Investing & Trading Tips From Top Hedge Fund Managers

As investors and traders in times of uncertainty it helps to take a look at back at the rule book. Here are some trading and investing tips from top money managers. Many of these excerpts are from Steven Drobny's excellent series of interviews in his book Inside The House of Money. Some of these tips may overlap or be slightly contradictory, however taken as a whole they form a fantastic set of rules and tips for both novices and even the most experienced pros.

 

1. Never get emotional

This is rule number one of any investment. Never get emotional about an investment.

"We try to look at things as unemotionally as possible. You have to forget where something was yesterday or a month ago or a year ago and figure out if it makes sense now, here. Par of our job is to ask ourselves, if we had a clean sheet of paper, would we or wouldn't we consider this investment at the current price?"

- Marko Dimitrijevic

2. Never think you are smarter than the market

We've all experienced a point where we've said 'the market shouldn't be doing this', or 'this doesn't make any sense'. Well as I've often experienced it doesn't matter if you've done your homework and you're right for all intents and purposes, the market can have other ideas.

"In terms of valuation, no matter how cheap you think something is, it can always get cheaper. vice-versa, no matter how much you think something's overvalued, it can become overvalued."

- Marko Dimitrijevic

"Many traders I've met over the years approach the market as if they're smarter than other people until somebody or something proves them wrong. I have found this approach eventually leads to disaster then the market proves them wrong"

- Jim Leitner

"Confidence is a very, very dangerous thing. Simply because you've had a good run doesn't mean it will continue. In fact, once you've had a good run, you're at your most dangerous. Overconfidence is an absolute killer. Markets can take it away as easily as they give it"

"If you're not humble, you're not going to last very long."

- Christian Siva Jothy

"The market is smarter than you will ever be, with its combined knowledge of all participants. Pay attention to the signs."

- Yra Harris

"You can be right, but your timing can be totally wrong."

- Dwight Anderson

"Being short the Internet stocks too early in 1999. Right trade, wrong time. I taught me the lesson that you can be right and lose all your money."

- Scott Bessent

3. Understand market psychology and sentiment

We all know fear and greed drives markets. However investors often undertake copious amounts of research and analysis on balance sheets, earnings forecasts, macro fundamentals and then blow their timing and their profit because they didn't look at market sentiment.

"Psychology and sentiment are a huge part of the markets"

-Christian Siva Jothy

"I believe markets are nothing but psychology... there's not better background for trading than psychology and economics, because that's what it all boils down to. ...Behavioural finance explains why markets do what they do"

- Dr. John Porter

"Long before I came into the markets I knew that a lot of conventional finance theory didn't work, but it took me a while to realize that markets didn't necessarily react in the most rational way to a piece of macro news. What is much more important is positioning and sentiment"

- Dr. Sushil Wadhwani

"...we track volatility indicators and various sentiment indicators that tell us if people are getting more optimistic or pessimistic."

- Peter Thiel

4. Always set stop losses: cut your losses and have discipline

Many say that one of the best ways to learn is by making mistakes. Certainly anyone who has been on the losing side of a trade and watched as they lost more and more money would recognise the value of stop losses. Most successful traders and investors use stop-losses and know when to walk away.

"When a disaster is happening, just get out. Chop all ropes. Trust your instincts on what is winning and recognize what trades are not working, so you can cut them before they suck too much energy and money from you."

- David Gorton

"Repeated mistakes are a sign to pull out of a trade. Irrationality is always a time to get out of a trade. You've got to have a stop-loss because you've got to be able to say, 'I may be wrong at some point.'"

- Dr. Andres Drobny

"The most important quality of a trader is discipline. That is a sine qua non of trading; one must have discipline. It is even more important than idea generation. The key over time is to have the discipline to capitalize on your successes and minimize your mistakes because, ultimately, the game is about preservation of capital.

...I learned that the stop-loss is by far the most important aspect to a trade. Going back to discipline, the stop-loss is a very difficult thing to implement, but if you have a proper stop-loss, you'll never blow up. You'll be out long before you get anywhere near the end."

- Dr. John Porter

"When the stop is breached, you don't ask any questions, you just get out."

- Dr. Sushil Wadwhani

"How to take a loss - just do it, because you can always get back in.

...There are guys around here who'll complain about missing a move and I say, 'Let it go. As long as you still know how to take a loss, that's what it's all about.' At the end of the day it's 100 percent right. You can't be afraid of losing, because then you may as well disappear. You will have no chance in this business. Also, if you think you're smarter than the markets, you'll have no chance. Don't be stubborn. Listen to the market."

