the University of Virginia, and I tell my students, “I’m going to save you from going to business school. Here, you’re getting a $100k class, and I’m going to give it to you in two thoughts, okay? You don’t need to go to business school; you’ve only got to remember two things. The first is, you always want to be with whatever the predominant trend is. My metric for everything I look at is the 200-day moving average of closing prices. I’ve seen too many things go to zero, stocks and commodities. The whole trick in investing is: “How do I keep from losing everything?” If you use the 200-day moving average rule, then you get out. You play defense, and you get out.”
“It’s just the nature of a rip-roaring bull market. Fundamentals might be good for the first third or first 50 or 60 percent of a move, but the last third of a great bull market is typically a blow-off, whereas the mania runs wild and prices go parabolic.”
My takeaway: Paul Tudor Jones is timing non-rational human behavior based primarily on his pattern recognition skills. He does things like “spend an entire day watching a projection of his hedge fund’s positions blinking as they change.” What he does is interesting, but I am not interested in trying to replicate it myself. It does not suit my temperament, interests or skills. In other words, I am temperamentally unsuited to adopt his trading approach. I would rather drop a 100 pound stone on my toe than to watch blinking lights on a screen for a living. I put what Paul Tudor Jones does in what Charlie Munger might call the “not interested” pile. Would I put money in a hedge fund Paul Tudor Jones ran? That is a moot question since he has no need or desire to raise money from people like me just as David Tepper would not invest money for me if I asked him. Would I invest with someone else who said he or she would replicate what they do? I doubt it, and certainly not anyone I know of right now. Whether I would invest in a tweaked index fund that considered a factor like momentum is a different question. I have not done this so far and it would certainly depend on the fees charged by the manager. Outperformance that is less than the manager’s fees is not interesting to me.
Understanding a factor like momentum is a big part of what Paul Tudor Jones does. Ben Carlson gives an excellent summary of the momentum approach to trading here which reads in part:
“The momentum factor is based on buy high, sell higher or alternatively, cut your losses and let your winners run. Value investing is based on a long-term reversion to the mean. Momentum investing is based on that gap in time that exists before mean reversion occurs. Value is a long game, while momentum is usually seen in the short- to intermediate-term… And it is a terrible idea to chase performance if you don’t know what you’re doing or why you’re doing it. Momentum is chasing performance, but in a systematic way, with an entry and exit strategy in place. Momentum tries to take advantage of performance chasers who are making emotional decisions. This is why the best momentum investors use a rules-based approach, to avoid those emotions.”
It is worth noting that momentum has been on a favorable roll lately. That does not mean the performance of momentum as a strategy will continue, but that momentum can work to outperform the market is a fact.
Despite his unique system, Paul Tudor Jones shares many approaches and methods with other great investors who have adopted different systems. I describe some of these commonalities below.
2. “I am always thinking about losing money as opposed to making money.”
“Don’t focus on making money; focus on protecting what you have.”
“At the end of the day, the most important thing is how good are you at risk control.”
“Where you want to be is always in control, never wishing, always trading, and always, first and foremost protecting your butt.”
“I look for opportunities with tremendously skewed reward-risk opportunities. Don’t ever let them get into your pocket – that means there’s no reason to leverage substantially. There’s no reason to take substantial amounts of financial risk ever, because you should always be able to find something where you can skew the reward risk relationship so greatly in your favor that you can take a variety of small investments with great reward risk opportunities that should give you minimum draw down pain and maximum upside opportunities.”
“[I’m looking for] 5:1 (risk /reward). Five to one means I’m risking one dollar to make five. What five to one does is allow you to have a hit ratio of 20%. I can actually be a complete imbecile. I can be wrong 80% of the time, and I’m still not going to lose.”
The focus of great investors on not losing money is universal. Warren Buffett says the same thing, as do Seth Klarman and Howard Marks. This desire not to lose money is another way of saying that great investors and traders want to find bets with a lot more upside than downside. In other words, they are looking for asymmetry of potential outcomes: big upside and small downside. That’s optionality. They want to find bets that are very substantially in their favor. Great investors and traders are not gamblers since they seek positive expected value when making a bet.
3. “If you have a losing position that is making you uncomfortable, the solution is very simple: Get out, because you can always get back in. There is nothing better than a fresh start.”
Only bet when the odds are substantially in your favor. Don’t bet unless you have a margin of safety. If you are not feeling certain and comfortable with your bet, then don’t bet. Put differently by Charlie Munger: “the wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time they don’t. It is just that simple.”
4. “I think one of my strengths is that I view anything that has happened up to the present point in time as history. I really don’t care about the mistake I made three seconds ago in the market. What I care about is what I am going to do from the next moment on. I try to avoid any emotional attachment to a market.”
Treating past decisions as sunk and looking at each position on that basis is a great skill for an investor to have. Researchers put it this way: “People have trouble cutting their losses: They hold on to losing stocks too long, they stay in bad relationships, and they continue to eat large restaurant meals even when they’re full. This behavior, often described as ‘throwing good money after bad’, is driven by what behavioral scientists call the ‘sunk-cost bias’” What has been spent is spent. Once it is gone it is gone.
5. “By watching [my first boss and mentor] Eli [Tullis], I learned that even though markets look their very best when they are setting new highs, that is often the best time to sell. He instilled to me the idea that, to some extent, to be a good trader, you have to be a contrarian.”
That you can’t perform the market if you are doing just the same things as the market is a mathematical fact. You must sometimes be a contrarian and sometimes be right about that view in a way that makes the magnitude of what you do right outperform the crowd. Paul Tudor Jones said once: “I also said that my contrarian trading was based on the fact that the markets move sideways about 85 percent of the time. But markets trend 15 percent of the time and you need to follow the trend during those times.” How he does this is a mystery to me. It’s pattern recognition, but what’s the pattern?
