Hedge Fund Mindset Mastery Bonus Section

Bonus Section 2
Hedge Fund Mindset Mastery

Contents
. . .Bonus
** . . . . . .Section
. . . . . . .**. .Hedge
. . . . . .Fund
. . . . .Mindset
. . . . . . . .Mastery
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1. . . .
. . . Shortage
No . . . . . . . .of . . Money
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1. . . . . . .
. . . . . . . Differences
Seismic . . . . . . . . . . Between
. . . . . . . .Hedge
. . . . . Fund
. . . . .Managers
. . . . . . . . and
. . . .Retail
. . . . .Forex
. . . . . Traders
. . . . . . .Thinking
. . . . . . . . . . .2. . . . . . .
. . . . . . . . Difference
Leverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6. . . . . . . . . .
. . . . . . . . . . . Difference
Expectations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .18 ...........
. . . . . . . . . Difference
Discipline . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20 ...........
. . . . . Difference
Stops . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .27 ...........
. . . . . . . . Difference
Liquidity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .31 ...........
. . . . . . . . . . . .Difference
Inefficiencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .52...........
. . . . . . . . . . Difference
Pyramiding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .64 ...........
. . . . . . . .Sizing
Position . . . . . Difference
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .71...........
. . . . . . . . .of
Examples . .Big
. . . Hedge
. . . . . . Fund
. . . . .Trades
. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .88
........
** Bonus Section ** Hedge Fund
Mindset Mastery
No Shortage of Money
There are many traders that believe that the hedge funds and banks have taken all the money.
They may believe that they have all the money in their little enclaves in New York, Greenwich,
London, Switzerland. They believe that they are masters of the universe. That they capture all
the market moves and that leaves nothing for the small speculator. That somehow the hedge
funds have taken all the money and now there is shortage of it in the markets. That somehow
there is a shortage of opportunities. That somehow there is a shortage of inefficiencies. That the
market entering a period of choppiness or ranginess is a result of the hedge funds taking all the
money.
Hedge Funds and Big Banks Are Not Gods
The big banks and hedge funds are not gods. They are not efficient. If they were efficient then
you would see a big bank or hedge fund making money in every market environment. They
would somehow capture a lot of the macro moves with large position sizes. They would make
billions or tens of billions every year. But you do not hear too many stories like that because
markets and their participants are not efficient.
You would of heard George Soros or Paul Tudor Jones making a killing every year with 40% or
50% returns by capturing a big trend or big market swing with a large position size. But it hasn’t
happened in the past few years. Why? Because people are inefficient. They can’t spot every
move. They cannot spot every macro move. They cannot position size maximally for each trade
opportunity. Even if they do spot some of the moves, they may choose to trade them with small
or moderate position sizes.
Why didn’t Warren Buffett short the housing market using the same financial instruments that
other hedge funds used? He could of made tens of billions of dollars for Berkshire. Instead his
net worth dropped by 50%. Paulson spotted the housing crash and market meltdown of 2007 –
2008 and made big profits during those years.
So why didn’t Buffett catch those same trades as well?
His value investing mindset for stocks and companies does not make him flexible enough to
capture those types of macro opportunities in the currency markets and other financial markets.
He just doesn’t have those types of market beliefs.
Now he obviously has a lot of money, but he still misses out on the macro moves. He is not
efficient enough nor flexible enough to capture those macro moves.
It is important not to feel intimidated by any of the big market players out there. They can make
the same mistakes and have the same inefficiencies as the smaller traders, but they just do it with
huge positions.
As Robert Ringer said in the book To Be or Not to Be Intimidated?:

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Theory of Intimidation, which states: The results a person
achieves are inversely proportionate to the degree to which he
is intimidated.
The more you feel intimidated by the other players in the market, whether they are brokers, or
hedge funds, or the people you read and hear about on the news, then the less chance you will
have at extracting profit from the market. They are fallible human beings, just like the rest of us.
Always remember that the global macro moves, multi day momentum moves, one day volatility
explosions keep on happening in markets and financial instruments all over the world. They keep
on happening because you cannot program such things into a computer. It is impossible. You
need a human to perceive, interpret and act on the order flow and information flow.
And as such there is no shortage of money out there.
Seismic Differences Between Hedge Fund

Managers and Retail Forex Traders Thinking
Why am I writing these bonus lessons you may ask? I will tell you the exact reason why.
When I first started order flow trading, I only thought that there were short term inefficiencies
revolving around stop hunting and news trading. I didn’t really believe in the longer term
trading. I didn’t believe in global macro trading. The reason was because I was limiting my
mindset and beliefs. I was only thinking about how the banks and medium sized hedge funds
hunt stops. I was only thinking about the short term inefficiencies that I could exploit. I was still
stuck in the retail forex trader thinking world. And it can be very limiting and turn down your
profit capabilities.
But eventually I started to read up on how the big hedge fund managers trade. I started seeing
what kind of trades they placed, what their mindsets were, and how they were going about
executing and positioning their orders. I started researching the big global macro trades that
occurred in the past. I wanted to find out ways about how I could position myself for the bigger
moves.
And the more I delved deeper and deeper into the research of global macro trading and hedge
funds, the more I found that there were big differences between the way hedge fund managers
think and the way retail forex traders think. If you want to progress to the highest level of order
flow analysis and learn global macro, then you HAVE to understand how hedge fund managers
think. It is the fastest way to open your mind to see the true and maximum potential of the forex
market and any financial market.
More Order Flow Generators, Market Participants, Scenario Knowledge
Traders hunger for explanation, they hunger to know why price moves. At least that is what I
always hungered for. I wanted to know why one trade succeeds and another fails. I wanted to
know why someone can make 150% in a year, and then only make 30% in another year, and then
lose 10% in another year. There were so many questions that I was looking for answers to. By
searching for these answers I didn’t expect them to directly lead me to knowing whether the
market is going to move up or down tomorrow. That is not what I expected. What they did for
me was to help me in indirect ways. They helped me to develop my global money flow mindset
and liquidity mindset. They helped me to further develop my trading psychology, money
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management and position sizing strategies. That all helped me to become a well rounded trader.
With that knowledge I was able to infuse it into my own unique trading strategy and personality.
All the information and exercises taught to you up until now can help you explain a larger
number of market movements. But nobody can explain everything. It is impossible.
What this hedge fund mindset mastery portion will do is to help you you to do is to realize the
various new order flow generators, market participants and scenarios that could be playing out
behind the scenes.
The knowledge here will help you further acknowledge and assign meaning to “why” prices are
moving above and beyond that already described. It helps to fill in any gaps about “why” price
can move. It gives you more order flow generators, and scenarios to think about.
It gives you more market participants with different potential ways to structure their orders and
injects them into the order flow mix.
You will never be able to know 100% why the market moves, but this hedge fund mindset
mastery section will help fill in many of the gaps that you may have about trading systems,
psychology, money management, position sizing, etc. It will greatly help to fill in any gaps about
what you need to do as your trading account grows.
One of the biggest problems I had when learning order flow trading is that I would attempt to
mix and match order flow with some sort of technical indicators and chart patterns. I hungered
for an explanation why price was moving. And if I could not find an order flow reason for it, I
would be tempted to throw up some sort of MACD, trendline, or read some chart or price pattern.
Human beings have a hunger to know why, and if they don’t get an answer to that question, they
begin to fall back to whatever sounds good to them.
That is exactly what I did and I would fall back to the technical indicator trap whenever I would
bump up against a void in my order flow knowledge.
Eventually I realized that I had to learn how the big hedge funds traded to help fill in the gaps in
my order flow and market knowledge.
Once I learned how hedge funds think, I never went back to the technical indicators again.
Because I could tap into my arsenal of order flow knowledge, processes, systems, exercises to
explain why price was doing what it was doing. If I got stuck, I applied my new found hedge
fund mindset to fill in any gaps in why price was moving.
This hedge fund mindset mastery can be an extremely powerful edge.
Trading Progression
Price Action Trading is a step above technical indicator trading.
Order flow trading is a step above price action trading.
Global Macro is an even higher level of order flow trading
And finally, attaining the Hedge Fund Mindset Mastery is an even higher form of order flow
mastery. It is a higher form because you begin to think about how other market participants
execute large orders and deal with the problems of scaling a trading system to handle billions of
dollars of orders and still be profitable.
Not Everything Is Applicable Every Second Of Every Day

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I can’t tell you that you can use all of the order flow generators and market participant and hedge
fund information every second of every single day. You probably can’t. You may not even find
the information on IFR, or forexlive about some of the things going on behind the scenes. They
cannot be aware of everything as everything is not reported, even though a lot is. So you may not
find concrete information and data on them. You have to visualize it in your mind.
But I would much rather use that market participant and hedge fund mindset mastery as opposed
to adding another trendline, or ichimoku, fib, etc. I want to avoid that sort of stuff. Thus, in
order to avoid that, I have developed more strategies and mindset beliefs about how the market
participants can interact and hedge funds can act, even if you do not find any concrete
information in the form of an IFR news release on them every single day.
You won’t really find anyone explaining the markets in the following ways, for they have not
attained the hedge fund mindset yet. Of the ones that do have part of the mindset, they may mix
it up with various technical indicators and chart patterns and confuse the message. And of the
rest of them that know, precious few are willing to share it with the world in an easy to
understand format.
Summary of Differences:
Remember the general principle: As the fund gets larger, the lower leverage you will have
available, the lower leverage you will use, and the lower returns you will be looking to generate.
Hedge Fund Size Typical Leverage Used / Returns Looking To

zz Max Available Generate
$1 million 1x – 20x 10-500% per year
$100 million 1x – 10x 10-200% per year
$1 billion 1x – 5x 10-150% per year
Retail Traders ($1,000 – 5x-500x 100% – 10,000% per year

$50,000)
General Principles:
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Retail Trader Thinking Hedge Fund Thinking
Concentrated Positions, Correlated Low Risk, Multiple, Uncorrelated Positions

