If you’re watching a football game, the 50-yard-line is the best place to sit. Not so in the financial markets.

In the financial markets, opportunities exist at the extremes. Extremes in sentiment. Obviously, that’s where I make my living. When emotions charge the markets, when people are yelling at each other on TV and online, when the stock market is making the front page of the paper above the fold, that’s where the opportunities are.

Today, we’re in the middle of the range, in the midst of a giant consolidation, and there is not much to do until we break one way or another.

My newsletter business has been pretty quiet these days. I measure interest in the market by how much incoming email I get, and there are tumbleweeds blowing through my inbox right now. It’s pretty boring. Of course, boring can be good after the year we just had.

99% Boredom

I’m fond of saying trading is 99% boredom and 1% sheer terror. Actually, I stole that quote from the Coast Guard, where they say that driving a ship is 99% boredom and 1% sheer terror. Both are true.

I can’t tell you how much boredom I experienced at Lehman Brothers. If you’ve never spent time on a trading floor, you might believe there is a constant stream of trades throughout the day. Actually, they’re mostly concentrated when the market opens and closes, and there is a lot of space in between where not a lot goes on.

When I was first looking for a job on Wall Street, someone advised me to call the trading desk at 2 p.m. It’s slowest during lunch, but people are eating and have cheesesteak grease all over their hands and are more in the mood to talk in the afternoon. There’s a lot of online shopping for shoes and ties and betting on sports.

So, this is an essay on what to do when things are boring. A rookie trader might think it would be a good time to make something happen, but it’s generally the worst time to make something happen. The best course of action is to wait for something to happen, then react to it. If there are no opportunities, then don’t trade. I day-traded a lot of S&P 500 futures during my time on Wall Street. In the beginning, I was trading every single day and barely breaking even. Toward the end, I would only trade 20–30 days all year and made multiple millions of dollars.

Sometimes, I think about what kind of hedge fund I might have if I had one. Generally, hedge fund investors want you to be fully invested all the time. Otherwise, you’re charging a management fee to sit on cash. In the marketing materials for my hedge fund, I would say that there would be long periods where the money wouldn’t be invested at all. Yes, I would be charging a management fee to sit on cash, but wouldn’t an investor rather pay for the privilege of waiting for an opportunity? Maybe not. This is why I don’t have a hedge fund.

Using Your Margins to Manage Risk

I like to say in my newsletter that I’m only good for about two or three good ideas a year. But when you publish a newsletter, people expect a little more than that. So, I end up with about 30 ideas a year, but 27 are marginal. The good news is that some of the marginal ideas turn out to be good ideas, and the bad news is that some good ideas turn out to be bad ideas.

If you have a position that is 2% of your portfolio that goes up 100%, then it adds 2% to the return of your portfolio, which is not a lot. This is why position sizing is perhaps the most important concept in investing—far more so than idea generation. You want your winning trades to be your biggest positions and your losing trades to be your smallest positions. That, my friend, is easier said than done. There’s been more than one occasion where my highest-conviction idea, the one I was most sure about, turned out to be dead wrong.

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This is where risk management comes into play. If one of your marginal ideas starts to work, one of your 2% positions, then the market is telling you something—it is telling you that you should add to the position. And correspondingly, you should starve losing trades of capital.

This is a pet peeve of mine—everyone places so much value on idea generation, which is one reason why newsletters are so popular. But idea generation is only about 10% of the investment process. Position sizing and risk management are the other 90%. Some people are good at idea generation, and some are good at position sizing and risk management. If you get all three right, then you’re Stan Druckenmiller.

Anyway, my recommendation this week is to stay out of trouble. And if the market breaks through the trendline, it’s going to be a grab-a-thon.

Jared Dillian

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