6. “[Eli] was the largest cotton speculator in the world when I went to work for him, and he was a magnificent trader. In my early 20s, I got to watch his financial ups and downs and how he dealt with them. His fortitude and temperament in the face of great adversity were great examples of how to remain cool under fire. I’ll never forget the day the New Orleans Junior League board came to visit him during lunch. He was getting absolutely massacred in the cotton market that day, but he charmed those little old ladies like he was a movie star. It put everything in perspective for me.”
“I want the guy who is not giving to panic, who is not going to be overly emotionally involved, but who is going to hurt when he loses. When he wins, he’s going to have quiet confidence. But when he loses, he’s gotta hurt.”
Having control over your emotions is a very valuable thing since most mistakes are emotional or psychological. I believe this anecdote is making the point that people who can keep emotions and actions in spate buckets have a big advantage. Self-control and self-awareness are very valuable.
7. “My guiding philosophy is playing great defense. If you make a good trade, don’t think it is because you have some uncanny foresight. Always maintain your sense of confidence, but keep it in check.”
“Don’t be a hero. Don’t have an ego. Always question yourself and your ability. Don’t ever feel that you are very good. The second you do, you are dead.”
This is a series of statements about the dangers of hubris. Oscar Lavant put it this way: “What the world needs is more geniuses with humility; there are so few of us left.” The best investors and traders are humble. They know they have made, and will continue to make, some mistakes.
8. “I got out of the brokerage business because I felt there was a gross conflict of interest: If you are charging a client commissions and he loses money, you aren’t penalized. I went into the money management business because if I lost money, I wanted to be able to say that I had not gotten compensated for it. In fact, it would probably cost me a bundle because I have an overhead that would knock out the Bronx Zoo. I never apologize to anybody, because I don’t get paid unless I win.”
This is a quote about having “skin in the game.” Advisors with skin in the game perform better and are more accountable. What is good for the advisor or manager is good for you which lowers conflicts of interest. Aligned incentives are a very good thing, not just in investing but in life generally. The more aligned interests are the more you can base a relationship on trust. The more trust that exists the fewer resources need to be devoted to compliance. The optimal outcome is what Charlie Munger calls “a seamless web of deserved trust.”
9. “This skill is not something that they teach in business school.”
That Paul Tudor Jones can do it does not mean that you can do it: “I get very nervous about the retail investor, the average investor, because it’s really, really hard. If this was easy, if there was one formula, one way to do it, we’d all be zillionaires.” The danger of writing something like this blog post is that many knuckleheads will surely say “Oh, I can be just like Paul Tudor Jones.” No, the chances of that being true are vanishingly small. There is only one Paul Tudor Jones. You are not Paul Tudor Jones. But his record exists. It can’t be ignored.
10. “I’ve done really well on the short side. There’s nothing more exciting than a bear market. But it’s not a wonderful way for long-term health and happiness.”
“I spent 20 years doing it, it’s not the right way to make a living trading. It’s simply not.”
Shorting stocks has negative optionality. Mohnish Pabrai says: “When you are long on a stock, as it goes down in price, the position is going against you and it becomes a smaller portion of your portfolio. In shorting, it is the other way around: if the short goes against you, it is going to become a larger position of your portfolio. When you short a stock, your loss potential is infinite; the maximum you can gain is double your value. So why will you take a bet where the maximum upside is a double and the maximum downside bankruptcy?” Warren Buffett points out: “You’ll see way more stocks that are dramatically overvalued than dramatically undervalued. It’s common for promoters to cause a stock to become valued at 5-10 times its true value, but rare to find a stock trading at 10-20% of its true value. So you might think short selling is easy, but it’s not. Often stocks are overvalued because there is a promoter or a crook behind it. They can often bootstrap into value by using the shares of their overvalued stock. For example, it it’s worth $10 and is trading at $100, they might be able to build value to $50. Then, Wall Street says, “Hey! Look at all that value creation!” and the game goes on. [As a short seller,] you could run out of money before the promoter runs out of ideas.”
11. “The single most important things that you can do is diversify your portfolio. Diversification is key, playing defense is key, and, again, just staying in the game for as long as you can.”
It may seem odd that what some people call a gut trader like Paul Tudor Jones is focused on diversification. What he and other investors are saying is that if you don’t play defense and you lose, you are out of the game. They know that you can’t win unless you remain in the game. Diversification also allows you to “practice patience.” Paul Tudor Jones said on one occasion “if you don’t see anything, don’t trade.” He adds: “there’s no reason to leverage substantially. There’s no reason to take substantial amounts of financial risk ever, because you should always be able to find something where you can skew the reward risk relationship so greatly in your favor that you can take a variety of small investments with great reward risk opportunities that should give you minimum draw down pain and maximum upside opportunities.”
12. “The secret to being successful from a trading perspective is to have an indefatigable and an undying and unquenchable thirst for information and knowledge.”
Paul Tudor Jones may be a momentum trader but he is also an investor who looks at fundamentals. You can’t find mispriced assets unless you have an investing edge and that edge can come from better information and knowledge.
Buckley School Graduation Speech: http://dealbreaker.com/2009/06/paul-tudor-jones-gets-ridiculously-real-with-ninth-graders/
WSJ interview: http://turtletrader.com/paul-tudor-jones-interview/
Notes on a talk at UVA: http://www.marketfolly.com/2013/06/notes-from-virginia-investment.html#ixzz3dotoQ7Bn