Joe Vidich – Harvesting Losses

This article is part of our ‘Guru’ series – profiles of successful traders, with takeaways for the UK private investor.

You can find the rest of the series here.


Today’s post is a profile of Guru investor Joe Vidich, who appears in Jack Schwager’s book Hedge Fund Market Wizards. His chapter is called Harvesting Losses.

Joe Vidich

Joe Vidich

Joe Vidich runs the Manalapan fund and appears in Jack Schwager’s book Hedge Fund Market Wizards.

Vidich is one of the relatively few interviewees who were not already in Schwager’s network.

  • He found him in a hedge fund database after searching for funds with an exceptionally high return per unit risk.

Vidich’s chapter is called Harvesting Losses

Performance

For the ten-plus years since the fund’s formation in May 2001 (until the time of Schwager’s interview) the fund has a compound annual return of 18% pa net (24% pa gross), with a maximum drawdown of 8%.

  • Note that the period from 2001 to 2011 included two serious bear markets.

Vidich’s benchmark (the HFR Equity Hedge index) was up only 4% pa, with a 29% max drawdown.

  • Schwager’s “Gain to Pain” ratio for Vidich’s fund is a very high 2.4.
Early days

Vidich graduated from Columbia School of International Affairs with a master’s of international business.

He worked as a stockbroker, and then a market maker and prop trader in small brokerages for a dozen years before starting his firm.

  • Working as a market maker gave him good experience on the short side, as the retail traders he was selling to were predominantly going long.
Lessons learnt

Schwager asked Vidich what he learned from his early days.

I learned that it is always better to do your own work and get your own information because then you will have more confidence. If you listen to someone else to get into a trade and things go bad, then you have to listen to that person again to get you out.

There are times when fear dominates. Those are the times you have to be a buyer. Those are the times of great opportunity.

I learned the danger of selling expensive stocks just because they are overpriced and buying value stocks just because they are underpriced.

Pricey stocks are always 30 per cent pricier than they should be because people are willing to own them at 30 per cent above what they should own them at. A good growth stock is always overvalued, and a lousy company is always
undervalued.

That is the danger of buying value stocks. Until you get the turn where the market recognizes an improvement in the business model, they are always going to be undervalued.

As an equity trader, I learned the short-selling lessons relatively early. There is no high for a concept stock. It is always better to be long before they have already moved a lot than to try to figure out where to go short.

Trading style

Vidich combines long-term investments with short-term trading.

  • He looks at the big picture for the economy to decide on sectors and subsectors, then chooses stocks in these sectors based on both fundamentals and price action, using the latter particularly for entry points and exits.

Vidich is a very active trader, with a turnover of 20x annually (approximately 15x of this is on the short side).

  • Net exposure ranges from 80% long to 37% short.
Openings

Do you know what happens in a bull market? Prices open up lower and then go up for the rest of the day. In a bear market, they open up higher and go down for the rest of the day.

Prices behave that way because in the first half hour it is only the fools that are trading [pause] or people who are very smart.

When the market closes near the high of the move, there will be some traders who want to sell near the high, and they will be sellers on the next day’s opening.

Conference calls

Vidich listens to a lot of company conference calls (300 per quarter, or five a day) and closely follows the price action relative to the sentiment of the call.

  • He’s looking for divergence between the sentiment and the price action.
  • Underperformance is bearish, outperformance is bullish.

What matters is the market sentiment, not public sentiment. I try to drown out the public sentiment, except if public sentiment [CNBC] is so heavily one-sided.

One reason that I have done well is the evolution of information flow in the marketplace. When the SEC adopted fair disclosure in 2000, it meant that company conference calls had to be open to everyone.

When you listen to a conference call, you hear what the analysts’ questions are, and the analysts generally know a lot more about the company than I do.

Stop

They are for fools. If you want to ensure that you get the low of the day, use a stop.

People tend to place their stops near the same price level – usually at a new recent low. If the market trades down, the [old] stops will be hit, and since there will usually be a lack of buy orders at the new lows, prices will gap lower.

We will sometimes try to place our buy orders one-half point below where we believe the stops are.

You can, however, use mental stops, which are essentially evaluation points. The right way to manage risk is to monitor your positions and to have a mental point at which you reevaluate the position.

Emotions

Don’t ever consider yourself right.

I try not to sell on the way up; I try to sell on the way down. I might be giving up much more on the upside than the difference in selling it a little bit lower.

The hardest thing is to sell on the way down. The best way I have found to do it is to start by selling 20 per cent of the position. That doesn’t hurt, and if the stock comes back, I can still say I was right.

I scale out, and I also scale in. Sometimes, though, it is best to just liquidate the entire position.

It is really important to manage your emotional attachment to losses and gains. You want to limit your size in any position so that fear does not become the prevailing instinct guiding your judgment.

To be successful in the markets, you have to be willing to change your opinion. Most people are not willing to change their opinion.

Most people are more afraid of making money than losing money. They’re afraid of losing money. But they are only afraid of losing gains.

If the stock is down 20 per cent, they are not going to sell it. What they are really afraid of is not being right.

Charts

Charts are extremely important. One of the best patterns is when a stock goes sideways for a long time in a narrow range and then has a sudden, sharp up-move on large volume.

That type of price action is a wake-up call that something is probably going on. Whatever is going on with that stock will also have implications for other stocks in the same sector.

Diversification

If you are diversified enough, then no single trade is particularly painful.

The critical risk controls are being diversified and cutting your exposure when you don’t understand what the markets are doing and why you are wrong.

Some stocks with losses will come back, and you will sell those. Getting out sometimes right before a stock turns is the price you pay to keep your losses under control.

Conclusions

I found this chapter more useful than I expected, particularly in terms of looking for divergence between (informed) sentiment and price action.

The advice to scale in and out of positions is also potentially useful, although I suspect that Vidich has a more concentrated portfolio than mine.

  • I certainly believe that taking a small (and potentially reversible) action is better than taking no action at all.

And Vidich’s recommendation that position sizing should be such that you have no fear is also good.

  • This has been expressed elsewhere as “Sell down to the sleeping point”.

Vidich is also very flexible, switching from long to short to long again as price action develops.

  • I suspect this is a more difficult approach to develop than the other tips.

Finally, it’s clear that what Schwager means by Harvesting Losses (the title of the chapter) is our old friend Cut Your Losses – the essential core of risk management.

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