Global Macro Trading Journal

Daal said:
Stated in statistics terms, the lower the confidence interval around how much a stock is worth the less you should own (a smaller position size) and the less willing to add to a position you should be. I sorta learned this principle when Einhorn commented that he was avoiding HLF (a 0% position size) because "the range of outcomes is too wide" to get involved.
More...

I'm no statistics expert so I'm not sure my use of the term 'confidence interval' can be applied to this situation. I'm trying to expand on the Einhorn idea because I don't think he fully captured it. In every stock the range of outcomes is wide, every stock could go to $0 or to some really high number. The key factor is the range of RESONABLE outcomes. Whether there is a credible case for the stock to reach those levels. So, to restate the rule: The wider the range of resonable (likely) outcomes, the less the investor should own of it and the less willing to add a position the investor should be

How to determine the range of likely outcomes? You got to read the long case, read the short case, know a lot about business, look at the capital structure, try to infer things from insider behavior, the industry etc etc. Its all one big guesstimate

But of course, one can't take the rule too far. If there is a wide range of likely outcomes but the stock is trading at close to one of the extremes, it might pay to go the other way. VRX is either a $0 or worth a lot more than the current price. It has gotten beaten down so badly by the short thesis that I just think its worth going the other way because the wide range of outcomes is actually good when the stock is at one of the extremes. Its like owning a mispriced option

This might be why Einhorn covered his HLF short and stayed on the sidelines after the stock collapsed. The stock went to an extreme (to the downside after the Ackman presentation), he had the chance to take a profit at one of the extremes. Owning a short at that level no longer made sense so he took it
 
I build a graph of this theory. I'm calling it the Einhorn Rule (with an improvement in it)

upload_2017-1-5_7-24-14.png


upload_2017-1-5_7-24-23.png
 
Last edited:
Why do I believe VRX fits my improvement to the Einhorn rule (the extreme without a substantial change in Resonable Outcomes) because the hit to the industry has been a fraction that it was to VRX for one (making it totally different from Kodak). Its all about this Pearson story and whether or not he lied and committed fraud. At the downside extreme, a long has never been with more reward to risk ratio and a short has never had as bad as a reward to risk ratio. Some facts have surfaced (that relate to the Person story) but it has probably been a mixed bag, some were good some were bad, overall, there is still a wide range of outcomes but since a long is protected by the $0 bound and a short isn't, the long side is the one with an edge in my view

Hempton disagrees but of course, he is short a tiny postion. Once again Hempton the commentator (or more accurately, the anti-Ackman activist) and the investor are completely different people
 
Whats interesting is that short selling inherently violates the Einhorn rule, but especially in stocks that are vulnerable to short squeeze dynamics like:
-low float stocks
-crowded shorts
-illiquid stocks
-volatile stocks
-stocks in volatile industries

Einhorn got hurt pretty bad on Volkswagen and I'm sure that must have been a factor to walk away from shorting HLF (where Ackman could get squeezed).

But whats interesting is that I read on a Hempton investor letter him saying something to the effect of 'We made as much as the market but taking less risk, because we short'. It wasn't these words but that was the message. I just can't see how this is possibly true. From the perspective of an investor, he is taking more risk, not less

He is essentially walking in this mine field of wide range of resonable outcomes stocks, saying that he can pick them well, time them well and risk manage them well, for years and years in the future. If you look around the Market Wizards series, as time passes more and more of them turn out to be not so great managers and had to shutdown (same is true in the HF industry in general). And these guys are not short selling small and mid cap stocks. The degree of difficult of that kind of shorting is even higher. As time passes the odds are that the performance of Hempton shorting will get worse and likely, it will increase risk in the portfolio rather than decrease
 
Last edited:
I say this even though I do some small cap and mid cap shorting myself. Usually as daytrades and sometimes, reluctantly, as swing trades. But I got no illusions about it, I know I'm taking more risk, not less, than the market. Its just that the risks tend to take time to pop up in the P&L. Similar to how shorting options lead to consistent gains and then a big loss. I think short selling is the same, so it has the effect of increasing long-term risks in a portfolio. But it might also increase returns, which is good and hence why it can be done. But its very difficult to do it well, specially if the time frame is many days or months
 
Daal said:
I'm no statistics expert so I'm not sure my use of the term 'confidence interval' can be applied to this situation. I'm trying to expand on the Einhorn idea because I don't think he fully captured it. In every stock the range of outcomes is wide, every stock could go to $0 or to some really high number. The key factor is the range of RESONABLE outcomes. Whether there is a credible case for the stock to reach those levels. So, to restate the rule: The wider the range of resonable (likely) outcomes, the less the investor should own of it and the less willing to add a position the investor should be

How to determine the range of likely outcomes? You got to read the long case, read the short case, know a lot about business, look at the capital structure, try to infer things from insider behavior, the industry etc etc. Its all one big guesstimate

But of course, one can't take the rule too far. If there is a wide range of likely outcomes but the stock is trading at close to one of the extremes, it might pay to go the other way. VRX is either a $0 or worth a lot more than the current price. It has gotten beaten down so badly by the short thesis that I just think its worth going the other way because the wide range of outcomes is actually good when the stock is at one of the extremes. Its like owning a mispriced option

This might be why Einhorn covered his HLF short and stayed on the sidelines after the stock collapsed. The stock went to an extreme (to the downside after the Ackman presentation), he had the chance to take a profit at one of the extremes. Owning a short at that level no longer made sense so he took it
More...
Isn't the term "wider range of reasonable outcomes" almost the same as tail risk? Tail risk includes black swan events of course, but we all know it'll never happen, until it does, then we never stop worrying it will happen again, and suddenly the unreasonable has become reasonable.
 
justrading said:
Isn't the term "wider range of reasonable outcomes" almost the same as tail risk? Tail risk includes black swan events of course, but we all know it'll never happen, until it does, then we never stop worrying it will happen again, and suddenly the unreasonable has become reasonable.
More...
I would say its a little different than tail risk. Tail risk would be unlikely outcomes that are possible but still, unlikely. The 'resonable' part relate more to 2 possible 'baseline scenarios' that can happen (or a range of likely scenarios). Kinda like a Tobacco company going to $0 or doubling based on the outcome of a legal trial. HLF going to $0 or to $100 based on whether or not its a pyramid, VRX going to $0 or $60 based on whether or not its drug/business portfolio is solid or not, etc.
 
Buffett recommends concentration and 'going for it' when one finds a quality company that has 'low risk' and a good price. He defines low risk as a 'little to no chance of a permanent loss of capital'. The Einhorn rule would relate to companies that have a real (resonable) chance the investor will face a permanent loss of capital. This forces the investor to play smaller (if at all), not to be adding to the position as it goes against him
 
I did some calculations. I estimated that it takes about 25 times the average US per capita income to be able to retire from the income off US REITs (after-tax). Which is about $1.3M dollars(Using IYR after-tax dividend). In Brazil, it takes about 12 times the average annual per capita income (pre-tax because the income is tax free) to retire. Which is about $138,000 USD.
I'm trying to buy these REITs as much as I can, this seem to be such a global anomaly that it can't be sustainable
 
You must log in or register to reply here.
Back
Top