Positions in various different markets
0.50% – 2.00% (or higher) risk per trade 0.01 – 0.50% risk per trade
5x-30x leverage use almost always 1x (zero leverage) —> 5x leverage used
zz (sparingly)
Only place trades when they are “in the Disciplined every day to search for
mood” opportunities
Only place trades when they feel they have Will execute their system no matter if they
time to analyze the market are on a winning or losing streak
They may take a break from the market if Will take as much time as necessary to
they get on a losing streak analyze a market and find the good trades.
Will still trade during losing periods, but
may reduce position sizes and risk per trade
Like to place the full, leveraged position on Flexible to place the full position size on at
all at once once, or only place small exploratory bets
first, then add more if the market moves in
their favor
Usually get in and out all at once. Scale in and out of positions
Will typically always use physical stops Can choose to use mental stops, since they
since they always trade leveraged positions take positions using little/no leverage and
and high risk per trade only risk small amounts per trade. Can use
a mix of physical/mental and time stops
Typically don’t care about liquidity Always thinking about liquidity

considerations zz
Blame their broker, blame the spouse, Only blame themselves for their losses
blame the kids, blame the weather, etc zz
Believe that stops/option barriers are the Believe that news/sentiment/fundamental/

most important zz and global macro is the most important
Bet on technical indicators/chart patterns. Always bet on a scenario / macro view /

expectations re adjustment
Think they need access to more “insider” or Know that they want to have an
special information interpretation advantage. They need to do
more with the information they do have.
Search for the Holy grail system that never Are perfectly happy with a trading system
produces losses that has a win rate of 30-60%, but very high
reward to risk ratio
Get margin calls Never get anywhere close to a margin call
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I cannot obviously know the exact maximum opportunity set. No one can know such things. I
am just teaching you general principles. So you know how to think about the market and attain
the proper mindset about the inefficiencies in the market and how often they can occur for the big
hedge funds. The principle that if the hedge fund wants to place a big trade, the maximum
opportunity set for such trades falls drastically the bigger trade they want to place. For example
if they want to place a trade for $1 million dollars, then finding a financial instrument and
inefficiency to place a $1 million dollar order is very easy. There are thousands of them per year
across the global markets. On the other hand if a hedge fund wants to place one trade for $30
billion in one market, then finding a financial instrument and inefficiency to place such a huge
bet is very difficult and there may only be a few of them per year.
Size of Trade Maximum Opportunity Set
$1 million Thousands per year
$100 million Hundreds per year
$1 billion 100 per year
Leverage Difference
Not Too Much Leverage / Zero Leverage
The retail forex traders will typically always use leverage on their trades. They can use anywhere
from 5x – 500x leverage. The biggest hedge funds will not use much leverage. Sometimes they
do not use any leverage. If the hedge fund does use leverage, then they keep it to a manageable
amount of somewhere between 2x – 5x capital.
Now why is this so?
The biggest hedge funds are usually running billions of dollars under management. If a $5
Billion hedge fund chooses to use 10:1 leverage let’s say, that would be putting on a $50 billion
dollar position. The forex market cannot handle that much liquidity. There aren’t too many
markets that can handle such a large position. If a hedge fund chose to put a $50 billion dollar
position on aggressively, then they would move the price by 700+ pips against them. If they
chose to close out the trade in the same aggressive manner they would move the price 700+ pips
against them right back. End result: a 700+ pip loss. The forex market just cannot handle such
aggressive, large orders into the market. Of course, if they chose to use limit orders that would
be a slightly different story. Or if they had the overwhelming macro order flow on their side,
then that would obviously help them.
The market disciplines large hedge funds. No large hedge fund is crazy enough to use 50:1
leverage. It would be suicide as the market participants will sniff out their position and gun the
market to take out their stops or give the hedge fund a margin call. Even if they leverage up in a
low volatility environment it is still dangerous. Because if they leverage up in a low volatility
environment, and the market becomes volatile, then they need to make sure that the volatility
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happens in their favor. If the volatility goes against them, that they can take big losses.
Especially when they have high leverage. Low volatility environments can turn into bigger
volatility as the market begins to hunt the big hedge funds positions if they are over leveraged.
Also, if the big hedge funds are leveraged 10:1 or 20:1, like many retail speculators are, then
extremely small fluctuations can represent extremely large portion of the account equity. A 50
pip move, or 100 pip move can represent large portions of the account equity This extremely
high leverage can cause you to look at a trade much differently than if you were only leveraged
2:1 or 3:1.
The lower leverage you use, the less stress you have because the risk per trade is lower, and
therefore you can absorb some losses. The high leverage forces you to be near perfect with your
timing of the market, the direction of the market, and the liquidity of the market.
Blowing Trading Accounts?
Some people may wonder if the price gaps 100 pips and there were market players stuck on the
wrong side of the market, did they blow their accounts? Well, if you are talking about retail
forex, where traders can use 20-30:1 leverage, then yes, those retail traders could have
suffered catastrophic losses if they were on the wrong side of the market and didn’t get out in
time. But as for the bigger players, they do not use that much leverage or use zero leverage. So
that move may have given them losses, but in percentage terms it was not a big portion of their
accounts. The retail traders may have taken big losses, but they are such a minuscule part of the
market and they don’t matter to the market’s movements.
I remember I was following this news service where some stops were tripped in a currency pair
and it resulted in a sentiment/psychological move for 50-100 pips or so of movement. Then this
analyst on the squawk box talked about how there was a rumour some highly leveraged hedge
fund’s stops got hit and they blew up. I immediately used my hedge fund mindset mastery
knowledge and realized it was bullshit analysis. No single large macro hedge fund is going to
have a hugely leveraged forex trade and place a physical stop next to the market and then blow
up. Far more likely, the reason for the market tripping stops and causing a sentiment/
psychological shift for 50-100 pips was because of the news/sentiment/fundamental/macro
traders. But this analyst on the forex squawk box obviously didn’t know that. They applied their
wrong market belief and said that they heard a rumor some hedge fund blew up on a forex trade.
High Leverage = Cannot Handle Fluctuations
When some people are trading extremely high leverage, they cannot handle large fluctuations
against them. So sometimes they get scared and then “lose their position.” They do not have
their desired exposure. It is a lot easier to stay in a position that you still think it will move in
your favor when you only have 0.50% of your account at risk on a trade, versus 10% of your
account on risk per trade like someone using high leverage might be using.
For when you have high leverage, every little tiny movement in price represents a huge amount
of your account equity and most people cannot handle it.
As Druckenmiller said in The New Market Wizards when he was getting desperate to try to save
his firm:
I took all of the firm’s capital and put it into T-bill

futures. In four days, I lost everything. The irony is that
less than a week after we went bust, interest rates hit their
high for the entire cycle. They’ve never been that high since.
That was when I learned that you could be right on a market
and still end up losing if you use excessive leverage.
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Paul Tudor Jones
What kind of trading did Paul Tudor Jones do back in the 1980’s? In the Trader Documentary it
shows him trading crude oil and stock index futures. He puts on an almost $100 million dollar
position at one point. He was still not using much leverage as his firm had around $110 – $125
million dollars under management. Perhaps he was using 1:1 leverage. Or on
certain occasions if he had profits for the year and sensed a good opportunity, then perhaps he
would use some more leverage to around 2x – 5x capital.
When PTJ was short on Black Monday was he using 25:1 leverage? 10:1? He was only running
about $100-300 million in capital. He made close to 100% that October. He had on a profitable
short S&P futures position as well as a profitable long bond position. He was only using between
2x – 5x leverage maximum.
On another occasion in the Trader Documentary, Jones lost 5% or so or around $5 – 6 million

