[pool balls break]
JAMIE MCDONALD: So we've talked about what drives markets. We've talked about charts and the way-- how important they are in coming up with your idea. And we've spoken about the different asset classes and the fundamentals of each and how they're correlated.
So now, what do we need to think about when it's time to put risk on, when it's time to put a trade on? So what are the stuff we need to discuss?
ROGER HIRST: You're looking at things like, what's your entry point?
JAMIE MCDONALD: Yeah.
ROGER HIRST: How do you approach that first action in the market? Then, do you go all in at the beginning, or do you layer it? Where's your exit, if you've got it wrong or you think you've got it wrong? Where are you going to start taking profits? That's the basic level.
But you've also got to think about how that trade fits into your portfolio. And time horizon, again, time horizon, which is how long is this trade on for? Is it based on the economics around the trade? Is it based upon your life experiences in what you need? Are you putting something on which you think is going to sit there earning you income for 10 years? Or is this a two-month trade?
So there's all those things around it, which are-- there's a whole bunch of variables from who you are, what you want out of it, through to that specific trade and the framework you're in it.
JAMES HELLIWELL: I think that's key, as well as the starting point, is understanding what you're comfortable with as an investor, what your philosophy is. Asset classes, for example, or particular trades, from time to time I'm sort of drawn towards when there's a clear opportunity and you think, this is probably a really good set up.
But ultimately, I've struggled to hold positions in them because they're just not-- like crypto, for example. It's just generally not an asset class that I'm comfortable with in terms of volatility, in terms of the other risks that come with having your money in those areas or those asset classes.
JAMIE MCDONALD: So is that maybe like the first question you need to ask yourself is, what kind of person am I in terms of risk appetite? Depending on what my financial position is, I'm willing to lose 100 quid here and there, or 1,000 pounds here and there. But then again, going back to your point. It's like, over what time period am I thinking about doing that?
From my personal point of view, I think about different buckets. You got your job. There's a level of security around that. Maybe you're working at a big [inaudible] bracket firm, or maybe you're a tech start up. I think that comes into play there because you're like, how secure is my job?
Then you've got where you live. Frankly, it's like, do I own the place? That gives you some sort of security. And then you've got your savings and your investments, and it's like, well, what do I want that portfolio to look like? And you want that portfolio to look slightly diversified from the rest of your life.
ROGER HIRST: It's something Brent Johnson's talked about, which is that when you look at investing, you shouldn't just look at, oh, I've got $10,000 or $100,000 to put into various assets. It's like, I've got a house, or have I got a house? Or am I renting?
JAMIE MCDONALD: Yeah.
ROGER HIRST: Have I got stocks in a company? If you're an entrepreneur, do you already have an investment, effectively, you own part of the company? Or have you been given loads and loads of shares? Maybe you work for a tech company and they given you loads of share options.
At that point, you don't want to just double down and go, right, I'll just buy loads of equity in the NASDAQ because you've got loads of NASDAQ-like equity already.
JAMIE MCDONALD: But it used to be this-- we used to have this conversation at UBS all the time because, obviously, if you-- I was working in equity sales at UBS, so I had quite significant exposure to the equity market. If it was doing well, typically, your pay was good. But then, some people would say, well, that's your edge.
You should have your savings in equities because that's what most about. And that was always something I never quite could get my head around is like, should you-- or maybe it just depends on what kind of investor you are. Are you happy to put all your eggs in one basket and go, I do have edge in this area versus the guy on the street? Therefore, I should be betting big on that.
JAMES HELLIWELL: So I guess it's a question of diversification, right, between your career or the occupation that you're in and your investment. So that's, I think, another angle I hadn't really considered before.
ROGER HIRST: And also how many balls can you juggle because I'm someone who, I look at things, I think, I can probably deal with 10 concentrated positions. So I can look at a few things, but if you gave me one of your portfolios with 50 stocks in it, I'd be absolutely lost because I couldn't deal with that many variables.
So what I want to do is I want to have a few things which I think I can control. At least I know I can be on top of them because the last thing I want is to have something that's sort of blowing up but I didn't really understand why it was doing that or what was doing. So I'm much more one of those people with fewer positions, but there's other people might have 50, 60, 100. Who knows? So that's going to be down to the individual as well.
