MAGGIE LAKE: In this part of the course, we're talking about how to best express your investment ideas, build a portfolio around them, and manage it. To truly understand how it works and then refine your own approach, it makes sense to listen to the people who do it best. So in this section, we're going to hear directly from some of the best investors and traders about how they manage their portfolios. We'll look at how some of the best in the business do it and extract their principles so you can apply them yourself.
We will go through your context and risk appetite, trade construction, including trade expression, time horizon, entry and exit points, position sizing, and how volatility and leverage play into that, portfolio construction and risk management, including diversification, leverage, portfolio exposure, and more.
Now before you even start building a portfolio, you have to do what we discussed in part one of this course. You need to understand your objectives. Be honest about your risk appetite. And in general, think hard about what sort of investing strategy you're most comfortable with. Or to be really succinct about it, you need to understand what type of investor you are.
Secondly, you also need to look at the bigger picture, your entire wealth, and your lifestyle, and where you are in your life in order to make the right investment decisions for you. Understanding yourself and your financial situation is ground zero for successful investing and risk management. Let's hear Brent Johnson on the topic.
MIKE GREEN: We see this with tech entrepreneurs all the time who are forced to manage their exposure to a single security. Our mutual friend Zed Francis, or others, are extremely good at helping people think through those risks. Where do you start to say, there's too much volatility in the portfolio, or there's too much volatility in this position on the portfolio that has now become a large enough portion of my net worth that it affects the way that I think about it?
BRENT JOHNSON: So I'd say a couple things. One is again, this has to-- it kind of goes back to who you are as a person, how you look at your portfolio. If you're somebody who just absolutely hates the drawdown of any kind and you're looking at your portfolio six times a day or three times an hour and you're looking at your phone to check the price of a specific security or your overall balance, I think in order to not go crazy, you have to start trimming earlier.
If you're somebody who doesn't mind the swings and you're a contrarian or you'd like to embrace the volatility, and you're a little bit more of a gambler, I think then you can wait longer. But I think you have to be really honest with yourself about what kind of investor you are. Because if you are stressed, it's going to be harder for you to make a wise decision. And so if you can handle stress better than somebody else, then maybe you don't have-- maybe you can withstand that drawdown or whatever it is, or the risk level, a little better than the other person.
But for me, I built my business on helping people diversify out of one stock. Living in Silicon Valley, you'd meet these people who had 99% of their money in one position. And seeing so many people, I cannot tell you the number of people I said, listen. Just sell 20%. Just sell 30%. Buy your house, pay it off so you can always live in it. And they are like, well, I'll just wait for the next earnings call. And the stock went a little lower. Well, I can't sell now because now I'm 20% below what I was.
I said, we'll just sell. No. I'll wait. I'm pretty sure we're going to come back. It goes 20% lower. And just, everybody always thinks that their stock is going to the moon. And because I saw it so many times where people wouldn't do it, I think it helps me to actually do it.
MAGGIE LAKE: So there you have it. Step one is to be clear what you want from investing. We said that in part one. And I'm repeating it again now on the other side of our journey. A steady, low stress income, a high octane, high volatile return, well, only you can decide that. But do decide it first. Now let's move to that moment after you've generated an idea when you need to express the trade. Let's hear from Raoul Pal and Harris Kupperman.
RAOUL PAL: So time horizon is crucial to me because I'm using economic data and the movement of economies. Economies are like juggernauts. They take-- or supertankers. They take forever to turn. You need to understand that. Now there are some people who are very good at trading around both time horizons of the shorter term. As Paul Tudor Jones said to me, very importantly, he said the best investors I've ever seen and the best traders have a time horizon that matches their idea horizon.
What that means is if my horizon is the business cycle, then kind of six to 18 months tends to be the right sweet spot to express the parts of the business cycle that we're in. But if you're trading on sentiment, it could be one week. But then you shouldn't care about anything longer term. Because it's irrelevant to your view.
You might just want to say, what trend has the market been in for the last week, month, year? And within that, you would understand where you might want to add and reduce your bet. But for God's sake, don't trade a central bank bubble and all these big narratives, and then trade a two week time view. Because that's just not what you're doing. You're actually trading what goes on over the next two weeks. Then you need to ask yourself, what is happening on the next two weeks that I think I have an edge for? And if I understand that, then trade that. But that's not what I do.
