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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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Implementing the trading philosophy: holding a core group of stocks long and a core group of stocks short and then using leverage to trade S&P futures, bonds, and currencies==== Im not surprised, but Im somewhatpuzzled* Youve repeatedly indicated that you give a deal of weight to technical input. With the market in a virtual free-fall at the time, didnt the technical perspective make you apprehensive about the trade? ==== A number of technical indicators suggested that the market was oversold at that juncture. Moreover, I thought that the huge price base near the 2,200 level would provide extremely strong support-at least temporarily. I figured that even if I were dead wrong, the market would not go below the 2,200 level on Monday morning. My plan was to give the long position a half-hour on Monday morning and to get out if the market failed to bounce. ==== When did you realize that you were wrong? ==== That Friday afternoon after the close, I happened to speak to Soros. He said that he had a study done by Paul Tudor Jones that he wanted to show me. I went over to his office, and he pulled out this analysis that Paul had done about a month or two earlier. The study demonstrated the historical tendency for the stock market to accelerate on the downside whenever ail upward-sloping parabolic curve had been broken-as had recently occurred. The analysis also illustrated the extremely close correlation in the price action between the 1987 stock market and the 1929 stock market, with the implicit conclusion that we were now at the brink of a collapse. I was sick to my stomach when I went home that evening. 1 realized that I had blown it and that the market was about to crash. ==== Was it just the Paul Tudor Jones study that made you realize that you were wrong? ==== Actually, theres a second important element to the story. In early August of that year, I had received a call from a woman who was about to leave for a vacation to France. She said, My brother says that the market is getting out of hand. I have to go away for three weeks. Do you think the market will be all right until I get back? I tried to be reassuring, telling her, The market will probably go down, but I dont think it will happen that quickly. You can go on your vacation without worry. Do you know who my brother is? she asked. I have no idea, I answered. Hes Jack Dreyfus, she informed me. As far as I knew, Dreyfus was busy running a medical foundation and hadnt paid much attention to the market for the past fifteen or twenty years. The following week, Howard Stein brought a visitor to my office. This is Jack Dreyfus, he announced. Dreyfus was wearing a cardigan sweater and was very polite in his conversation. I would like to know about the S&P futures contract,1 he said. As you know, I havent looked at the market for twenty years. However, Ive been very concerned about the conversations Ive been hearing lately when I play bridge. Everyone seems to be bragging about all the money hes making in the market. It reminds me of everything I read about the 1929 market. Dreyfus was looking for evidence of margin buying to confirm his conjecture that the market was poised for a 1929-type crash. The statistics on stocks didnt reveal any abnormally high level of margin buying. However, he had read that people were using S&P futures to take long positions in the stock market at 10 percent margin. His hypothesis was that the margin-type buying activity was now going into futures. To check out this theory, he wanted me to do a study to see if there had been any unusually heavy speculative buying of S&P futures. Since we didnt have the data readily available, it took us a while to complete the study. Ironically, we finished the analysis on Friday afternoon, October 16, 1987. Basically, the data showed that speculators had been consistently short until July 1987 and after that point had switched to an increasingly heavy long position. I went to see Jack Dreyfus on Saturday, October 17, to show him the results of the analysis. Remember, he had expressed all his concerns about the market in August. At this point, I was already very upset because Soros had shown me Paul Tudor Joness study. Dreyfus looked at my study and said, I guess were a bit too late to capitalize on my fears. That was the clincher. I was absolutely convinced that I was on the wrong side of the market. I decided that if the market opened above the support level on Monday morning, which was about 30 Dow points lower, and didnt immediately rally, I would sell my entire position. As it turned out, the market opened over 200 points lower. I knew I had to get out. Fortunately, there was a brief bounce shortly after the opening, and I was able to sell my entire long position and actually go net short. That same afternoon, Five minutes to four, Dreyfus came by. He said, Forgive me for not telling you before, but I had already sold S&P futures to hedge my exposure in the stock market. How much did you sell? I asked. Enough, he answered. When did you go short? I asked. Oh, about two months ago. In other words, he had gone short at exactly the top, right around the time I had told his sister not to worry about an imminent top in the stock market. He asked, Do you think I should cover my short position here? At that point, even though the Dow had already fallen 500 points to near 1,700, the futures were trading at a