LEVERAGE, CONCENTRATION AND ILLIQUIDITY….
I love this Steve Cohen quote from the Dealbreaker article published today:
“Leverage, concentration and illiquidity are the three things that can kill you”
These are words to live by in the investing world.
Leverage gets more traders in trouble than probably any other single factor. Uncontrolled (unhedged) leverage can be a sure way to the poor house. Using leverage is the equivalent of stepping off of a pony and jumping onto the back of a wild bull. Most people can’t control it and the few who do still tend to get hurt at some point in their career. Gambling with money you don’t have is a great way to lose your shirt. Only the uber experienced should attempt it. If you’re utilizing leverage you need an edge and if you don’t have an edge you need a hedge.
Concentration (meaning a portfolio with few positions) can be a double edged sword. It will help generate your biggest winners (think Warren Buffett with Geico, AmEx, etc) and it will cause your biggest losers (think Amaranth or LTCM). The key is knowing your market. Don’t go all-in on a position if you don’t have an exit strategy and don’t have an edge. Most people don’t have either and therefore have no business investing with a concentrated portfolio.
Illiquidity is a traders worst nightmare. There is nothing worse than wanting out of a position with no buyers. If you can’t find a buyer or seller you’re not in a market and if you’re not in a market you might as well have never gotten into the position in the first place. Invest in liquid positions. You can’t have an exit strategy if you’re trapped in a position.
Cullen Roche
Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.
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11 Comments
Looks like another close at the highs today. If anyone is surprised by this, shorting stocks and not massively long by now you are an utter idiot.
LEVERAGE, CONCENTRATION AND ILLIQUIDITY….
you just defined the cause of the Financial Crisis, resulting in
Too Bigger To Fail, more leverage, concentration in derivatives, toxic assets hidden by Mark-to-Illusory accounting all be lead by the same players….go figure.
I’d agree with all the above with the caveat being that all three should be viewed with a balanced, cold eye. all three will generate your biggest gains and your biggest losses. The key though is to have an edge and emotional discipline. After all, they are only tools. Tools wielded incorrectly will lead to lost limbs.
The Fed is concentrated and ultra levered. Thankfully they never have to worry about liquidity.
Actually, it is “Hubris, leverage and illiquidity” that is the deadly combination
Everyone being long the market seems to setup the ultimate risk wrt liquidity.
Ironically, it looks like leverage and concentration (in the S&P 500, if being concentrated in an asset class counts) since March 2009 would have been a highly successful strategy. Once again, I give up on waiting for an entry point. Buy the top!!!!
T.W.R don’t look at it, its to late for an entry point. This is closer to the climax they engineered. $700 billion TARP program, $1 trillion in stimulus spending,hundreds of billions of dollars of guarantees to Fannie Mae, Freddie Mac, HUD, FDIC, $4 trillion worth of assistance over the past few years through credit facilities,leverage and investments that would not be profitable at market-determined interest rates. The bubble is being re-inflated and jumping in is what BB needs to keep it going.
FYI Cullen, this is a great write-up on all his comments – much more detail than I’ve seen elsewhere. So good I saved it down in a word doc for later…
http://dealbook.nytimes.com/2011/02/15/sac-capitals-cohen-opens-up/
Am I retarded – you had the link at the top. Sorry.
If you think illiquidity is a problem in the securities markets, you should see what it’s like in the housing market.