JAMES HELLIWELL: That, understanding the risks, understanding the position is exactly what I was getting at at the beginning when I said, look, certain things, such as crypto for me as one example in the past, is just too complicated. There are too many ways that it can go wrong beyond, necessarily, the directional bet or the play that you're making because of where your money is tied up and so on.
If I don't fully understand something, I'm not going to be able to hold the position if I'm sort of foolish enough from time to time to begin to believe that, OK, I should still get that on or go for it.
JAMIE MCDONALD: Or you get the sizing right. So let's say crypto and you think, well, I don't want to invest in something I don't understand, but you understand thematically it's going to be something that's going to be a big part of your life. There may be, instead of putting 5x of whatever you're going to put in, you put 1x.
And then, even if it goes to 0, OK, I can handle that. But at least you're in the game. And then, sorry, this is actually something that we've chatted on Real Vision a lot about. People have said to me, not that I'm an expert, but people have said to me, well, what's the fastest learning curve you can have to investing? And basically, it's to go out and do it.
But then again, you've got to do it in the right size. You might be able to tell me who it was who said, trading one future can give you more experience than three years of at University learning about finance.
I think there's some truth to that. You really do care. Your heart's in it. If you've got risk on out there, just keep it small so that you can learn and stay in the game.
JAMES HELLIWELL: And that's the crypto crowd as well. The guys have got started in crypto before traditional markets that we've been discussing alongside it. Those guys have got such an edge, I think, in terms of the development and the progress having started out there.
JAMIE MCDONALD: Actually, it's one thing that Mark Ritchie used to say when he was looking at an idea. He'd start positioned small. And then, when you've got a small position size, you watch how it trades. And then you get to understand what are the factors that are driving this. And it's one of those things which, had not had a small position-- that was terrible-- had you not had a small position, you wouldn't have had such engagement with it.
So just another example of getting a small position, getting some skin in the game, and then watching it. It's a very powerful learning tool.
ROGER HIRST: And I think, what you're saying there is, what you're looking at, or to get involved in this-- or you've got to set your targets. You've got to get your ideas. And then you've actually got to dip your toe in. But you've also got to dip your toe in a sensible way.
So you don't start off by putting 20%, 25% of your net wealth, or at least your investable wealth in. You'd probably start off with something very, very small, almost something you're not expecting to make money on. And you know how it always is. The things that you don't put enough money in and they work, you always say, I've not done a big enough size.
But the point is that you start off because it's the learning process. But you start small with-- maybe your game plan is, I'm going to build up over six months. I'm going to use this, and I'm going to get myself invested. But even then, being invested might not be the right thing. It might be just better to wait, wait, wait until something comes along. And even if it's that first small trade, you wait until something that really hits you, that really ticks all your boxes.
JAMIE MCDONALD: I've got a good story for you. Roger, you take that shot. I've got a good story. From my best ever cricket coach, this is a very British story. My best ever cricket coach, [inaudible] Philip Spray he used to say to me, good batsmen know which balls to play, but great batsmen know which balls to leave.
And that always used stick with me because it's like, a really good sportsman has got the technique, knows what to do. But it's about-- it's the great people wait for the big opportunity. And that's just what you're saying.
JAMES HELLIWELL: [inaudible] trading, yeah.
JAMIE MCDONALD: Yeah, you can even get it once or twice a year. But being hurried into a trade, and that feels like sort of an immature thing, isn't it? It's like, oh, I've got to be invested. I've got to be invested, when actually, that's the luxury of being at home is that you don't have to be fully invested.
I was supposed to be invested all the time, well, pretty much. But-- and
ROGER HIRST: That's not the best way of doing it because that's very much the professional way.
JAMIE MCDONALD: Yeah.
ROGER HIRST: And that's not the way that most people would go about it. In fact, maybe the really best professionals, some of the best ones, have actually had those very concentrated positions, which might also not be the right way to do it. But you don't want to kind of go for fully invested the whole time because you're trying to eke out 1% a month. That's not how most people live. You should wait for the opportunity.
JAMES HELLIWELL: What's that story about the really big eurodollar trade where the guy went to the beach like three times or something. Just kept coming back.
ROGER HIRST: Raoul talked about that, yeah.
[interposing voices] on.