dollars as the market went against him. If he was leveraged 1:1, then the market may have
moved 5% against him causing the loss. Or if he was leveraged 2:1, then the market moving
2.5% against him could of caused the loss.
The same thing that happened back then happens today. Crude oil, stock indexes, and currencies
can absolutely move 5% or 3% or 2% in one day. So even if you run 1:1 leverage in a single
financial instrument, it can be a big move for a lot of the big hedge funds.
High Leverage – Large Hedge Fund vs Small Speculator
High leverage can destroy both the large hedge fund and small speculator. They both take similar
risks using high leverage. But the hedge fund takes an even larger risk when choosing to use
high leverage. If the small speculator places a large trade with 20:1 leverage, if they get stopped
out there may be liquidity to bail out of their trades at the price that there stop loss is at or close to
it.
For example if the small speculator with a $20,000 account places a trade for 400,000 currency
units, if their stop loss gets hit there can easily be liquidity for them to exit their position. They
can have zero slippage on their stop loss orders during normal market conditions. They take
huge losses as a percentage of equity, but there stop losses can still get filled.
Now contrast that with a hedge fund that has $300 million under management. If they use 20:1
leverage and decide to place a trade for $4 billion, then not only are they using large leverage, but
they have liquidity risk as well. Unwinding $4 billion dollars worth of a currency pair can move
the market 40 or more pips against them.
The small speculator can get their orders filled all within 1 pip, while the hedge fund using such
similar high leverage cannot get their stop loss orders filled within one pip. It will cost them 40
pips or more using the above example.
Thus the large hedge fund chooses not to use a lot of leverage. You will not see many of them
using more than 2-5:1 leverage if they are using any leverage at all. I have heard stories of some
of the big hedge funds back in the 1990’s using leverage of somewhere up to 5x – 10x capital on
certain occasions. However, most of them nowadays want to keep leverage at lower amounts.
What If A Hedge Fund Placed The Same Orders As The Bank of Japan?
Back when the Bank of Japan intervened in the currency markets in September of 2010, they
bought up around $25 billion dollars worth of USD/JPY. They moved the price up from around
82.90 to 86.00. So they spent $25 billion to move the market 300 pips. Imagine if a hedge fund
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spent $50 billion dollars to move a less liquid currency, like the GBP/USD for example. If they
issued the orders as aggressively as the Bank of Japan did, then they would move GBP/USD by
well over 700 pips. The Bank of Japan can potentially absorb billions of dollar of paper losses,
or attempt to hold the long USD/JPY positions for many months or years hoping the exchange
rate comes back up.
The hedge fund cannot do that. If they are stuck on the wrong side of the market with a $50
billion dollar position, and they are down a few hundred pips, that is a multi billion dollar paper
loss. They need to report this in their performance to their investors. Once the investors see this
huge loss, they stand a good chance to withdraw their money. When they start to withdraw their
money, the hedge fund will need to start liquidating the large forex position to raise capital.
When they liquidate the large forex position, they stand a good chance to move price against
them taking even bigger losses if there are not many macro participants to take the other side.
The hedge fund’s funding and capital base is not as stable as the Bank of Japan’s. Which is why
the hedge fund needs to keep leverage low, or not leverage up at all, especially if the market is
moving to or going to move against them.
High Leverage = Big Orders = Potential Front Running
There is another problem when executing big orders. That is the problem that other market
participants may want to front run the large hedge fund’s orders.
For example, if a hedge fund wants to buy $25 billion worth of a currency pair and do it
aggressively, there can be other market participants that want to front run those orders. If a hedge
fund executes orders to buy $25 billion, then that can push the price up aggressively and forces
the hedge fund to pay up more.
As the hedge fund is buying, word can leak that they are buying a large amount, and other traders
can jump on the bandwagon and start buying as well. If the hedge fund got in part of their
position and the price moved 50 pips, then as other traders get in as well that can move the price
another 30 pips or so. Then when the hedge fund goes to get the rest of their position filled they
will be forced to pay ever higher prices in this scenario.
The same thing happens if they liquidate aggressively. If the market figures out that the large
hedge fund wants to liquidate billions of dollars aggressively they can front run those orders and
force the hedge fund to pay worse prices to liquidate the position. If a hedge fund is liquidating a
long position and the price has dropped 50 pips, other market participants can pick up on it and
start selling as well driving the price lower by 30 pips for example. By the time the hedge fund
goes to liquidate the rest of the position, the market has dropped further and they need to pay
worse prices to get out.
No hedge fund is that stupid to place such huge orders into the market. They know they are
taking a huge risk and thus will not use leverage, or if they do very little.
Back when George Soros broke the Bank of England in 1992, and sold short over $10 billion
worth of pound sterling, he did not use a lot of leverage. He didn’t use 10:1 leverage. His hedge
fund’s assets under management at the time was around $3 – 6 billion dollars, so Soros used less
than 4:1 leverage. Thats it, just less than 4:1 leverage. No more.
And you will find that a lot of large hedge funds with a few billions in assets under management
or larger do not use more than 2x – 4x leverage. Because they know it is too risky
and unnecessary to produce a lot of money for them. We will get into expectations difference in
the next chapter.
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When a hedge fund grows to be tens of billions of dollar large, then they keep reducing their
leverage. Most funds of that size don’t use any leverage. Ray Dalio, the founder of Bridgewater
Associates, the hedge fund with over $50 billion dollars under management, uses zero leverage.
In fact, he credits his success to refusing to use a lot of leverage.
Hedge Funds That Use High Leverage Have High Failure Chances
If you look at the hedge fund failures of the past two decades, you will see the ones that collapsed
used a lot of leverage. Long Term Capital Management, the hedge fund ran by the Nobel Prize
Laureates Myron Scholes and Robert Merton, was using 25:1 leverage at the beginning of 1998,
a full seven months before problems started. When you use such high leverage, yes returns are
stellar during good times when your trading system is working, but if the market goes against
you, or a crisis erupts and you are not positioned properly (get the macro wrong) then your
capital is going to start vanishing very quickly. Long Term Capital Management collapsed within
12 months by the end of 1998.
The big hedge funds know this. They generally do not want to take stupid risks and thus DO
NOT use a lot of leverage. Most of them don’t use any leverage. John Paulson, one of the
richest hedge fund manager with tens of billions in assets under management will typically
always uses less than 2x leverage. Never more than that. He may have used a little bit of
leverage to place his gold bets over the past few years, but he kept it below 2x of his total assets.
The bigger the hedge fund, the more difficult it is to find investments, and trades that are liquid
enough to handle a large size.
Big Blowups Require Big Volatility
You do not see a hedge fund blowing up or taking big losses, or racking up big gains unless there
is volatility and big market movements. Hedge fund blowups, big losses and big gains are
usually not going to occur within a small 50 pip choppy day. It is just not going to happen.
Because hedge funds do not use as much leverage as the retail forex trader does. The hedge fund
may be using zero leverage or up to two or three times capital. And as such a 50 pip move can be
a drop in the bucket for them.
If a hedge fund has $1 billion dollars under management. They use 2:1 leverage and place a
position for $2 Billion in the EUR/USD. If the market moves 50 pips against them that is a loss
of $10 million dollars, which is 1% of capital. Losing 1% of capital is not going to cause a
blowup, or large loss or large gain.
On the other hand the retail forex trader may place the same trade in the EUR/USD. Lets say the
retail forex trader has an trading account value of $50,000. They decide to use leverage of 20:1.
The retail forex trader places a position for $1 million EUR/USD. Thus every 50 pip move
represents a $5,000 gain or loss. Every 50 pip move is 10% move in the trading account capital
gain or loss depending on if the market moves for or against the retail trader. Thus, the retail
forex trader stands a good chance of blowing up, racking up huge losses or huge gains because
they are using a lot more leverage, so even small market movements like 50 pips can represent a
large portion of their equity.
Another example is when Crude Oil dropped 10% in a day in the year 2011. That actually caused
some big losses, whether realized or unrealized for many commodity hedge funds. Because even
if the hedge fund used zero leverage, the market still moved 10% in one day. Hedge funds which
were leveraged 1:1 being 100% long crude oil could of lost 10% that day even though they did
not use any leverage. That represented potential for racking up big losses or big gains. They
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were not going to blow up unless crude oil moved against them even more. Being down 10% is a
very big loss, but it is not the end of the world, so long as there is liquidity to exit your positions.
On the other hand some small speculators in the crude oil market using high leverage could of
blown up, suffered huge losses, or profited with huge gains.
Prime Brokers Will Not Let It Happen
Most prime brokers are not crazy enough to give a hedge fund a lot of leverage. Remember some
of the advertisements from Metatrader brokers offering 400:1 leverage, or 500:1 leverage? Yes
that is crazy. But retail forex traders fall for that. I personally never used above 25:1 leverage,
and even that was crazy. So 400:1 is even more crazy. Because your stops would be so small
that a 10 pip move in the wrong direction would give you a margin call.
A prime broker is not going to give a hedge fund 400:1 leverage, nor are they going to give a
hedge fund 100:1 leverage. They have to protect themselves as well so they try not to extend
more than 10:1 leverage usually. Even if a large hedge fund is given 10:1 leverage, they may
never go near those type of leverage levels. It’s sort of like when a retail forex broker gives you
50:1 leverage. You have a lot of potential buying power. But you never have to use it. You can
only use 1:1 leverage or 5:1 if you want. Just because someone gives you a lot of leverage
doesn’t mean you have to use it and place big position sizes. You can be very strategic and
precise with your use of leverage.
What Do Retail Forex Traders Do?
Retail forex traders are probably not going to use less than 3:1 leverage. You would be hard
pressed to find a retail forex trader uses zero leverage. Most of them use some leverage. The
crazy ones use between 20-50:1 leverage. While the other retail traders risking between 1-7%
per trade are using between 2-15:1 leverage depending on their risk and stop size.
The retail traders like to use leverage, sometimes a lot of leverage because they are gunning for
huge returns. They are attempting to take a $30,000 account to hundreds of thousands or millions
very quickly. The biggest hedge fund do not use leverage or use low leverage amounts. This
forces them to accept lower returns. There is an expectations/returns difference which I will
discuss shortly.
Traders with small accounts of $50,000 can trade very differently from big hedge funds that have
$500 million under management.
How Do Hedge Funds Survive Large Market Movements?
Many people wonder how large hedge funds with many millions and billions of dollars can
survive huge market movements. I used to have retail forex trader thinking. Then my thinking
progressed to order flow thinking. Now I have combined the order flow thinking with hedge
fund mindset mastery. I had to learn how hedge fund managers think in order to gain more
market knowledge and clarity about how various market participants respond to different market
moves.
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One of the primary reasons hedge funds can survive huge market moves is because they use very
little or no leverage at all. Lets say the Euro makes a huge move as it did on July 1st, 2010. The
EUR/USD made a 350 pip up move on that day. This can elicit different reactions from different
people. Let us go through all of the possible reactions:
1. The order flow trader may salivate as they caught a good chunk of the up move. They know
that the explosive volatility can be their friend if they are in harmony with the order flow and
information flow. Order flow traders, especially day traders love the one day volatility explosion.
Because that is where the very nice reward risk ratio trades occur. They have embraced the
market volatility and love it.
2. Another person may feel horror as they were caught short and they got stopped out. They
took a loss and were completely blindsided by the huge up move in EUR/USD. But they
controlled risk and only took a small loss.
3. Another person may feel even greater horror as they were caught short EUR/USD, but were
either extremely highly leveraged, or didn’t have a stop loss in place and they got absolutely
annihilated. These people may have taken a hit on their accounts of over 5%. Some of them may
have taken double digit losses on that day. These traders may operate in horror and fear about the
Page 12
market volatility. They haven’t yet figured out how to harness the market volatility. They have
not yet figured out how to control risk.
Now the hedge fund manager can view this very differently.
The EUR/USD moved around 2.8% on that day. The retail forex trader that was highly leveraged
probably didn’t just suffer a 2.8% loss. Depending on where their stop loss was, and how much
leverage they were using suffered a much greater loss than 2.8% on that day. It could of been 5%
or double digit losses.
If a hedge fund was stuck short on that day, chances are they did not take a loss much bigger than
2.8%, probably no where near that. Let me explain why. Lets assume a hedge fund has $1
billion dollars under management. If it chooses to place a position against the EUR/USD, then it
probably will use little to no leverage. Lets assume it uses around 1:1 leverage. If it is short $1
billion EUR/USD, then that is $100,000 per pip value. If it loses the whole 350 pips, then it has
lost $35 million dollars. A $35 million dollar loss represents 3.5% of its capital. This is
assuming that the hedge fund felt very strongly about being bearish EUR/USD and decided to bet
the whole fund on that one trade idea.
Hedge funds sometimes bet the whole fund on one trade, but this doesn’t happen all that often.
Usually the hedge fund will choose to spread out its bets across a variety of different markets or
currencies. The global macro hedge fund can have different positions in different markets. For
example they may have a position in some stocks, in some commodities, in some bonds, or in
some currencies. They rarely bet the whole fund on one trade idea.
So lets say a global macro hedge fund with $1 billion in assets wants to short EUR/USD. They
probably have already allocated part of their portfolio into other markets. So when they choose
to establish a fresh short position in EUR/USD they will probably not bet $1 billion on it. They
may bet $300 million lets say. They choose to short $300 million EUR/USD, instead of $1
billion because they don’t like to bet the entire fund on any one trade, and because they have
already allocated capital to different positions in other markets.
So now, if the hedge fund takes the full 350 pip loss on a $300 million dollar position, it only
loses $10.5 million dollars. A loss of $10.5 million for a $1 billion dollar hedge fund is only a
loss of around 1%. So that hedge fund would of taken a loss of only 1% instead of 3% or more,
because they did not bet their entire fund on one trade idea.
But the hedge fund did not only have a short EUR/USD position that it lost $10 million on.
Remember it only allocated $300 million to that one trade idea. It had another $700 million
dollar in positions in other markets. This means that it could of been hedged against a rise in the
EUR/USD by having positions in other markets. So while it may have taken a $10 million dollar
loss by betting wrong on being short EUR/USD, it may have had other positions that rose in
value on that same day. So it could of potentially taken a smaller loss than $10 million, or it
could of broken even, or it even could of posted a profit, if their other positions posted a big
profit.
So if the hedge fund was short $300 million of EUR/USD, but long gold for a similar amount,
then it possible that they hedged out their losses.
Of course it is always possible that its other positions lost money in addition to the money lost on
the EUR/USD short trade. In that case the hedge fund would of taken a bigger loss than 1%.
That is always a possibility as well.
And that is a big reason why hedge funds can survive, when they are stuck on the wrong side of
the market, or when the market gaps against them. They survive because they use little to no
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leverage, and can bail out of the market quickly, and because they potentially have other
positions on that act as some form of hedge.
Therefore, next time you see a stock, commodity, bond, currency, or another financial instrument
go up or down by a few % points in one day, don’t automatically assume that it means the hedge
fund took the equivalent gains or losses. The hedge fund probably didn’t bet the whole fund on
one trade, and probably had positions in other markets that may have either amplified the gains,
dampened the gains, amplified the losses, or dampened the losses.
Obviously, this does not mean that the hedge fund is always hedged. As I described earlier, there
was a time when Crude oil crashed one day and it caused some big losses for some commodity
hedge funds:
http://articles.businessinsider.com/2011-05-09/wall_street/29960872_1_big-funds-biggest-
commodity-crude-oil-markets
When hedge funds take different positions and spread their capital out among different bets, they
are expecting some of the positions to pay off big time. They are expecting some trades to pay
off 5 times what they risked, 10 times what they risked, even 20 times what they risked. So
hopefully, those positions compensate for any losses in other positions within the fund. That way
the fund can survive huge market movements, because there exists the possibility that other
positions within the portfolio have posted nice gains.
Now this spreading out of bets occurs a lot in the stock markets. But they can spread the bets
around in other markets as well. They can play the currency, commodities, bond markets, credit
markets, foreign markets, etc.
Therefore, remember it is entirely possible for a hedge fund to hold through a large paper loss, if
another position within the portfolio is posting a huge gain. Thus they sort of cancel each other
out.
But of course that is not always the case. Sometimes after a huge move, it is possible for
someone to nursing a huge paper loss and they can decide to eventually liquidate that position
which is showing a huge paper loss in order to staunch further losses.
I talk to some retail traders who operate under the mindset that after a huge move in the currency
market, there exists very little/no potential for future order flow in that same direction. They may
think that every retail trader that was using leverage and took a loss has already bailed out of the
market or gotten wiped out. But the truth is that the retail traders don’t matter. They don’t move
the market. After a big move, it is still possible for a hedge fund to be caught on the wrong side
and be forced to liquidate a large position over the course of several days. Not all liquidations
can happen in a single day. Remember the principle that billions of dollars of orders can come
into the market at any point if certain scenarios/triggers are met? A hedge fund stuck on the
wrong side of the market may eventually decide to liquidate that position, further moving the
market to a new extreme, or continuing the trend.
Other times the hedge fund may delay liquidating because they may have a paper profit on some
other trade. For example if a hedge fund is stuck with a loss of $200 million on a bad currency
trade, but they have shown a profit of $200 million in the stock market, they could potentially
hold off liquidating the currency trade if they still believe in the trade. They have offsetting gains
in other markets. However, if those offsetting gains were to evaporate, or if the currency trade
loss grows too big, then they may be forced to get out of the currency trade. This is why you can
see some market moves get very extended and there can be some more position liquidation even
after a multi hundred pip moves. This is because not everyone gets out after a 200 pip adverse
move. Some people try to hold on. Some other traders may only liquidate after a 400 pip move,
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others only after a 600 pip move. Sometimes the liquidation occurs over several days. A lot
depends on:
• How big or small they position sized

