Bruce Kovner

Who is Bruce Kovner?
New York magazine refers to Bruce Kovner as the most powerful New Yorker you’ve never heard of. Jack D. Schwager writes in Market Wizards that Bruce Kovner may be the world’s largest trader in the interbank currency and future markets. He is the founder of Caxton Associates, a global macro hedge fund with an estimated $14 billion in assets under management – one of the world’s largest hedge funds.
Bruce Kovner struggled to find a direction in his career early in his life. After dropping out of his Ph.D program from Harvard, he took jobs as a political campaign manager, a pianist, and a cab driver before entering the world of commodities trading. He is also intensely secretive, shy, and humble. There is surprisingly little information about his personal life (the New York magazine’s piece contains the most detailed information that I found), but what little I found was extremely high praise for Bruce Kovner’s intellect. His interview in Market Wizards was one of the more insightful interviews in the book and is a must read for students of financial markets. The notes that I took on this section are longer than others.
On making mistakes:

October 19, 1987 – the week of the stock market crash. I closed out all my positions on October 19 and 20 because I felt there was something happening in the world that I didn’t understand. The first rule of trading – there are probably many first rules – is don’t get caught in a situation in which you can lose a great deal of money for reasons you don’t understand.
You have to be willing to make mistakes regularly; there is nothing wrong with it. Michael taught me about making your best judgment, being wrong, making your next best judgment, being wrong, making your third best judgment, and then doubling your money.

You are one of the most successful traders in the world. There are only a small number of traders of your caliber. What makes you different from the average guy?

I’m not sure one can really define why some traders make it, while others do not. For myself, I can think of two important elements. First, I have the ability to imagine configurations of the world different from today and really believe it can happen. I can imagine that soybean prices can double or that the dollar can fall to 100 yen. Second, I stay rational and disciplined under pressure.

When you compare the trainees that made it to the majority that did not, do you find any distinguishing traits?

They are strong, independent, and contrary in the extreme. They are able to take positions others are unwilling to take. They are disciplined enough to take the right size positions. A greedy trader always blows out. I know some really inspired traders who never managed to keep the money they made. One trader at Commodities Corporation – I don’t want to mention his name – always struck me as a brilliant trader. The ideas he came up with were wonderful; the markets he picked were often the right markets. Intellectually, he knew markets much better than I did, yet I was keeping money, and he was not.

So where was he going wrong?

Position size. He traded much too big. For every one contract I traded, he traded ten. He would double his money on two different occasions each year, but still end up flat.

On the importance of technical analysis:

There is a great deal of hype attached to technical analysis by some technicians who claim that it predicts the future. Technical analysis tracks the past; it does not predict the future. You have to use your own intelligence to draw conclusions about what the past activity of some traders may say about the future activity of other traders. For me, technical analysis is like a thermometer. Fundamentalists who say they are not going to pay any attention to the charts are like a doctor who says he’s not going to take a patient’s temperature. But, of course, that would be sheer folly. If you are a responsible participant in the market, you always want to know where the market is – whether it is hot and excitable, or cold and stagnant. You want to know everything you can about the market to give you an edge. Technical analysis reflects the vote of the entire marketplace and, therefore, does pick up unusual behavior. By definition, anything that creates anew chart pattern is something unusual. It is very important for me to study the details of price action to see if I can observe something about how everybody is voting. Studying the charts is absolutely crucial and alerts me to existing disequilibria and potential changes.

On sustainable market moves:

The Heisenberg principle in physics provides an analogy for the markets. If something is closely observed, the odds are it is going to be altered in the process. If corn is in a tight consolidation and then breaks out the day the Wall Street Journal carries a story about a potential shortage of corn, the odds of the price move being sustained are much smaller. If everybody believes there is no reason for corn to break out, and it suddenly does, the chances that there is an important underlying cause are much greater.

Let’s say you do buy a market on an upside breakout from a consolidation phase, and the price starts to move against you – that is, back into the range. How do you know when to get out? How do you tell the difference between a small pullback and a bad trade?