This was back in early 2000s, and it was a case of the world's slowing down, or certainly the US was slowing down. And the expectation was that eurodollar would basically continue to rally--
[interposing voices]
Yeah, so it basically implied that it's going to be a lower and lower interest rate as the Fed cut rates throughout this three year period. Basically, put this trade on, and it carried on moving in the right direction.
And the reason why that was such a great trade is that, comparing-- and this is where volatility also comes into it in that, he put on a trade, which was effectively a bit like being short equity. Problem with being short equity is you had your face ripped off by these 20%, 30%, 40% rallies, the whole way down from 2000 down to 2003.
The eurodollar trade was-- affected the rates trade of that where rates just priced in lower rates, lower rates, lower rates throughout that period. So it was actually a safer trade to do even though the real trade there was thinking about equities.
Everyone thought about equities, but that was really hard because your stop losses got hit if you were short equities constantly getting hit out.
JAMES HELLIWELL: I'm sure had a much better time to show for it at the end of the holiday as well.
ROGER HIRST: Yeah.
[interposing voices]
Exactly. And the fact is that he had one position on which didn't require much thought process once he got it on. Probably all the work was done before that. But if you're long lots and lots of equities, or short equities, you are constantly, constantly having to monitor it. And that's not everybody's cup of tea.
JAMIE MCDONALD: Yeah.
ROGER HIRST: Not everybody can do that. So I think that the key thing with all of this is that everybody's going to be different. I like fewer positions. But when you're looking at putting a position on, you think that the right trade is short equities. Well, maybe it's not. Maybe it's something else.
When you're looking at Japan in 2012, was the right to trade long equities? Was it short yen? Or was it a bond trade? It turned out to probably be something between the yen and the equity trade. And the equity trade probably was the better one in the end. But there's different ways of doing the same trade, and that's what this chap was doing in eurodollar. He was actually playing the dot com bust but through the eurodollar futures.
JAMES HELLIWELL: So that's expression, and ultimately, how are you going to-- or which instrument you select to express a similar view.
JAMIE MCDONALD: Yeah.
JAMES HELLIWELL: But it can have a slightly different twist or kicker, slightly different benefits embedded into doing eurodollar futures rather than short equities.
JAMIE MCDONALD: Now, I think we should talk about the timing of putting a trade on, like how long you run it for. But another sort of form of risk management is also self-emotional management, if you see what I mean. There's so many people who come on Investor Masterclass who talk about the fact that they need to stay healthy.
They need to stay objective about a lot of the positions they have. And I think that's a big part of it because sometimes you'll be looking across a portfolio and one of your trades is going really badly. And naturally, you spend 90% of your time working out why that's going wrong.
And at that point, that's when you can really neglect what else is going on in your portfolio. So I think there's something to be said about, from a risk management point of view and trade construction point of view, is to actually try and as unemotional as you can and stay objective on your views.
ROGER HIRST: And with all of that, as well, when you have a portfolio put together, you actually have somewhere-- I wouldn't say you want them to go down, but you know that if they're going down, it means the rest of your portfolio is working, which is basically you're going to have some things in there which are a hedge.
JAMES HELLIWELL: Yeah.
ROGER HIRST: So you might have a portfolio where the whole thing is basically playing reflation, and then you have a long dollar trade as your hedge in case that whole reflation breaks down and the dollar starts to go up.
JAMIE MCDONALD: Was this Brent Johnson?
ROGER HIRST: Brent Johnson talks about that as well. In some ways, that is the milkshake theory, which is, the worst case scenario is when you have the napalm run of the dollar, which destroys everything because it goes up far too quickly, far too high, far too quickly. And it destroys risk in almost every other asset.
So you have all your long positions on, but you have that long dollar bet on, not because it's your core position, but it's a hedge against what are your core positions.
JAMES HELLIWELL: What was that one about having everything so perfectly hedged in your portfolio that--
ROGER HIRST: You're the market. You never went green or red.
JAMES HELLIWELL: They just stayed the same. It's bleeding out cost.
ROGER HIRST: People can do that, and they can over trade. So you still got to try and find-- you're going to have some parts of your portfolio, which you want the majority of it to go up. You want the majority of your portfolio to perform. And that's the balance, and that's why I think you should probably stick at the beginning with fewer positions slightly more concentrated. And you can then work out much more easily the correlations.