• If they still believe in the trade
• If they have offsetting gains elsewhere
Also remember that the people liquidating positions are not the only source of order flow. There
is also the news/sentiment/fundamental/macro order flow that is sitting on the sidelines waiting to
commit fresh capital. If they see a big move, sometimes they want to be on that big move
continuing.
Survival Continued
If you ever wondered why some hedge funds can hold losing positions for a much longer period
than retail forex traders, it is because the trade that they have on can be a small part of their
portfolio. And/Or they have other positions that are acting as hedges and showing a paper profit
which balance out another trade that is a paper loss.
How does this help you?
Well, even if the market makes a huge move for example 500 pips, or 700 pips, etc, there may
still be some large market players with a paper loss attempting to hold through that market
volatility. They may place their stops near recent market activity. Therefore don’t automatically
think that all the stops of wrongly positioned market players have already been tripped.
Longer term traders and macro traders can hold through substantial draw downs if they want to
because they are using very little, sometimes zero leverage. When you have on a position that is
not leveraged, even 1% or 2% moves in the underlying financial instrument don’t seem that big
to you. They don’t seem that big to you because you are not using 5x or 20x leverage.
Reason For Leverage Use In The Currency Markets
People can use massive leverage in forex because currency pairs usually do not move more than
1-3% per day on average. Therefore, on an unleveraged basis, if you can capture 100% of the
daily move, the maximum you can make is 1-3%. Therefore, many retail forex traders use
leverage. If you use 20:1 leverage, then all of a sudden a 3% move in the EUR/USD, which lets
say is 400 pips, suddenly isn’t a 3% move for your account. The gains and losses are amplified
with leverage. So that a 3% move can represent a 60% + gain or loss in your account. Someone
who traded with only 1:1 leverage, their account moved only 1-3%. But if you trade with 20:1
leverage, then your account can move 20-60%.
That is why many people use leverage for futures and currencies, since they usually only move a
few % per day.
Being leveraged 1:1 in a single stock is a lot riskier than being leveraged 1:1 in a currency pair.
The EUR/USD may move against you by 1% or 2% or 3% per day. If it does, usually you will
have some time or liquidity to bail out of your trade.
But with a stock, if there is some bad news, it can gap against you by 5%, 10%, 50%, etc. A
currency pair isn’t normally going to gap against you by 5% or 10%.
Therefore, position sizing and leverage use depends a lot on the potential volatility of what you
are trading.
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This contrasts with stocks, which can move 1%, 3%, 5%, 20%, or 50% in one day. Some stocks
can gap that much if there is news that can change the fundamental value of the company.
Obviously, not every stock is going to move that much. But if you take a look at the daily
winners and losers in the stock market, you will see some huge 5%, 10%, 20% moves on certain
days for certain stocks.
A stock can gap a lot. The chances of a currency pair gaping 10% or 1,000 pips is much lower
than a stock. Although it has happened several times in forex history. It happened with the 1985
Plaza Accord Trade in the USD/JPY where it gaped hundreds of pips. It happened again with the
SNB Devaluation in September 2011 for the EUR/CHF where it gaped 800 pips. Chances are,
since forex is a 24 hour market, there will be some liquidity to execute transactions.
That potential for bigger moves in stocks and the fact that the stocks can gap, means that people
will not use much leverage in stocks. Soros used leverage in the currency and futures markets.
He may have leveraged himself 1:1 or 2:1 or larger in concentrated currency and futures
markets. But he never leveraged himself 1:1 in a single stock. He leveraged himself 1:1 in the
stock market on many occasions, but never in a single stock. He always made sure to spread out
his bets among many different companies so that if one stock went bad on him due bad company
specific news, it didn’t blow him up.
Also, the potential for a stock to go to zero is far greater than the potential for a major currency
pair to go to zero. That is another reason why very little or no leverage is used with stocks by the
professional traders.
Also, the potential for a stock to move 50% or 100% within one year is far greater than the
chance of a currency pair moving 50% or 100% in one year. Even in the biggest of trending
years, currency pairs will not typically move more than 10-25% in one year. Since their volatility
on an unleveraged basis is lower, some people choose to attempt to juice returns in the currency
markets by adding leverage.
Since the volatility for stocks can be higher, most people choose not to use much if any leverage
in stocks. In fact, you will typically see many hedge funds have a limit to how much % of their
assets can be in one stock. Some hedge funds have a rule that the stock can represent no more
than 5% of the portfolio. So, if they had $100 million under management, and they had that rule,
they would not buy more than $5 million dollars in one stock.
How do they make money then? Well they are playing for bigger moves! If that stock rises 50%
in one year, then that $5 million dollar stake turns into $7.5 million, which is a $2.5 million dollar
profit and a 2.5% profit for the whole portfolio for just one trading position in which they
allocated 5% of their capital. They then try to find five or ten or twenty different small positions
they can take that may pay off that big.
Contrast that with currencies, where if a $100 million dollar hedge fund chooses to place a $5
million dollar bet on the euro for example. If the euro moves 10% in a year, then they make
$500,000 profit. That is only a 0.5% return on their total portfolio. It is a small return.
Therefore, for currencies many hedge funds choose to use some form of leverage, even if it is a
little bit.
Paul Tudor Jones
Paul Tudor Jones was asked how his trading differed from his early days. He said he does the
same thing. The only difference being that he uses less leverage. Why does he use less leverage?
Because he is attempting to trade a larger amount of capital. Back in the 1980’s when he was
only running a few hundred million he might of used leverage equaling 2-5 times capital. Now
Page 16
that he runs a few billion dollars, he doesn’t use much leverage if any. He probably always keeps
leverage below 2 times capital now.
http://chinese-school.netfirms.com/Paul-Tudor-Jones-interview.html
So again, I’m probably the exact same trader as I was 15 years