- Yra Harris

5. Recognise when you are wrong

There will be times when you are wrong. Even the most successful investors and traders do not have a perfect track record. Again it's about limiting your losses when your wrong not about getting everything right. Soros is more well-known for his billion dollar profit on Black Wednesday, however his 2 billion dollar loss on Russia is less publicised.

"There is no shame in being wrong, only in failing to correct our mistakes."

- Soros

"Another characteristic of a really good trader is the ability to change their mind."

- Dr. Andres Drobny

"However strongly you believe in something and however coherent the case is, you need to be (1) willing to accept that you might be wrong, and (2) able to take the position off even though you may not be wrong in a medium-term sense."

- Dr. Sushil Wadwhani

"I've seen guys blow upwards of $50 to $60 million in under a year-gone. You can see it happening. They start hanging on to a position too long because they can't get themselves to admit they were wrong. If you're right at the wrong time, you're wrong"

- Yra Harris

6. Always ask 'what's the worst that can go wrong?'

Even investors that create complex and sophisticated risk management models can underestimate worst case scenarios. The prime example of this is Long Term Capital Management (LTCM). The smartest of the Wall Street smarties at LTCM calculated a 1 in 6 billion chance of a major blow up, and a major blow up is exactly what happened in 1998.

"Human biases tend to force people to focus exclusively on the good side of trades, which can be very dangerous. The problem is, something can always happen, and markets often go where they are least expected to go".

- Jim Leitner

"It doesn't matter how well things are going, you should always kind of pinch yourself, take a step back, and ask, "What can go wrong?" In fact, the better things are going, the more you should look at where your risks are and what the downside is."

- Christian Siva-Jothy

"What I like to do is look at what might happen, or how do I cover myself if I am wrong? ... The great traders of the world make a little money even when they're wrong, and they make a lot of money when they're right... a good [investment] manager is always asking the question, "What if I'm wrong?" The great ones always seem to do this."

- Dr. Andres Drobny

"...things can always get worse than you can possibly imagine. You can never say that something is not possible, because anything is possible in the future. In light of this, you always need a disciplined stop-loss in place."

- Dr. John Porter

7. Read and research

Tiger Asset management, at one point one of the world's most successful hedge funds would do mountains of primary, ground-up micro research to confirm their hypotheses. There are many sources of information that you can read to keep up to date with emerging trends and ones that are winding down.

Some of the more editorial publications that come recommended include The Economist and The Financial Times.

The Economist is one of the most recommended reading materials and is read by top hedge fund managers like Jim Leitner, Dr. Andres Drobny, Yra Harris and Jim Rogers.

The Financial Times is also highly recommended Dr. Andres Drobny, Yra Harris, Jim Rogers

8. Don't try to pick market bottoms

Everybody knows picking market bottoms is a mug's game and one of the often battered around analogies is that picking a bottom is like 'catching falling knives'.

"There are certain things that all floor traders know: "A market only has one top and one bottom, go ahead and pick it," or "Pick a bottom, get the same thing, a handful of shit.""

- Yra Harris

9. Never underestimate technical analysis

Technical analysis can also be referred to as charting, or at it's most basic level, price action (everything that a security's price does). Technical analysis is often scoffed at by fundamental analysts and investors. Even if you don't believe in technical analysis, many, many other market participants do, and they use it to make their decisions and for that reason alone it is worth knowing. Paul Tudor Jones made a mint and elevated his status in the hedge fund world to super star status in '87 when he identified similarities between technical trading patterns in 1987 and the great crash of 1929 and returned over 62% for October alone and 200% for the year. You can catch a glimpse of Tudor Jones and his team identifying correlations between '87 and '29 in the documentary Trader.

"At the simplest level, I like to see price action. It's very important. It tells you when people have bullish or bearish sentiment. I love watching price. If I could only have one tool, it would be a ticker, or the equivalent"

- Christian Siva-Jothy

"If someone came to me with a head-and-shoulders pattern and a price target, I would sort of smile indulgently and think, "They'll learn." I quickly learned that my attitude was dead wrong. Markets are very humbling. I must confess that I've been impressed at how well purely technical traders can do and how well purely technical trading systems do over time. I've been impressed by the persistence of these profits.

... you can read a lot of academic articles testing simple technical trading rules, showing that they do, on average, make money.

...I do look at these things as any market practitioner should."

Dr. Sushil Wadhwani

"Technical analysis shows you what the crowd is thinking."

- Scott Bessent

10. Don't limit yourself to one asset class

Any seasoned investor would tell you that to reduce your risk you need to diversify. Many investors may invest in stocks in a range of industries to help diversify their portfolio. However stocks are all correlated with the broader market and move in varying degrees when the market moves, this correlation is known as Beta. By investing in a broad range of asset classes such as stocks, bonds, commodities and currencies investors can achieve higher levels of diversification and less correlation between their holdings.