A bigger portfolio, you need to be getting into some quite hardcore maths to be able to understand what those correlations are. So simple to start off with, slightly fewer positions, and ones where you know roughly what the framework should be so you can always test your thesis.
So once you're in, you kind of go, OK, those three are moving in the right way. Those two might not be, and these bits here aren't doing anything. OK, well, that's telling me something. So that's what you really want.
JAMES HELLIWELL: In my experience, the more complicated you make it, the more fragile your portfolio becomes. And when something does go wrong, it really goes badly wrong because it was all based on how historically things should have performed.
ROGER HIRST: So how do you-- in terms of getting into those, so you've got this idea where you've got all these trades potentially on.
JAMES HELLIWELL: Yeah.
ROGER HIRST: Or you have these trades you'd like to put them, but how do you actually pick the entry point, because it's not a case of I've got a great trade that I like here. I'm going to go straight out and ring up my broker.
JAMES HELLIWELL: Yeah.
ROGER HIRST: You might have a 1, 2, maybe 3-week window where you're thinking about putting it on.
JAMIE MCDONALD: Well that's what I would do, but I typically am a bit more on the risk-averse side, believe it or not, considering my career choice. But always, my gut was to put half a position size on because the way I think about it, and maybe this is just too simplistic. But somethings at a price out in the market. Roughly speaking, it's a 50% chance it's going to go up and 50% chance it's going to go down.
Vaguely speaking, there's all these myths about people used to look out the window and see which way in the crane was pointing that day. And that's what the trade they put on, and they ended up making money, or people who get their pets to bet for them.
JAMES HELLIWELL: That's confirmation bias there.
JAMIE MCDONALD: Yeah, yeah, yeah, just something to hang your hat on,right? But if you can just tilt the balance more in your favor, and you can do that by not putting your full position size on to begin with. So putting half on, seeing how it trades, seeing if you've got the opportunity to get bigger. And if you put half on on day one and it goes up, take some off and you've made some money there. But if it goes down, you've got some ammo still in your pocket to put more on.
ROGER HIRST: And that's half that position. It's not half your portfolio here. That's half your position that you're entering into.
JAMIE MCDONALD: Yeah.
ROGER HIRST: Yeah. And so, then when you do that--
JAMIE MCDONALD: Yeah.
ROGER HIRST: You're probably talking about it from fundamentals, but let's say, either fundamentals or from a technicals perspective. Once you've put that trade on, so in asset x, do you think-- this is probably where I'm wrong, on the downside if you're long.
JAMIE MCDONALD: Yeah.
ROGER HIRST: And this is where I think I'm going to start taking profits. Do you go in with that mentality where you have an out, and well, an out, both an [inaudible] loss or an [inaudible] to profit when you enter the trade?
JAMIE MCDONALD: Well, this is a perfect time to bring in the use of charts because I would have in my head a range which I think the stock should trade at. It's at 30 now. I think it should be-- I think it's worth 40 to 45, but if it gets to 25, ceteris paribus, I'm probably wrong. Something that is wrong.
And that's where you kind of put your stop loss. So it gets to 25, I'm out. I've only lost five. But I knew that my higher probability it was going to go to 40, and that's kind of the way I did it.
ROGER HIRST: But do you adjust that for [inaudible]? If it hits your target quickly, do you still take it off? Or if it's your target quickly, do you think--
[interposing voices]
JAMIE MCDONALD: Yeah.
ROGER HIRST: So this is kind of--
JAMIE MCDONALD: That's the key is to re-evaluate constantly.
ROGER HIRST: Because a lot of people will say that maybe a swing trade or short-term momentum trade could become a long-term secular trade. So for instance, at the beginning of 2022, inflation's going through the roof. Could we be seeing something completely different where commodities actually are on something, which is now a 30-year trend. But you put a trade on and it goes up a bit. And then we have a recession. It comes off because you've got a recession and things come off on the back of that.
But do you go, actually, you know what? This is still a long-term trade, and if I still got profits in the bag, even when that, let's say, copper comes off, do you stick with it? Or do you trade short term around the long-term trend?