ago, it’s just less risk, less return.
Temporary Leverage, Never Permanent
Of the large hedge funds that do use a good chunk of leverage, they usually only do so
opportunistically and temporarily. For example of a $10 billion dollar hedge fund is using 3:1
leverage, don’t assume that they are levered that much each and every single day of the year.
They may only be levered that much on certain days or certain weeks or certain months. If they
find a nice trading opportunity with some decent liquidity, they can put on some leverage. But if
they don’t see any nice opportunities, they will pare down their positions and reduce the leverage
drastically. They will run small positions until they can see better opportunities, at which point
they can raise the leverage a little bit.
Take for example George Soro’s Quantum fund in his book The Alchemy of Finance. When
George Soros starts his real time experiment his fund is using around 2-3 times leverage. Once
George Soros sensed that the time was ripe to place a big bet, he placed bigger trades that raised
the leverage to around 5x capital. Once he sensed that the big moves global macro moves were
drying up, or there was too much uncertainty, he reduced leverage back down to around 3x
capital. In this way he is constantly raising and reducing leverage to take into account the
different macro environments. He was constantly varying his position sizes. However, he did
maintain a cap on his leverage. He never really wanted to go above 5x capital.
Contrast this with the retail trader crowd that can go crazy with leverage. One moment they have
a trade on with 2x leverage, the next moment they ramp up the leverage to 10x, if they get
crazier, they ramp up the trade to 20x leverage. Then, if they are right on the trade they make a
huge double digit profit, if not they suffer a huge double digit loss. That is because they are
raising leverage too fast and to too high a level. Going from zero leverage to 5x or 10x or 20x
leverage within one day is a very, very, very large increase. The retail traders do this because
they expect to make 500%+ in a year. Thus they want to use 10x and 20x leverage.
George Soros doesn’t want to use 10x or 20x leverage, because the expectations for his returns
for the year were around 30-100%. If you only are only targeting around 30-100% per year, you
do not need to use 10x or 20x leverage to achieve that goal. That is why he only tweaked
leverage by small amounts. He raised leverage from 3x to 5x. If he was only using 3x
leverage, he figured he may only make 50% if he was right. So he raised leverage to 5x, and he
was right on the trades and made 100%. The retail traders is leveraging 10x or 20x because they
expect to make 500%, 1,000%, etc.
Remember the general principle: As the fund gets larger, the lower leverage you will have
available and the lower leverage you will use.
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Hedge Fund Size Typical Leverage Used / Max Available
$1 million 1x – 20x
$100 million 1x – 10x
$1 billion 1x – 5x
Retail Traders ($1,000 – $50,000) 5x-500x
Expectations Difference
There is a big expectations difference between hedge funds and retail traders. Expectations in the
form of what percentage returns they expect to make and what they are targeting.
The retail trader is trying to turn a few thousand dollars or a few tens of thousands of dollars into
$100,00, $500,000, $1 million +, etc. They are trying to make anywhere from 100% – 10,000%
per year. Or at least until they hit their target, whether that target is 100k or 500k or 1 million,
etc. They just want to get the big money fast. They are looking for a quick buck. A fast buck.
They are looking to get rich quick.
I am not saying it isn’t possible. It is possible to make a lot of money in a single year and make
500% or 1,000%. The problem lies in that most retail traders who want to make those returns are
not willing to put in the work required. If they do decide to do something, then they may fall into
the technical indicator or chart pattern trap. When in reality, if they developed concepts and
found a system based on order flow, liquidity, volatility, news, sentiment, expectations,
positioning, etc, then they would stand a far better chance to reach those large profit years.
The hedge fund manager thinks a bit differently. In most cases they are not looking to make
500% or 1,000% in a year. They know that is virtually impossible to do unless they leverage up
too much and take excessive risk. And they do not want to take excessive risk, especially when
they have a certain lifestyle that they want to maintain. If some of them are already making
millions of dollars then why should they leverage up crazily and risk their lifestyle? They don’t
want to risk excessively. The retail trader who has a spare $1,000 or $5,000 on the side figures
that if he leverages crazily and loses it, then he can just try to rebuild and go at it again. But the
hedge fund manager that has $10 million or $100 million dollars usually doesn’t want to risk it
all. Why go on a volatile ride making tens of millions of dollars, only to leverage up crazily and
lose it, then try to make it again? They don’t want that much volatility. So therefore, if they want
lower volatility, they need to be willing to accept lower trading returns.
The hedge fund is not looking to make 500% a year. They are usually looking to make
somewhere between 15-50% for the year or so. You have to understand that a lot of these top
hedge fund managers manage hundreds of millions or several billions of dollars or tens of
billions of dollars. They are not going to force themselves to take huge risks to try to make 100%
a year. If they make 15% a year that is considered “good” most of the time. If they make 30% a
year that is considered spectacular.
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The hedge fund managers knows that in most situations achieving a 500% or 1,000% return is
almost impossible. There are a few exceptions to that rule, like when John Paulson bet against
the housing market and some of his credit funds were up over 500% for the year. But those don’t
happen too often. The opportunity set to make 500% or 1000% for a large hedge fund is very
low.
The hedge funds generally do not want to make huge leveraged bets when they have already
made hundreds of millions or several billions and manage billions more in other peoples money.
They figured out that they do not have to leverage excessively or generate crazy returns in order
to make more millions or more billions of dollars.
Ray Dalio has a net worth of $10 billion. Lets assume he has all that money in his hedge fund
called Bridgewater Associates. Lets assume that Bridgewater manages $40 billion in additional
money. If he makes just 20% per year, he can make $2 billion off his personal fortune, then
additional management and performance fees from the other investors in his fund.
Or lets take Paul Tudor Jones with a net worth of $3.6 billion dollars. Lets assume his Tudor
Investment Fund manages $10 billion dollars. If his hedge fund makes 15% for the year, Paul
makes over $500 million from his personal stake, then adding in the management fees and
performance fees from his other investors in his funds, and he can make even more.
Large hedge funds do not have to shoot for high returns, thus they do not need to use a lot of
leverage. They don’t have to force themselves to lever up and try to achieve 500% returns.
Even when Paul Tudor Jones was trading back in the 1980’s, even during his best years he was
not up 500%. There were some years he did post triple digit returns in the 100% to 200% range.
But he never made 500% or 1,000% or 10,000% in a year like some retail forex traders are
trying to do.
The retail forex trader is trying to turn $5,000 into $25,000 or $100,000 within a year. The hedge
fund manager is NOT trying to turn $5 billion into $25 billion in one year. They don’t have to
put themselves under such extreme pressure. Because the hedge fund manager knows that if they
try to leverage themselves up like that to achieve a 500% return, that the chances of blowing up
are very large. Especially when trying to get in and out of the market with large positions. It is
very difficult and you move markets against you. Not to mention the fact that the investors in the
hedge fund can get nervous and yank their money if they see you leveraging and risking too
much. If they withdraw their money and the hedge fund does not reduce the size of its bets, it’s
leverage increases.
What the retail forex trader is trying to do is leverage themselves up day in and day out trying to
make 1,000% gains. They risk a large chance of failure, especially if they do not know about
order flow trading.
That doesn’t mean that retail traders can’t experience enormous returns in excess of 100% a year,
they certainly can do that. The reason is that they can be nimble and take advantage of short term
inefficiencies like news trading, and swing trading capturing multi day momentum moves.
Now you may ask how does a hedge fund using little or no leverage and post decent returns of
20-40% a year? The answer is that they catch bigger moves! I will discuss this in the
Inefficiencies Differences chapter.
Low Risk Per Trade
Page 19
Most hedge funds are not going to risk 10%, 5%, not even 1% or 2% risk per trade. They would
be more likely to risk 0.10% on a trade idea.
For example, one of the traders profiled in the book Hedge Fund Market Wizards said that he
risks a mere 0.10% per trade, and may even get out quicker than that if he doesn’t feel right about
the situation.
The reason is because they are not trying to make 1,000% a year or 100% a year. They are only
shooting for 10%, 20%, 30%, or 40% a year. Thus, if they risk 0.10% per trade, and they want to
get to 20% in a year, they only need 200R in one year. And how do you get 200R in a year?
Well you catch a few nice trades. If you have a few trades that net you 3R, another trade gets
you 5R, a few trades get you 10R. Maybe you catch a few big winners that net 15R or 20R.
Pretty soon you can reach your desired goal if you continue to trade well and only take small
losses relative to your wins.
Remember the general principle: As the fund gets larger the lower returns you will be looking to
generate.
Hedge Fund Size Returns Looking To Generate
$1 million 10-500% per year
$100 million 10-200% per year
$1 billion 10-150% per year
Retail Traders ($1,000 – $50,000) 100% – 10,000% per year
Discipline Difference
From the book Reminiscences of a Stock Operator:
Speculation is a business. It is neither guesswork nor a

gamble. It is hard work and plenty of it.
Speculation is a hard and trying business, and a speculator

must be on the job all the time or he’ll soon have no job to be
on.
A man must give his entire mind to his business – if he wishes

to succeed in stock speculation.
It doesn’t matter if it is stocks, bonds, commodities, currencies, etc. You still need to dedicate a
large portion of your day and dedicate your entire mind to it.
One news article from back in the days joked about hedge funds:
Page 20
Normally, you find dinner conversation is half business and and
half sex and politics. With these hedge fund guys there is
very little sex and politics.
Stanley Druckenmiller
Stanley Druckenmiller was rumored to go to sleep at 8:30 PM EST on weekdays in order to wake

up at 4:30 AM EST the following day. Why would he go to sleep so early? He could want to get
a good night’s rest. Or he could want to wake up early to see and trade the action in Europe. Or
both.
Serious traders, successful traders do what is necessary to find the opportunities every time they
should. They do what is necessary to stayed plugged into the information flow and opportunity
flow each and every single day. They do what is necessary to capture the volatility.
Paul Tudor Jones
Paul Tudor Jones said in his interview in 2000:
http://chinese-school.netfirms.com/Paul-Tudor-Jones-interview.html
Question: What are some perceptions and priorities of yours

that have changed over the years?
PTJ: I think there’s a natural progression that everyone goes

through. The older you get, the more you’ll realize that a
quality life is one that has an extraordinary balance in it.
The guy that’s working at 75 years of age and still running a
company, that doesn’t have any appeal to me because I think his
life is out of balance. If the only thing that he can find
that’s satisfying to him is being involved in a profession with
something, I think you’ve got to have more balance. In my 20’s
all I cared about was being financially successful and today I
look to strive for a more balanced life. In that context
though, when I come to work I’m as competitive as anybody
you’ll meet and I clearly look forward to the day when I have
the best performance of my peers, the macro hedge funds, for
the year, which hopefully will be this year.
Paul Tudor Jones said in Reminiscences (Annotated Edition)
Instead of working 40-hour weeks as most of our trading

forebearers did, we work 80-hour weeks now because the
information available has probably multiplied by 1,000 times in
what oftentimes is an information race.
Michael Milken
Michael Milken was the junk bond king who made $550 million in 1987, which up until that time
was the most money earned by a human being in a single year. He even eclipsed the $100
million Paul Tudor Jones made during that year from the shorting of stock index futures. Milken
was rumored to work 18-20 hour days. He would be in the office around 4 AM and not leave
until 7pm or so. Then he would take work with him home. He was rumored to only sleep four
hours a night. When he was younger, he wore a miners headlamp on the bus to his commute into
New York City so he could read company prospectuses and 10k filings.
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I am not saying you should or shouldn’t go work 20 hours days. I am merely pointing out how
devoted and disciplined many of the top traders were to their work. If you want to succeed in
trading, you have to let it consume you for a good portion of your day.
Jim Rogers
Jim Rogers described his life when working with George Soros in the 1970’s in the book Money
Masters of Our Time:
The most important thing in my life was my work. I didn’t do

anything else until my work was done.
The author, John Train then proceeds to describe Jim Rogers:
He rode his bicycle every day to the office on Columbus Circle,

where he worked nonstop-taking not a single vacation in a ten
year period.
John Neff
The book Money Masters of Our Time describes John Neff:
He works sixty to seventy hours a week, including fifteen hours

each weekend. In the office he
concentrates virtually without interruption and drives his
staff extremely hard.
Marty Schwartz
Schwartz writes in his book Pit Bull:
My strengths are dedication to hard work, dogged persistence,