MAX WIETHE: All right. So let's get into then, you said that you've basically tried to find lower risk ways to play these themes as you've evolved. Maybe what is something-- let's start with the high risk ways, the things that you've maybe grown out of after years of doing this. What's the bad way to play a theme?
HARRIS KUPPERMAN: There's lots of bad ways to play a theme. The bad way is usually something where you're taking a permanent capital risk. It's you believe in a commodity. The worst way is a junior exploration stock that has no revenue, no chance of revenue, and its hopes and dreams. As you start going down your risk spectrum towards safer, you have a producing company where I don't really know geology, I don't know the economics of operating it. You still have political risk. You have country risks. Then you can go to a larger company that has multiple mines so you're not risking one mine.
And then finally, you can just go into owning the commodity itself. And then from there, you can say, how do I set this trade up so I really don't lose money? Maybe you're going to write some puts and buy a call spread. And net, net you're almost no capital out, maybe even have a small credit. You put this trade on that captures upside with a net credit to you.
You're not going to have as much upside maybe, but you're going to have enough upside with no risk that it's far more interesting. And there's just lots of ways to structure it. And I think people often go brute force as opposed to really trying to finesse how to approach a thematic idea.
MAX WIETHE: Well, one trade that have on right now is calls on oil, and specifically how far out chose them versus trying to play the front end of the curve. I think that would be a good case study for us to go through.
HARRIS KUPPERMAN: Yeah, let's talk about that. So I'm bullish oil. I think oil goes much higher. There's a lot of ways you can play oil. You could buy a junior exploration company, you could buy a small producer, you could buy Exxon, which is a massive company. They all have different risk return profiles. Exxon is knocking a 20 bagger. Though I don't think it's going to. Some $1.00 stock might go to a hundred. There's everything in that spectrum.
I looked at it, and I said, I don't anything about geology. I don't really trust management teams that much, especially in resources. They tend to overpay for assets because they want a bigger kingdom. You have geopolitical risk, you have all these risks. I don't want to do with any of that. So I said, I want to just own oil. And the front of the curve is very volatile. I don't really have a view on next week's price. I have a view that the price over time is going higher. And you look at the curve. And this is about six months ago I put this trade on.
I was buying December 2025 oil and I paid low 50s for it, 52, 53. A year earlier, oil had gone negative. And this part of the curve was in the mid 40s. So I felt like I was risking about five bucks or so to see what happens. And I love a trade where you could risk five to maybe make a few hundred. And of course, as it gets to be front of the curve, it could go negative and went negative once in my life. Anything could happen. But I have a three, 3 and 1/2, four year look. And early '25, I can readjust.
I also thought there was a lot more leverage in buying calls, and call options, and call spreads. There's a lot of ways you could express this view. I bought the December, '23. I bought the 90 by 100 call spread. I paid $0.65 for it. If oil is 101, I make 15 times my money. I think it's pretty good chance it's over a hundred.
And I don't that many small little junior stocks that are 15 baggers. So here, I got rid of all the idiosyncratic crazy risk that I just don't want to touch. And I just purely captured that view that oil is going higher.
MAGGIE LAKE: So a few very important points to make here. Raoul is highlighting a trap, which people can fall into easily when investing, betting on one trend, for example, a cyclical one, and expressing it with a tactical short term trade. Those horizons don't match. And you're in dangerous territory. Once you've narrowed down your idea and horizon, you need to decide on the best expression. Honestly, there are so many ways to express an idea that you need to ask yourself, what are the risks I'm willing to take?
And which are ones that I can't tolerate. That's what the risk spectrum of an investment idea is, as Harris described. At the start, you have more direct expressions that tend to be more straightforward, like buying oil. The more you move out on the spectrum, the more risks you're adding for a potentially larger return, which is not guaranteed though.
In Harris' case, he's not willing to deal with the political, management and other risk of small and large oil companies, and appreciates the fact that he's not qualified or interested enough to assess those risks. Instead, he's focusing on the raw commodity and finding the best expression there. He's extremely clear about what risks he's after and what he is unwilling to take. OK, now, let's have a more detailed look at how to size positions. Because it's really so important to have an approach to it.