level that was equivalent to a Dow of 1,300. I said, Jack, you have to cover the position here. The S&P futures are trading at a 4,500-point discount based on the Dow! He looked at me and asked, Whats a discount? ==== So did he cover his position at that point? ==== He sure did-right at the absolute low. ==== Getting back to your career path, why did you leave Dreyfus? ==== I felt that I was managing too many funds (seven at the time I left). In addition to the actual management, each fund also required speaking engagements and other activities. For example, each fund held four board meetings per year. ==== How could you possibly find the time to do all that? ==== I couldnt; thats why I left. During this entire time period, I had been talking to Soros on an ongoing basis. The more I talked to him, the more I began to realize that everything people had told me about him was wrong. ==== What had they told you? ==== There were all these stories about turnover at the firm. George had a reputation for paying people well but then firing them. Whenever I mentioned that Soros had tried to hire me, my mentors in the business adamantly advised me not to go. Soros had actually started referring to me as his successor before I ever joined the firm. When I went to Soross home to be interviewed, his son informed me that I was his tenth successor. None of the others had lasted too long. He thought it was hysterical. And when I arrived at Soross office the next day, the staff all referred to me as the successor. They also thought it was very funny. ==== Did you consider simply going back and managing your Duquesne Fund full-time after you left Dreyfus? ==== That was certainly an option. In fact, Duquesnes assets under management had grown tremendously without any marketing at all simply because of all the publicity I had received from the strong performance of the Dreyfus funds. ==== Why didnt you go that route? ==== Quite simply, because George Soros had become my idol. He seemed to be about twenty years ahead of me in implementing the trading philosophy I had adopted: holding a core group of stocks long and a core group of stocks short and then using leverage to trade S&P futures, bonds, and currencies. I had learned a tremendous amount just in my conversations with Soros. I thought it was a no-lose situation. The worst thing that could happen was that I would Join Soros and he would fire me ill a year-in which case I would have received the last chapter of my education and still have had the option of managing Duquesne. In the best case, it would all work out. ==== Did your relationship with Soros change once you started working for him? ==== The first six months of the relationship were fairly rocky. While we had similar trading philosophies, our strategies never meshed. When I started out, he was going to be the coach and he was an aggressive coach. In my opinion, George Soros is the greatest investor that ever lived. But even being coached by the worlds greatest investor is a hindrance rather than a help if hes engaging you actively enough to break your trading rhythm. You just cant have two cooks in the kitchen; it doesnt work. Part of it was my fault because he would make recommendations and I would be intimidated. After all, how do you disagree with a man with a track record like his? Events came to a head in August 1989 when Soros sold out a bond position that I had put on. He had never done that before. To make matters worse, I really had a strong conviction on the trade. Needless to say, I was fairly upset. At that point, we had our first let-it-all-out discussion. Basically, Soros decided that he was going to stay out of my hair for six months. Frankly, I wasnt too optimistic about the arrangement because I thought that he had been trying to do that all along but was simply incapable of it. The situation was saved, however, by events heating up in Eastern Europe in late 1989. As you may know, transforming Eastern Europe and the Soviet Union from communist to capitalist systems has been Soross main endeavor in recent years. He has set up foundations in eleven countries to help achieve this goal. With George off in Eastern Europe, he couldnt meddle even if he wanted to. Everything started to come together at that time. Not only was I trading on my own without any interference, but that same Eastern European situation led to my first truly major trade for Soross Quantum Fund. I never had more conviction about any trade than I did about the long side of the Deutsche mark when the Berlin Wall came down. One of the reasons I was so bullish on the Deutsche mark was a radical currency theory proposed by George Soros in his book, The Alchemy of Finance. His theory was that if a huge deficit were accompanied by an expansionary fiscal policy and tight monetary policy, the countrys currency would actually rise. The dollar provided a perfect test case in the 1981-84 period. At the time, the general consensus was that the dollar would decline because of the huge budget deficit. However, because money was attracted into the country by a tight monetary policy, the dollar actually went sharply higher. When the Berlin Wall came down, it was one of those situations that I could see as clear as day. West Germany was about to run up a huge budget deficit to finance the rebuilding of East Germany. At the same time, the Bundesbank was not going to tolerate any inflation. I went headlong into the Deutsche mark. It turned out to be a terrific trade. |
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