ability to concentrate for prolonged periods, and a hatred of
losing.
Schwartz, in Market Wizards read from a list of his trading rules:
The last words I have at the bottom of the page are: Work,
work, and more work.
Bill Lipschutz
Lipschutz talks about how he worked virtually 24 hours a day for years when he was at Salomon
brothers. Even at age 52 he only got around 3-4 hours of nonconsecutive sleep during a day.
http://www.hathersage.com/fx/news/TraderMonthly_Nov06.pdf
Jesse Livermore
From the book Jesse Livermore: World’s Greatest Stock Trader:
Livermore now had a plan, an investment strategy that he

believed worked, and he know that one essential secret of
success was at its core – the hard work of never-ending
analysis.
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It was also reported in Time magazine in the 1920’s that Livermore stayed in his office to study
his trades and the market until 8pm even though the stock market closed at 3pm.
Monroe Trout
I have only had three days off in a year and a half.
To trade successfully you have to do it full-time. I allot

myself ten vacation days a year, but I never take them. I
firmly believe that for every good thing in life, there’s a
price you have to pay.
Michael Marcus
Michael Marcus talked about how hard he worked back in the 1970’s in Market Wizards:
I was, a professional trader who, in those days, spent fifteen

hours a day trading and analyzing the markets.
Marc Rich
The book The King of Oil: The Secret Lives of Marc Rich describes Rich’s discipline:
His greatest strength is surely the fact that he does not give
up until he has achieved his goal. He could work on something
day and night until it finally worked out. He never thought of
anything else except work. You cannot achieve what he has
achieved if you only work eight hours a day and keep your
weekends free.
Hedge fund managers and the top traders, have a huge discipline difference over retail traders.
The retail forex trader may search for opportunities only when “they are in the mood” or only
when they are on a winning streak. If they catch a few losing trades the retail forex trader may
get bummed out and stay out of the market for a few weeks because they are afraid of taking
risks as they believe it will cause more psychological pain. Or they may come back to the market
but not do all the proper due diligence that they are supposed to.
For example a chartist may look at only five different currency pairs, when they should of been
looking at twenty different markets. Or they may only perform analysis on the daily charts and
forget to look at the weekly charts and monthly charts. Or they may see certain chart patterns
and believe they are strong signals, when in reality they are not.
The order flow trader that is lazy may do some of the analysis, but not all of it. They may label
stops and option barriers on their chart, but do not do the news analysis. Or they may do the
news analysis, but forget about doing scenario analysis. Or they do scenario analysis but only
think about 2-3 bullish and bearish scenarios that can play out, while they should of been
thinking about more bullish and bearish scenarios.
Discipline and Habits Every Day
The hedge fund managers have to be disciplined to do all the work necessary every day. They are
hunting for opportunities all the time. That doesn’t mean they place huge trades every day or
make a portfolio allocation decision every day. But it does mean that they are searching for the
market that will make the next big move.
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Sometimes they are engaging in damage control. The market may be moving against them, and
there is a whole bunch of red numbers on their screen and they need to figure out which positions
to exit out of and how fast to dump them. But during that episode and after that episode they still
need to be searching for new opportunities. To find that next big move.
They are even searching for the next big move after they have had a huge profit day or week or
month. Remember Paul Tudor Jones during Black Monday 1987. He made a lot of money being
short the stock indexes that Monday. But while he made a lot of money from there, he was still
searching for the next big trade. Where is the next explosion of volatility going to occur? What
scenario needs to play out? He found it that same day going long bonds to make another killing.
When George Soros made $1 Billion dollars breaking the Bank of England, he did not stop there.
The breaking the Bank of England trade occurred in September 1992. Prior to that trade he
placed bets against the Italian Lira. After breaking the BoE, he shorted the Swedish krona as
well. After Black Wednesday, he went long British stocks and long British bonds as he felt that
the lower British pound and lower interest rates would be bullish for U.K. equities and gilts. He
was constantly searching for where the next big move was going to be.
Battle Hardened
A lot of these hedge fund managers are battle hardened. What does battle hardened mean? Take
this quote from Carl Icahn:
http://www.nytimes.com/2011/04/24/business/24backpage-ART-
MYFINESTHOUR_LETTERS.html
It may sound corny, but it bothers me more to lose money for

those who have entrusted me than to lose my own capital. I am
battle-hardened; they are not.
Icahn has been through the ups and downs. He has suffered the draw downs, survived and
bounced back from them. He knows how to stay in the game and keep playing. He has survived
through the volatility, bounced back to reach new highs. He has gone through the baptism of fire.
The good hedge funds are battle hardened. They have seen booms and busts, up markets and
down markets, insane volatility and periods of low volatility. But throughout all of that they still
need to be searching for new opportunities to profit. And chances are they are not looking for a
moving average crossover, or signal from Ichimoku Kinko Hyo. They are looking for a global
macro move that can move the market.
Similarly, with enough experience in the markets you too will become battle hardened as well
and spot the order flow opportunities whether you are up a lot or down a lot.
Always Be Trading
Steinhardt once said:
I do an enormous amount of trading, not necessarily just for

profit, but also because it opens up other opportunities. I get
a chance to smell a lot of things. Trading is a catalyst.
Paul Tudor Jones said in the Trader Documentary:
Page 24
Where you want to be is always in control, never wishing,
always trading, and always first and foremost protecting your
ass.
Both billionaire hedge fund managers Paul Tudor Jones and Michael Steinhardt have said to
“always be trading.” But what exactly does this mean?
This does not mean that they will constantly placing highly leveraged bets ten times a day risking
5-10% per trade. That is suicide and they know it. If they are going to probe the market and
practice the principle of “always be trading”, then they are risking tiny amounts, perhaps .05% or
.10% a trade, in order to help them gauge the market momentum and time a big trade.
This provides the hedge fund managers with a unique edge. Because they can constantly be
involved in the markets with small positions, they can get a feel for what the sentiment is, when
the news goes against them, when the market is not “acting right”, how the market is positioned,
etc. They can probe the market with small orders.
Because when you actually have a position on, even if it is a small one, the hedge fund manager
knows that he will be able to gleen more information from the market than another trader that
chooses to completely stay out.
They can actually see and feel the exposure of the profit and loss moving up and down, even if it
is a small position.
This helps the hedge fund position themselves for when the big move happens, because they have
already probed the market with small orders already, so they can time the market better.
Hedge Fund Managers Re Invest Into Their Own Trading
Paul Tudor Jones from the book Market Wizards:
I would say that 85 percent of my net worth is invested in my

own funds, primarily because I believe that is the safest place
in the world for it. I really believe that I am going to be so
defensive and conservative that I will get my money back.
This can help the average trader, because you always want to think about how to trade, grow an
account, and putting a lot of that money back into your trading account if you do not need it for
living expenses.
When you have a large percentage of your own net worth in your own trading account / fund, it
helps you focus on being the best, most disciplined trader possible who can manage risk, find the
best opportunities and stay away from bad opportunities.
Hedge Fund Managers Get It Wrong At Times
Some of the millionaires and billionaire hedge fund managers may have a big month or a big year
where they make a lot of money. Occasionally, some of them start to think they are god of
markets and can move the markets themselves, all because they had a hugely profitable year.
They start to think they have the Midas Touch. They think the next time they place a huge multi
billion dollar trade that the market “has” to move in their favor. After all they just had such a
profitable year and have attained the Midas Touch?
Then they fall back down to reality, because that is not the way the markets work. All trades,
whether big or small, whether placed from a rich hedge fund manager or not, require order flow
Page 25
and liquidity to validate their trades. Further order flow to come into the market and move it in
their desired direction.
Some hedge funds also get lax and lazy. They may stop doing the order flow thinking,
research, scenario analysis, global macro analysis. They stop thinking about what the risks are
and how much they can lose on each trade and start thinking about how much money they are
going to make.
That’s a big mistake. And it eventually catches up with them as the market hands the hedge fund
a few losses in order to bring it back down to reality and remind the hedge fund that they need to
place trades that have the massive order flow on their side.
Every trader or investor needs to make sure they are not emotionally affected after they have a
huge winning year. That doesn’t mean that you can’t be happy and celebrate. You should be
happy and celebrate and enjoy your success. You just need to make sure that success and
celebration doesn’t go to your head and causes you to see deviate from your system and start
seeing trades which don’t actually exist and over sizing positions because you think you acquired
the midas touch. Happiness and celebration, while maintaining your perspective, objectivity and
emotional balance is the ideal. Taking it to the level of euphoria, where you think you are god of
the markets, start deviating from your system and start oversizing positions is the wrong way to
go. There is a big difference between them.
Whether you are up 10% or 50% or 100% for the year doesn’t change what will happen in the
market. Just because you made 100% doesn’t mean there will be more opportunities in the
future. The market is still going to do its thing. If you are up 100% for the year going into
September, and the market was planning on doing its thing and making 5 MDMM’s and 1 GM
move in the EUR/USD by the end of the year, then you being up 100% for the year isn’t going to
change that. Your trading performance doesn’t change the markets maximum opportunity set. If
you are up 10% for the year or down 10% for the year, and the market was planning on making 5
MDMM and 1 GM move, then that is what the market is going to do.
You cannot say that just because you are up 100% for the year the market ‘has’ to start exploding
with volatility every time you place a trade. The market doesn’t have to do no such thing. The
market just follows the order flow, liquidity and volatility of the other market participants.
It is up to you to maintain your emotional balance and perform a dispassionate study of the
underlying market conditions every single trading day. That is your job.
Hedge Fund Manager Can Take Losses
Why do big hedge fund managers trip up and take big losses some of the time? Because there are
times when they get aggressive in allocating capital, in being quick to establish a position. They
may have just gotten an influx of cash and they want to put the money to work and establish
exposure in certain markets.
They can be under pressure to show their investors that they are doing something with the cash.
To show that they have some trades or some investments that they have placed bets on. Because
there are some investors that ask them why they are investing money in the fund if they are just
going to keep a lot of the money in cash and be forced to pay the hedge fund fees.
They didn’t get rich by sitting on the sidelines and having their money in savings accounts.
Some of them do not like excessively staying in cash or dithering. They prefer motion over
meditation. And that leads to some bad trades some of the time without proper order flow
research. They can get caught on the wrong side of the massive market momentum sometimes.
They can get on the wrong side of the news/sentiment/fundamental/macro order flow.
Page 26
Stops Difference
When I first started trading forex, I had the mindset of a retail forex trader. How do retail forex
trader think of stop losses? Well, what they usually do is they like to put on the whole position
all at one price, then set a physical stop loss all at one price. In other words, they get in the entire
position all at once, and then set a physical stop to get them out all at once. There are some retail
traders that scale in and scale out, or that use mental stops, but the vast majority like to get in and
out all at once and use physical stops.
The typical large hedge fund is usually not going to do that. If a hedge fund is running multi
billion dollar positions they cannot just get in and out all at one time and at one price. They
could theoretically call up a bank and ask them to be a counterparties to the whole multi billion
dollar order, but that would usually entail very large spread costs and thus the hedge fund is going
to try to take it’s chances in the market and try to establish or liquidate a position using a few
different counterparties. They will prefer to scale into and scale out of positions so that they have
many different counterparties to the trade.
If a hedge fund is holding on to a $5 billion dollar position, they are usually not dumb enough to
put in a $5 billion dollar stop loss into the market. That would be telegraphing to the banks
where the hedge fund’s pain tolerance point is. The hedge fund doesn’t want anyone to know
what that is.
Why?
Because if they did, and the market got close to that stop loss level, many times word will leak
out that there are some big stops at a certain level and the market will tend to gun that level. The
big banks and other hedge funds have an interest to do so, because $5 billion dollars worth of
stops all set at one point is a hell of a payday for the banks and other hedge funds. Because $5
billion dollars worth of stop losses, if triggered can lead to a price movement of 40-150 pips,
depending on what the liquidity situation is, what the macro situation is and how much the stop
hunters liquidate into them. Depending on how much order flow is needed to get to the stops, the
stop hunters can pocket anywhere from a few million to tens of millions of dollars from such a
massive unwinding.
Monroe Trout in The New Market Wizards had this to say about stops:
In general, I don’t like placing stops. If you’re a big