JAMES HELLIWELL: I can tell you where I got that wrong. It was in March 2020 when the central banks and the Fed came out, specifically came out and said, we're going to do all the more stimulus. And I bought Bitcoin. I think it was like 3,800 or under 4K.
And because of the move that it had within a couple of days, and I didn't intend that to be like, OK, this is going to be a long swing. Because it moved so far, so fast, I took it off. I thought, this isn't going to last. There's such an emotional reaction. I've been early. I've been well positioned. Take it off, and we know how that played out over the next couple of years.
JAMIE MCDONALD: This is a perfect example of how almost, no matter where you are in your investing career, have a game plan that you have for each of your positions. It may change because things change from a day to day basis, but at least initially say, I'm in this trade for these three reasons over this time horizon.
Now, if it changes, then you can be honest with yourself. But for you, in that position, you're like, I'm in this for a few years, and I'm going to write it down, almost literally write it down. And we've got some people who have been on the Real Vision platform, we say that's a great thing to do is just to write down what your price targets, over what time horizon, and just see where you were wrong.
Had you done that, you may have--
JAMES HELLIWELL: Well, I flipped my position into gold. So I was just expressing it differently from that point. And obviously, the farthest trade was just to remain long Bitcoin.
JAMIE MCDONALD: Good one.
[laughter]
JAMES HELLIWELL: It was still the around the same theme. It was just expressing it with the different assets. So the fact that there's going to be more QE more stimulus. It's going to rob the value of the dollar, and it's just a huge inflow of liquidity. So as I said, Bitcoin had moved too far, too soon. I then moved it across-- they express it in a different way with the same view. And yeah, missed out.
ROGER HIRST: In some ways, it's still horses for courses, isn't it? Mark Ritchie talks about how so many people are quite good at dealing with their losses because losses hurt us psychologically more. But we're really, really bad at running our winners and working out our winners and taking profits on our winners. And I think he always says, I have my target, and I take my profits.
But then I always look back at the Japan trade I always talk about, which is, they've got some people into Japan and then got them out before half the move was even done because I just saw 50% up. That's got to be more than enough. And actually, I should have stuck with the big macro thesis that's now taking place with the big chart pattern. This could be a long-term trend, so I should just run with it.
And so I think it's one of those-- again, it goes down to the personality. Or did you have a target? If you're someone who says, I'm going to put on trades, and I'm always going to have a target of 20%. And I will always take some, if not all, profits at 20%. It's a framework you can use, and it creates discipline. And with all of this, it's about the discipline.
JAMES HELLIWELL: That's it.
ROGER HIRST: What we've talked about here is, oh, we could do this. We could do that. We could be running our winners. Actually, what you want to do is go, OK, I'm going to enter my trades in this way. That's my methodology. And I'm going to run my winners in this way, and I'm going to have stop losses here. And it could be different for everybody, but that person should pick that style and relatively stick with it. Evolves over time.
But you shouldn't be going, oh, I don't what to do with this. Have some sort of formula. Have some sort of strategy in place for that whole running of your positions.
JAMES HELLIWELL: But we all do it, right? We all end up deviating from the plan from time to time. We need to do it less as a professional. I should be doing it less often, but--
JAMIE MCDONALD: I think that's our point is that saying that I think we'd all be better investors and traders if we had that discipline and tried to have that framework and stay glued to it. And you just said something, which I thought was interesting.
Two people can have opposite views on a specific asset and both be right. And I think that's an interesting thing to sort of--
JAMES HELLIWELL: How do you mean?
ROGER HIRST: This time frame again.
JAMIE MCDONALD: Well, exactly. So we talk about this thing that I could be long one particular stock and short another one simply as a hedge because I think it's only going to go up a few percent. The one I'm long, I think it's going to go up 5% or 10%. But ultimately, there's someone out there who thinks it's just going to go down. That's what they believe.
Now, it could go down a percent or two, and I could be right. And we can both be right, so to speak. That was the point I'm getting at.
ROGER HIRST: Brown and Julian, if you ever listen to them, they are always constantly saying, oh, we had the same idea but a different time horizon.
JAMIE MCDONALD: Yeah.
ROGER HIRST: Now, the reality is a different time horizon means someone's going to be wrong.
[laughter]
And someone's going to be right, but--
JAMIE MCDONALD: It's a way of keeping everyone happy.