MAX WIETHE: One of the things you said actually brought up a question. Let's say you do decide that the US regionals are the way you want to go. This is just for hypothetical sake. And you said you wanted to short. How do you go about deciding whether this is something you want to short outright by borrowing, or whether you want to look at options, or maybe even something else that I can't imagine? Going into individual names within the ETF--
RAOUL PAL: So firstly, ask yourself, is this the best expression of the view? It's usually not. Almost in all circumstances, if you're trading economic news, the bond market is the best expression. But we're getting to the latter stages of the bond market move where the moves aren't big enough and you have to take a lot of risk to do it. That's OK. But you might prefer options and I'll come onto options in a minute.
So I think, yes. The banks look like the best expression of my view right now. So I've taken that decision. What is my time horizon? Well, firstly, I'm probably going to take a tester position first. I'm going to work into a position and see if my thesis starts playing out. Because you don't want to go big immediately every time you put a trade on, or you're going to go bust quick.
So how you tend to do it is, well, I'm just going to try a smaller short position. And I would probably do it directly as a short.
MARK RITCHIE II: If you think you might want to buy something or want to own something, just buy a little bit. Take a position that almost seems meaningless so that you get a pulse on that particular market. The best traders and investors I know tend to be incremental, meaning they don't make these all huge, all in decisions in one day to go limit long or limit short something. It tends to be a process, either in their own research, and they're thinking, how they're managing a position.
RAOUL PAL: Well, I guess it also depends on what time horizon and how leveraged you are. Because obviously, there's plenty of guys who will play for a 3% move but are five times levered versus a guy who trades a 20% move that may take six months or a year to play out. What's your time horizon then?
ALEX: Actually, my best time horizon I would say is like two to five years. I'm a really long horizon guy, which requires me to be right almost every time.
RAOUL PAL: Although I find personally the long horizon trades are easiest to be right on.
ALEX: Yes. Exactly.
RAOUL PAL: But the hardest thing with those is sizing them.
ALEX: Well, what I found, and often found the hard way after many years of trying, that you really don't need to have so much on with a long horizon trade. Let me give you an example. Probably today, the best trade of my career was recent dollar yen trade, or one of the-- actually, all the best days of my career was like in the last few years. It was dollar yen, dollar euro, and long bonds, US bonds. Those are my three biggest trades for the last two years.
But I started to get into dollar yen in 2010. It was like 82, 83. I felt, it's not sustainable. Something is going to give. Japan is going to crumble. They cannot really sustain the debt burden with this kind of currency levels and deflation situation. I didn't know the mechanism. How would I know the DPJ would fall, that there would be all this thing? And I started to put the trade on. And I was honestly tortured for two years by that trade. Because it actually went all the way down to 76, 75. It was painful.
I wasn't-- I didn't have full size. But I put some on and I was just hanging out, adding a little, reducing a little, just waiting. When things started to move, the good thing about when you have something on is when things started to move, you feel much more confident pyramid. It's a pure psychological thing. There is no mathematical reason why you cannot get into dollar yen trade at 90. But if you're in it at some amount at 78 and it goes to 90 and you feel, I actually have to add--
RAOUL PAL: And also, often you've taken the pain. So you're comfortable with the pain.
ALEX: Right. Exactly.
RAOUL PAL: You know what it's like. You know what it feels like. So you're comfortable that as it's going up, if it comes back again, you know how to deal with that pain because macro trading is all about pain and knowing how to take it.
ALEX: So exactly. And but the interesting thing is I didn't have to have a lot on in 2010. I expressed my view and I held it. When it started moving, I can always put-- when I'm looking for a 30% move, there is plenty of time to add on this move.
RAOUL PAL: Interesting. Because I mean, most people who tried macro go the other way, which is larger positions with stops. And they'll keep stopping in, stopping out, stopping in, stopping out until they get it. Other people-- I mean, I prefer the longer trade as you do where you stay in it, stick with it. And it's just a matter of learning to size it less because obviously all of us get excited about a trade. They think-- right. I really want to do this.
And then it's pretty hard to scale back and say, no, no. I need to be able to realize that the money is to be made over an extended period of time and not in a one month blaze of glory.
ALEX: Well, I think what I've learned over the years is that if you have a trade that you plan to make again, as I said, you put 20% to 30% on, and it's like a multiyear trade, there are so many times to add to the trade. You'll have so many chances to pyramid your trade. And indeed, my position probably was five times bigger when dollar yen was 105 than what it was when it was 78. And my average, I think I looked at it. My average was probably like 90 or something, right? Not at all 78. But it was nice to make this money on from 90 to 18. Right?