player, you really have to be careful about putting stops into
the market.
Marko Dimitrijevic, who managed billions in assets in his hedge fund, had this to say about stop
losses in the book Inside the House of Money:
Stop-losses work in continuous markets and we use them there.

When you move into distressed debt or value plays where
markets aren’t continuous, they don’t work well and can be
dangerous. Our stop loss levels are always internal. If you
give stops to counter parties, they invariably get hit.
Ray Dalio in the book Hedge Fund Market Wizards said:
Schwager: Are there risk limits in terms of individual

positions?
Page 27
Dalio: There are limits in terms of position size, but not in
terms of price. We don’t use stops.
Stop Rumors Can Leak
The easiest stop locations are found using the chart based strategies. That is what I use most of
the time. Over the years, I am paying less and less attention to the stop loss information given on
IFR, forexlive, etc. As the years go by, I focus more and more on the news/sentiment/
fundamental/macro order flow.
However, for the hedge fund traders and bank traders, they can try alternative source stop loss
information. Rumours of where the stop losses are does leak out. Not all the time, but a decent
portion of the time. What % of the time? There is no way to know an accurate number, but if I
had to guess then it would be in the 30-60% range, which is a fair amount of time. The
information that does leak out you can find it on IFR, Forexlive, etc. It is very useful on its own,
but when you combine it with the information and strategies in this Order Flow Mastery Course,
then the information truly becomes astronomically more useful.
Word leaks out as bankers talk to each, hedge funds talk to each other. They try to sniff out each
others positions. They try to call brokers, banks, hedge funds, contacts in other countries
including in Europe, United States, and Asia. Eventually they start to put the pieces together
about where the stops are and how the market is positioned. Not all the time, but a fair amount of
time it does occur.
Lets say, in order for a stop hunter to trigger that hedge fund’s $5 billion worth of stop loss
orders, it needs to execute aggressive orders of around $2.5 billion to trigger the stops. If you put
on a position size of $2.5 billion in the EUR/USD, each pip is worth $250,000. So if the stops
get triggered and the price moves 60 pips lets say, and the stop hunters liquidate into them, they
can profit up to 60 pips. 60 pips multiplied by $250,000 dollars per pip equals $15 million
dollars. Not bad for a few hours or minutes worth of work eh?
Therefore most of the big hedge funds are not that stupid to put such large physical stop losses all
in one spot.
Combination Of Stop Losses From Market Participants
When I say that no hedge fund is stupid to place $5 billion dollars worth of physical stops at a
certain level, that doesn’t mean that such huge stop losses will never exist. They can absolutely
exist. Instead of placing a $5 billion dollar physical stop, they may just have an internal stop loss
in the form of a price point where a price alert goes off and where they will liquidate the entire
trade or begin the liquidation process.
Or there can be big stop losses to the tune of billions of dollars in a combination of physical or
mental stops, but that they will tend to be from a combination of different market players.
For example, in a bullish market the market makes a high, then pulls back a bit. Above the most
recent high there can be buy stops from chart pattern followers wanting to buy a breakout. There
can also be buy stop orders from traders who are currently short the market and want to cut their
losses if price rises above the previous high. Furthermore there is potential for there to be some
macro related buy stops if there has been some bullish news recently released into the market.
All those together can form a nice cluster of stop losses totaling many billions of dollars some
times.
What Kind Of Stops Do Hedge Funds Use?

Page 28
So now that we know that a hedge fund is usually not going to place a physical stop loss order
into the market for billions and billions of dollars, how do they bail out of positions that goes
against them? They have a few different ways. I list them below. Note that these strategies can
be used both to initiate a fresh position and to liquidate an existing position:
1. Physical stop loss orders of smaller size, spread out at various levels – for example if a
hedge fund is short $3 billion EUR/USD at 1.2600, they may have a stop loss for $300 million
every 50 pip higher starting at 1.3000. In this case they do not have a $3 billion dollar stop loss
at 1.3000, but rather it is spread out in the range between 1.3000 – 1.3500.
2. Mental Stop losses to get out all at once – If a hedge fund is short $3 billion EUR/USD at
1.2600, they can have a mental stop loss at 1.3000. They set a price alert at 1.3000 and if it
touches that price they start to manually execute orders to liquidate the whole position all within
a short period of time.
3. Mental stop losses that, that are spread out at various levels – If a hedge fund is short $3
billion EUR/USD at 1.2600, they can have a mental stop loss points that are spread out. So they
can get out of $300 million every 50 pips higher starting at 1.3000. They have price alerts at
1.3000, 1.3050, 1.3100, etc and as each one gets triggered, they get out of part of the position.
4. Mental stop losses that, once triggered, cause the hedge fund to wait for a possible
retracement to bail out – There are times when people have a mental stop loss point, that if it is
breached, they will start looking for a retracement in order to get out of the position at slightly
better prices. Of course that retracement may never come, but if they believe the market will
rebound, then they can wait for a retracement in order to get out.
George Soros used this strategy a few times in The Alchemy of Finance. There was one time he
was long Japanese stocks and long billions of Japanese bonds as the price dropped. His mental
stop losses were triggered. He knew he would have to get out at a loss, but he did not want to
sell at prices that he deemed were depressed. So he waited for a rally to come so he could bail
out of his positions.
Sometimes it works and you get out at a smaller loss. Other times it doesn’t work as the market
doesn’t retrace and you have a bigger than expected loss.
5. Mental stops that once triggered result in steady unwinding throughout the course of the
day/next few days – Lets say someone is short $3 billion EUR/USD with a mental stop at
1.3000. If price hits 1.3000, that can the trigger the exit strategy. The exit strategy may be to
cover $1 billion of the position every day for the next three days until the position is completely
covered no matter what the price is. So by the end of the three days, the position has been fully
gotten out of. Sometimes the price may hit 1.3000 and fall back down and you can cover at a
smaller than expected loss. Other times the market may move against you and you may cover at
a bigger than expected loss.
6. They use Time Stops – If someone is short $3 billion EUR/USD, they can use a time stop on
the trade. They can say if the market doesn’t drop within 24 hours, they will cover $1 billion
dollars. If the market doesn’t drop within another 24 hours, they will cover another $1 billion. If
the market doesn’t drop within another 24 hours, they will cover the last $1 billion dollar
position. Or they can say if the market doesn’t drop within one week, they will get out of the
whole position.
7. They wait for a change in fundamental value/sentiment to bail out – If someone has on a
multi billion dollar position, they may wait until they feel that the news/sentiment/fundamental/
Page 29
macro bias is against them. Once they sense that, they can start to bail out of the trade. Of
course determining the macro bias can be tricky at times.
8. Combination of all of the above – they can use a combination of two or more of the above
strategies. For example they can liquidate half the position based on time stop, while the other
half is using physical stop loss orders spread out at various levels.
No Physical Stops, No Mental Stops, No Stops at all
Also there is another potential strategy that some of them use. There are definitely some hedge
fund managers that DO NOT use physical stop losses. There are also some hedge fund managers
that DO NOT use ANY stop losses at all, mental or otherwise.
You may be shocked to think that, after all it is taught as trading 101 to always use stop losses.
Yes, but that is trading 101 for retail forex traders who trade small positions in the market of $1
million or less. Once you go into the big leagues and trade hundreds of millions and billions of
dollars strategies can change drastically. Mindsets can change drastically.
Here is an example from the Market Wizards book about Michael Steinhardt:
Schwager: Do you have any trading rules that you could define?
Steinhardt: Give me an example of a trading rule.
Schwager: A common example might be: Before I get into a

position, I know exactly where I am getting out. It doesn’t
necessarily have to be a risk control rule, it could be-
Steinhardt: No, I don’t have any rules about stops or

objectives. I simply don’t think in those terms.
How does Steinhardt get away with using no stop losses? I cannot be 100% sure, but I assume it
has to do with the varying of position sizes and how big a stop loss he used. He could of used a
big stop and had that big stop equal a very small portion of his equity.
If someone is risking 0.05% on a stock trade where every $2 move is 0.05% of the account, even
if the market gaps against you by a sizable portion, the maximum loss is still very small. For
example if you are risking 0.05% on a currency trade, where your risk is 0.05% of your account
every 30 pips. Even if the market gaps 200 pips against you, the loss is still only around .30% –
0.35%. A horrible loss considering you only wished to risk 0.05% and suffered a 0.35% loss.
But in the grand scheme of things, losing 0.35% is not going to blow your account.
Paul Tudor Jones
Here is a quote from Paul Tudor Jones about time stops from the book Market Wizards:
One of the things that Tullis taught me was the importance of

time. When I trade, I don’t just use a price stop, I also use
a time stop. If I think a market should break, and it doesn’t,
I will often get out even if I am not losing any money.
The Invisible Hands
On macro fund stop losses/pain tolerance points/exit strategies:
The Invisible Hands – The Philosopher:
Page 30
We are always looking for evidence that a hypothesis can be
falsified. I prefer saying “hypothesis falsified” rather than
“stop loss” because there are many potential reasons for a
falsified hypothesis. One piece of evidence is losing money,
whereby the market goes through some level that you think it
should not have. This is a market test, but fundamentals can
change as well. For example, there are many traders that make
money for all the wrong reasons. I always keep in mind why I
did a given trade, and if those reasons are no longer valid, I
take the trade off. You do not have to wait until a trade has
lost money before cutting it. At a thematic level, when a
hypothesis is falsified, we cut the position.
The Invisible Hands – The Commodity Hedger:
But if my underlying hypotheses are invalidated, I will take