ROGER HIRST: Well, you can because someone could say, look, I can take this because I've got a view which is 30 years. I can take a 40% drawdown because over 40 years I know that, generally, that 40% drawdown in whatever it is, will eventually dissipate and I'll regain it.
Whereas, another person might be saying, well, I've got a five-year horizon. 40%
[interposing voices]
Yeah, it will kill me. So that whole time horizon is dependent upon your risk profile, your aims, your goals. Are you saving for retirement, or you're just having fun? And if you're having fun and you've got a finite pot, and you don't mind losing your finite pot, that's very different from, let's say, me saving for retirement and kids going to university.
And that's different approaches, but your strategy has to be, those are my goals, right? Number one, this is how I'm going to operate, 10 positions. And I'm going to have an entry point like this, and I'm going to have exits and profit taking like that. And that will work for me, which might be completely wrong for you two.
JAMIE MCDONALD: Mm-hmm.
JAMES HELLIWELL: So as you're putting together those individual positions, how are you thinking in terms of the overall portfolio and that ultimately meeting your objectives? What sort of considerations are there for you guys?
ROGER HIRST: Volatility is one. Does something have a lot of volatility? And if it has a lot of volatility in the short term, what are my long-term aims with that? Can I take that volatility-- and there's a lot of things where I'd say volatility could work in my favor because I might have something where I want to enter it using a different product.
So I might not just be buying a long something, longer stock or longer a fixed income instrument. I might be using a derivative to get my entry point, where volatility works in my favor. And I actually want the thing to go down and basically force me to buy it lower.
But the point there is that I'm looking at stuff where I'm putting into my portfolio things. I'll have my expected return. It might be that some of these are income. Some of these are ones where I think they're going to outperform in an inflation environment. And I will have my maximum drawdown, which will be across my whole portfolio it's this, and across each individual stock it's that or in each individual investment.
So I'm always looking at those effectively risk return, risk reward returning aspects. But it's not calculated any particularly mathematical way. It's very much sort of finger in the air. It's just the way I do it.
JAMES HELLIWELL: I think that's a sensible way to do it because in my experience, again, going back to complexity is, the more you rely on data and historical simulation and all the rest, the more you go back to that and rely on that to try and eliminate risks or reduce risks in your portfolio overall, they just break when correlation increases during times of distress.
JAMIE MCDONALD: I was going to say--
JAMES HELLIWELL: You need liquidity.
JAMIE MCDONALD: What Roger was sort of doing was he seemed to pick up on his scenario analysis. And scenario analysis--
JAMES HELLIWELL: That's where it gets complicated.
JAMIE MCDONALD: Yeah.
ROGER HIRST: The thing that's, again, the difference between institutions, which have-- there are more people in institutions who are risk managers than there are people who are stock pickers and investment managers.
JAMIE MCDONALD: Yeah.
ROGER HIRST: And what they're actually doing is they're reducing the potential alpha down to effectively beta. So you look at these big institutions.
JAMES HELLIWELL: So by that [inaudible] you mean you're not ultimately going to outperform the market. You're just going to get market return.
ROGER HIRST: Whereas individuals don't have trustees or expectations from end investors of 50 basis points to a percent month. You as yourself can just go, right, I've got my long-term goals. This is the time frame I've got to do that. These are my risk limits. I can do nothing, or I could see something, which is, let's say, you had that view in middle of February 2020 and you went, you know what? It's clear that these markets are going down.
Now, with hindsight it's great thing, but some people did. And they put on some big short bets. And those short bets would have probably made them a lot of good money. And then other people would have said, I think this is going to rebound, and I'd have put more of my capital into the NASDAQ and tech stocks somewhere in March, maybe in April, and again made money and had one trade on for the rest of the year, which was effectively along the NASDAQ.
That's a totally valid way of doing it for an individual because you shouldn't have to sit there worrying about making 1% a month. What you want is, I need my pot of 50 to turn into 70 in three years' time.
JAMES HELLIWELL: Can you realistically trade in that way? Our industry wouldn't like to admit it, but can you?
ROGER HIRST: Well, institutions do. And institutions have done the whole-- the risk parameters have brought everything down to we have to constantly be in the market. But we also have to be constantly fiddling around with it. And that return is, it's reduced as a result of it.