Jack Schwager’s interview with Tom Claugus in Hedge Fund Market Wizards gave us an interesting look inside the mind of a hedge fund manager. Claugus openly discussed his early reservations about managing other people’s money and how that nearly drove him to give up on his dream of running a fund.
Claugus is also very interesting in that he generally trades against the market, looking for mean reversion situations. Shorting stocks in a rising market takes some serious balls, so it isn’t difficult to appreciate what guts Claugus must have to stick to his beliefs during difficult trading environments.
Top Five Quotes from Market Wizard Tom Claugus:
If you have a 10-year time horizon, you can make good decisions and make a lot of money. If you have a three-year time horizon, you could probably still do well. But if you have only a three-month time horizon, anything can happen. – Tom Claugus
This is obviously one of the primary frustrations that every hedge fund manager must deal with. People are always concerned with most recent performance as opposed to long-term track records and outlooks. Claugus explains that he has an even more difficult time with short sighted investors because his approach tends to underperform his competitors during major bull markets.
For many people, risk control means that they have a plan for what they will do if something goes very wrong. I try to avoid getting into that situation in the first place. – Tom Claugus
This is simply stated, and it makes a lot of sense. Avoiding situations that have the ability to blow up your account in the first place is the best way to control your risk of ruin. Of course, most traders who are just starting out don’t have the experience to properly identify these situations or distinguish them from profitable ones.
We spend a lot of effort to avoid getting into that type of situation in the first place. You want to design a portfolio that will survive a 150-foot tidal wave. The number one risk factor for me is leverage. – Tom Claugus
Similar to the previous quote, this requires a trader to have a solid foundation of experience. The best way to learn how to build a portfolio that can survive a tidal wave is to trade through a few of them. Then you will have the knowledge necessary to guard against them.
Just because you made money doesn’t mean you were right, and just because you lost money doesn’t mean you were wrong. It is all a matter of probabilities. If you take a bet that has an 80 percent probability of winning, and you lose, it doesn’t mean it was a wrong choice. – Tom Claugus
This is classic trading advice. It also has wider applications to the rest of our lives. It also gets a lot of play in the sabermetric baseball community. Being able to separate the outcome from the process is a key to success.
There’s no place to hide in a liquidity sell-off; people sell everything because they have to, not because they want to. The reverse rarely happens on the upside. People don’t run out an buy everything. There are always some stocks that are going down. The interesting thing is that shorts are actually easier to find than longs. It is easier to spot a broken company than a good company. It is easier to identify bad management than good management. – Tom Claugus
This is one of the most interesting arguments that I have ever heard to focusing on the short side of individual stocks. Claugus makes a lot of sense by pointing out that bad management and bad companies are easier to spot. They’re just like bad restaurants in that you can see the dirt from the parking lot. However, it still takes a great deal of experience and balls to short stocks during major bull markets, regardless of how terrible they are.