MAGGIE LAKE: Alex there tells us how he likes to stay nimble when he enters a position because his time horizon is two to five years. And he'll get many opportunities to load up and then sell within that time frame. And that's what he hangs his hat on. Stan Druckenmiller famously shared in his 2018 interview on Real Vision that he tends to start with the position one third of the maximum size he's looking to put on. Again, that's his rule of thumb. And it helps him get into trades at the right size and move from there.
In that second clip we just saw, Mark Ritchie makes a simple point, but one that really makes a difference. Just having a position makes you get a feel for what you're trading, which makes you more comfortable to increase your position if the appropriate time arises. OK, so now let's look at sizing from a different lens once you're already in a position.
PIERRE ANDURAND: 2011, really, we had a very good year in 2009 because we captured the move back up. Then 2010 was a bit more [inaudible], but we managed to make some money. And then 2011, that's when we had a bad year. And a lot of that loss happened in one day, which was like, I think, was that the 5th of May, 2011. Yeah. It was the day Osama bin Laden got killed. And for whatever reason, the market dropped more than $10 in that day. And there was no fundamental news. And it happened at the time, that when we had one of the largest positions we ever had.
So I had to reduce [inaudible] really fast because sometimes when the market moves in a way that you don't understand, you feel like maybe somebody knows something that I don't. And we have risk control. That's where we have to reduce when we start losing money in order to make sure we survive to see the good days.
So then we got out and then the market went back up a couple of days later. And it was all that for nothing. But that's-- actually, so the lesson was, OK, you'd better not be too levered, basically not have too big a position. Many when you feel like the market is in the same direction as you, so it's all a question of positioning the level of risk actually. We had-- and it was a weird year actually because every time we would put on a position, it would go first against us, a lot for one month, we would get out, then it would go where we thought it should be going.
So there was no trend where we got it totally wrong, where we misread the fundamentals. It was just being positioned a bit too big, and a market that was very choppy, that was really going for stopping people out. And these are the type of markets where we still struggle. I mean--
RAOUL PAL: Most macro guys struggle. Unless you're a shorter term trader, in which case they do well, I can't stand choppy markets. I just can't do it. Can't do it.
PIERRE ANDURAND: So the key is to stay alive, to focus on not losing at least too much money, and to know that the good days will come back at some point, and to keep the faith to carry on.
MARK RITCHIE II: I'd rather grab the easy 20% in the meat of the move. Now to your point though, as someone-- there's an old saying in trading that you don't want to let a losing trade turn into an investment.
JAMIE MCDONALD: This is exactly what I wanted to ask you about next. But go on.
MARK RITCHIE II: But you can let winning trades turn into investments. And this is precisely one of the things we do from time to time. So and often, how I will play themes or positions out for a bigger move. So I'll give you an example. Let's say, to your example before, I think this is going to move over the next couple of weeks. There's a chance to generate alpha. It could be in a specific sector or maybe a stock. And you time it just right. You nail the timing.
Well, if I'm at a multiple of my risk, meaning let's say I was thinking if it's going to move and I'm going to take a 5% or 10% stop, the stock has now moved 30%. I'm in a multiple of my expected gain relative to my risk. Well, I can take off 1/2 to 3/4 of the position. And now finance, the ability to hold that remaining position at no cost. Now it doesn't mean it won't potentially move the P&L around.
But as far as I'm concerned, I've now paid for that investment in full if I move my stop to break even. So that is something I do regularly.
MAGGIE LAKE: Let's stop there because this is an interesting tactic that Mark employs. When he makes more than he was expecting in a shorter period of time, he resets. He takes money off the table to use it as a cushion. Or as he puts it, he's now paid for his investment in full if he moves his stop loss to break even, meaning he's in the trade for free and can no longer lose money on it.
Remember, Mark is a tactical trader. So it works really well for him. Pierre is more of a cyclical trader, looking at trends over years. So when he sees volatility pick up, he reduces risk, which makes perfect sense. Volatility is a blessing for the tactical trader and a nightmare for the longer term investor looking to capture big trends.
If you're being a responsible risk manager, then you want to know by how much your portfolio can move in any given day, give or take. Well, if you're an investor that doesn't like volatile returns, then reducing position sizes during periods of volatility is absolutely the right thing to do. It also, as Pierre says, allows you the peace of mind that you'll live to see another day. OK, so that's individual position sizing. Now let's put it all together.