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.