Whenever I enter a position, I have a predetermined stop. That is the only way I can sleep. I know where I’m getting out before I get in. The position size on a trade is determined by the stop, and the stop is determined on a technical basis. For example, if the market is in the midst of a trading range, it makes no sense to put your stop within that range, since you are likely to be taken out. I always place my stop beyond some technical barrier.

It would appear that you have reached a size level that impedes your trading performance. Since you have substantial personal funds, did you ever consider just trading your own money and avoiding all the related headaches in managing money?

Yes, but there are several reasons why I don’t. Although I invest a great deal of my own money in my funds, the portion of my funds that is managed represents a call. I don’t say this to be flippant, since my reputation among my investors is extremely important to me, but a call is a much better position than a symmetrical win/lose position.

Can you talk about your fundamental analysis methodology? How do you determine what the right price for a market should be?

I assume that the price for a market on any given day is the correct price, then I try to figure out what changes are occurring that will alter that price.One of the jobs of a good trader is the imagine alternative scenarios. I try to form many different mental pictures of what the world should be like and wait for one of them to be confirmed. You keep trying them on one at a time. Inevitably, most of these pictures will turn out to be wrong – that is, only a few elements of the picture may prove correct. But then, all of a sudden, you will find that in one picture, nine out of ten elements click. That scenario then becomes your image of the world reality.

On analyzing current events:

Forgetting trading for a minute, one of the reasons I am in this business is that I find the analysis of worldwide political and economic events extraordinary fascinating.

The way you describe it, you make the whole process sound like a constant game, rather than work. Do you really look at it that way?

It doesn’t feel like work, except when you lose – then it feels like work [he laughs]. For me, market analysis is like a tremendous multidimensional chess board. The pleasure of it is purely intellectual. For example, it is trying to figure out the problems the finance minister of New Zealand faces and how he may try to solve them. A lot of people will think that sounds ridiculously exotic. But to me, it isn’t exotic at all. Here is a guy running this tiny country and he has a real set of problems. He has to figure how to cope with Australia, the U.S., and the labor unions that are driving him crazy. My job is to do the puzzle with him and figure out what he is going to decide, and what the consequences of his actions will be that he or the market doesn’t anticipate. That to me, in itself, is tremendous fun.

You talk about both the importance of risk control and the necessity of having the conviction to hold a position. How much risk do you typically take on a trade?

First of all, I try very hard not to risk more than 1 percent of my portfolio on any single trade. Second, I study the correlation of my trades to reduce my exposure. We do a daily computer analysis to see how correlated our positions are. Through bitter experience, I have learned that a mistake in position correlation is the root of some of the most serious problems in trading. If you have eight highly correlated positions, then you are really trading one position that is eight times as large.

On good trades:

The general rule is: The less observed, the better the trade.

What advice would you give the novice trader?

First, I would say that risk management is the most important thing to be well understood. Undertrade, undertrade, undertrade, undertrade is my second piece of advice. Whatever you think your position ought to be, cut it at least in half. My experience with novice traders is that they trade three to five times too big. They are taking 5 to 10 percent risks on a trade when they should be taking 1 to 2 percent risks.

Besides overtrading, what other mistakes do novice traders typically make?

They personalize the market. A common mistake is to think of the market as a personal nemesis. The market, of course, is totally impersonal; it doesn’t care whether you make money or not. Whenever a trader says, “I wish,” or “I hope,” he is engaging in a destructive way of thinking because it takes attention away from the diagnostic process.

On being wrong (this passage is from the New York Magazine article):

Marcus would tell another Commodities Corp. alumnus, Jack Schwager, author of Market Wizards, Interviews With Top Traders, that Kovner’s objectivity made him great. “If you can find somebody who is really open to seeing anything, then you have found the raw ingredient of a good trader—and I saw that in Bruce right away.” Weymar told me that one of the most important qualities of a trader is ego strength, the self-confidence that allows a person to acknowledge his mistakes and not fall in love with his ideas. “The biggest risk in trading is hubris.” This is because being wrong is actually an integral part of success. A successful futures trader makes many more losing trades than winning ones. The key is to recognize and concede the mistakes and cut losses. And ride the winners.