The other reason to look beyond a single asset class is because if you are a long only investor it can be extremely difficult to profit in a bear market in only one asset class. Different markets are in different stages of bull and bear markets. One could argue for instance that the stock market has entered a prolonged bear market that will remain for some time. On the other side of the coin commodities and bonds are in the middle of at least a decade long bull market.

"Be open to the entire spectrum of market experiences. I never locked myself down to investing in one style or in one country because the greatest trade in  the world could be happening somewhere else. My advice would be to make sure that you do not become too much of an expert in one area"

- Jim Leitner

"I have always invested worldwide, in all sorts of things, whether it's commodities or currencies, stocks or bonds, long or short. So for me it's just been a way of life. It's the only way to invest, as far as I knew."

- Jim Rogers

11. Don't overtrade

Buying and selling within very short spaces of time may a good approach for day traders, but for most the only person it makes rich is your broker.

"One of the most difficult things about trading its not to trade. That's probably one of the most common mistakes that people starting out in this business make. Overtrading is as bad as running losing positions for too long."

- Christian Siva-Jothy

"Don't feel that you're missing something, because there is always another train leaving."

- Yra Harris

"In trading, when there is nothing to do, the best thing to do is nothing.

... The way we're set up now is that if there's nothing do to, we do nothing"

- Scott Bessent

12. Never forget history

Bubbles happen again, and again, and again. History shows anything can become a bubble from Tulips to Railroads to Sea Exploration, Tech, Housing... the list goes on. There is a famous market adage 'The four most expensive words in history are "This time it's different"'.

"To be a long-term success in financial markets, you must understand history. The long-term success stories are those who know history either from experience, reading, or just understanding how markets work."

- Jim Rogers

13. Be wary of expert opinions

Ironically this guide is full of recommendations from experts, however when it comes to taking advice on specific investments, where an asset is heading many hedge fund moguls state that 'expert opinions' can be wrong just as often as they're right.

"...the average results of a group were much better estimators than expert opinions. We wrongly tend to look at other people as experts. If you ask currency experts where an exchange rate is going, they are just as likely to be wrong as some average guy on the street."

- Jim Leitner

14. Don't buy into stories

This especially goes for mainstream media reports and reporters who are always behind the curve.

"in general it's good to step away from the story and take it back to the numbers. Trading off a story is too amorphous. We need to quantify things and understand why things are cheap or expensive by using some hard measure of what cheap or expensive means"

- Jim Leitner

"Concepts eventually become exhausted, which is usually when they make the paper or magazine covers. In other words, when a certain concept becomes fully popularized, it no longer has any value to the market."

- Dr. John Porter

"Whenever something is really pounded or when something is skyrocketing and it is on the front page of the New York Times, no matter how much you agree with it in the long term, you have to reverse yourself for a while"

- Jim Rogers

15. Ask questions, listen, and never stop learning

Listening is not just an important skill in investing, but is an important life skill. The number of people I have encountered who have no interest in asking questions or listening to others and are only interested in spouting their own beliefs are too numerable to mention. These people usually start to quiet down when markets tank it.

"It's important to not be afraid to be ignorant or ask questions. Learn to love to listen to people and when you hear something interesting, follow up on it."

- Jim Leitner

"The goal is to constantly be learning. Markets are a real challenge and you've got to keep learning just to stay still."

- Dr. Andres Drobny

16. Leverage

The most successful hedge funds use leverage in their positions. Most of their leverage is implicit in instruments used such as options and futures.

17. Have an investment time frame

"I have a rolling one-year view of the world"

- Christian Siva Jothy

18. Know why you're (still) invested

"I impose discipline by keeping a trading diary. Every morning, I go through the same process: If I have any positions on, I ask why do I have the positions? What has changed?"

- Christian Siva Jothy

"They [investors] should be writing them to themselves as a sort of personal clarification process. Writing is a cleansing process and a great discipline. When you're writing something and it doesn't make sense, that's where you learn something and you say, "Wait, why doesn't it make sense, what don't I understand here?"

- Dr. Andres Drobny

19. Enjoy investing

Just like with anything in life, it is hard to be successful at something if you don't enjoy it.

"You have to enjoy it. Too many people come into this business for the money., and that's not going to work out over time"

- Christian Siva Jothy

20. Look forward

"What you have to do in markets, is try to look forward"

- Dr. Andres Drobny

21. Don't hold positions you're not comfortable with

"A famous trader once said, 'If you can't sleep at night, that means your positions are too big' That's why I can sleep. I make sure that I don't run positions that make me feel uncomfortable"

- Dr. John Porter

 

We hope these trading and investing tips help to limit the pain and maximise profits. We highly recommend checking out Steven Drobny's book Inside the House of Money in full.