the trade off, even if I am making money.
The above is what one trader recommends. I sometimes follow the above quote, other times I do
not. If I am making money on a trade for reasons I do not know about, I do not automatically
always get out of the trade. Sometimes there is something new going on, a new scenario, new
order flow generator, etc that is moving the market, that previously I may have been oblivious to.
If that new scenario is going to cause a volatility move, then I want to ride that market move.
Therefore, there are some trades where an unexpected move happens, that I do not understand,
and that provides me an opportune time to take profit. Then there are other unexpected market
moves, that you realize your initial hypothesis was wrong, but a newer hypothesis is coming into
play, and if you can identify it, you can stick with the trade and ride the market move that will
happen.
Liquidity Difference
Retail traders do not really think about or care about liquidity. They do not care because they are
trading small position sizes. Finding liquidity for a $10,000 or $100,000 or $1,000,000 dollar
order is easy.
The hedge fund on the other hand has to be constantly analyzing and worrying about the liquidity
in the markets. They constantly have to be playing out scenarios for what could make the market
illiquid. Finding liquidity for a $100 million, $1 billion dollar, or $5 billion dollar position is not
always the easiest task.
All the hedge fund blowups in the past haven’t just occurred because they placed bad bets. The
blow ups occurred because they got the market direction wrong, AND, they didn’t have liquidity
to bail out of their positions. Not having liquidity to bail out of positions tends to compound the
losses. It can also affect the emotional balance of the hedge fund manager and it’s employees.
Being trapped and not being able to bail out of your positions is a scary thing.
The Anonymous Currency Specialist from the book Inside the House of Money:
Liquidity, liquidity, liquidity is the key in real macro

trading. The hedge funds that blow up are always the one’s who
misestimate how much liquidity is in the marketplace. It’s
always the same thing, it’s always liquidity.
Monroe Trout from the book The New Market Wizards:
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I learned what are the most liquid time periods of the day.
When you’re trading one contract, that’s not important. But
when you’re trading thousands of contracts, it can be critical.
The Invisible Hands – The Philosopher:
Liquidity is a perpetual common risk factor across a broad

variety of markets, but because in normal times it is
invisible, econometric models and academia often assume the
risk does not exist.
You should always be thinking about what could cause markets to become illiquid and volatile.
Always be thinking about what could cause markets to gap. Never be surprised by gaps. So that
when they do happen you are prepared.
Lloyd Blankfein, the Chief Executive Officer of Goldman Sachs said:
I spend 98% of my time thinking about 2% probability events.
It is almost always the 2% probability events that kill the big hedge funds. While they think
everything is rosy, liquidity is ample, they are making steady profits, they go on vacation, ease up
on their market habits and do not notice the 2% probability events that are going to smack them
in the face.
Paul Tudor Jones from the book More Money Than God describing his experience on September
15, 2008 when Lehman Brothers declared bankruptcy and his firm lost over $1 billion dollars:
“I used to always think, ‘Holy cow, how’d these guys in 1929

lose it all? How could anybody be so boneheaded? You’d have
to be a complete moron!’ And then that day I thought, ‘Oh my
God. I see how these guys in ’29 got hurt now. They were not
just sitting there long the market. They had things that they
couldn’t get out of.”
For example if you are long 100,000 shares of a stock, and the market starts moving against you,
fine you start to realize you are going to take a loss. Let’s say you bought the shares at $50 and
now the market is down to $25 and you realize you are wrong and want to get out. You spent
$5,000,000 to purchase the stock and the current market value is at $2,500.000 The problem is
not only that you are wrong on the market direction. That problem can be solved by closing out
your trades. But you can only close out your trades if there is liquidity available for you to do so.
Being wrong on a position and having the position illiquid is one of the worst feelings ever. For
you realize you are wrong and want to get out and take your loss, but you can’t get out because
there is no one willing to take the other side of your trade. You cannot put a price on your loss
because there isn’t any liquidity or little liquidity to bail out of the market.
Take that example of being long 100,000 shares of stock. Before the market started collapsing,
you expected to be able to unload 100,000 shares of stock within 1-2$. In other words you were
operating under the expectation that if the market went against you there would be enough limit
bid orders to be able to sell 100,000 shares with only moving the price against you by one or two
dollars. Perhaps you expected there to be around 1,000 shares of limit bids available on average
per cent. So you operated under the assumption that you could get out with only suffering a
maximum loss of $1 less than the current market price.
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But the liquidity situation can change. It can drastically change depending on how the news/
sentiment/fundamental/macro traders are responding to the situation and whether they have
pulled their orders.
If the market get’s fearful that the economy may be headed for a crash and that wasn’t priced in
when you bought your shares at $50, and the market starts sliding, liquidity can dry up. The
market may have last traded at $25, and you expected to be able to bail out of your 100,000 share
long position within $1. So you expected to be out of your position when price hits $24, if you
started selling at $25.
But what if there are not 1,000 share limit bids every cent lower? What if there are only 100
share limit bids every cent down? If there are only 100 share limit bids every cent down, then
unwinding out of a 100,000 share position will drive the stock price lower by $10 per share! If
you started unwinding at $25, by the time you were to finish price would be at $15 per share.
You thought you would get $2,400,000 for your stock that you purchased for $5,000,000, but
instead you will be forced to sell some shared as much as $10 lower than you planned because
the market became illiquid.
That is when you are stuck with a difficult decision to make. Do you hold on to your shares and
hope that the market calms down and rebounds over the next few days/weeks/months? Do you
sell them as fast as possible and get the heck out? Do you sell them slowly?
Such are the difficult decision that need to be made when people are both wrong on the market
and wrong on liquidity.
Scaling In To Trades
When hedge fund managers place trades, they need to acknowledge and account for the liquidity
impact that their trades can have. They need to sometimes plan for it and figure out how they
will establish their positions without a major impact on price. Unless of course they are looking
to gun the market and take out stops, in which case they want to make a huge liquidity impact so
they can gun the stops.
Which is why when a hedge fund wants to establish a large position to express a global macro
view, they usually like to scale in to their trades.
What are the various ways they can scale in?
Here is the list:
1. “Sit on the bid/offer“ – In other words they set limit orders to execute at the nearest support
and resistance levels. If it is a large order, it could take minutes, hours or days to get filled fully.
For example of a hedge fund wants to get a big position and short $5 billion worth of EUR/USD.
Let’s say the market is trading at 1.4900 and they set $5 billion worth of offers at 1.5000
resistance level. They just leave the order there and wait to see how much gets filled, or if it gets
filled at all. Depending on if the market rallies and how strongly, that $5 billion worth of offers
can be filled in a day or it can take several days, or weeks, depending on how many times the
market tests the offers at 1.5000 and who else wants to sell there.
2. Fade the stops strategy with market orders – In this situation, if a hedge fund wants to
establish a long position lets say, it can wait for some downside stops to get triggered, then start
issuing market buy orders in decent chunks at a time. For example if a hedge fund wants to
establish a $2 billion dollar long position in the GBP/USD. If the market trips stops below
1.5000 lets say, and the hedge fund deems the price acceptable, it can start issuing batches of
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market orders. It can buy $50 million every minute or few minutes and see how the market
responds. Does the market move up a pip or two? Or does the selling completely overwhelm
any buy orders?
3. Fade the stops strategy with limit orders – In this situation, the hedge fund is looking to
fade stop losses with limit orders to establish a position. Take the GBP/USD example above.
Instead of the hedge fund waiting for the tripping of the stops and then executing some market
orders, the hedge fund can set limit orders in anticipation that if the stops below 1.5000 get hit, it
will get filled on some of it’s limit orders or all of them. It can set limit orders every 1 pip below
1.5000, or it can do so every 5 pips below or every 10 pips below 1.5000.
4. Fade the breakout days all day long with batches of orders – In this scenario, a hedge fund
is looking to establish a large position and wants to fade a huge one day volatility explosion. A
hedge fund realizes that it is very easy to get in a large position if you are going against the
immediate intraday momentum. For example let’s say the EUR/USD is about to make a huge
150 – 200 pip up day. The hedge fund realizes that there will be many buyers in the market
willing to hit the offers and push prices higher. It is much easier getting limit sell orders filled
than limit buy orders on such a day as the buyers are chasing the market higher and want to pay
up. If a hedge fund still believes the macro situation is still bearish and wants to get in a very big
position, and believes that the huge one day move is temporary euphoria and will reverse itself
within the next day or two, it can then decide to sit there all day and fade the intraday bullish
momentum and keep shorting the market. It can sit there with limit sell orders spaced 5 pips or
10 pips or 25 pips apart and let the buyers come and trigger them. Or it can decide to sell into the
strength using market orders. Or use a combination of both. Thus,by the end of the day when the
EUR/USD is up 100 or 200 pips, the hedge fund has established a huge short position and gotten
their desired exposure.
Of course, they could already be down 50-100 pip on their trades, and if they were to unwind it,
would cost them another 50-100 pips in slippage, but they got their desired exposure.
Here is a sample chart of the EUR/USD explaining this type of scaling in strategy:
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Selling a few billion into a huge 100-300 pip rally is very easy as there are many eager buyers
willing to be aggressive and push the market higher.
Here is an intraday chart of that day describing how a big hedge fund could get in a big position:
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Of course if they shorted like that they would instantly be down 100-200 pips on the position and
more if they tried to unwind the trade.
But in that scenario above, the trade worked out as EUR/USD collapsed a few days later:
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Now some people may be skeptical of these hedge fund mindset mastery lessons. They may say
this is crazy talk! No big hedge fund would do that. Oh really?
Well take a look at what Stanley Druckenmiller said in the book Market Wizards about him
putting on a $2 billion dollar long position in the Deutsche Mark:
Schwager: How large of a position did you put on?
Druckenmiller: About $2 billion
Schwager: Did you have any difficulty putting on a position

that size?
Druckenmiller: No, I did it over a few day’s time. Also,

putting on the position was made easier by the generally
bearish sentiment at the time. The Deutsche mark actually fell
during the first two days after the wall came down because
people thought that the outlook for a growing deficit would be
negative for the currency.
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As you can see the Deutsche Mark fell in value and formed a ODVE or MDMM to the downside.
Druckenmiller saw the macro situation differently and wanted to fade that move. So as the
Deutsche Mark fell, he was buying a $2 billion dollar position. It was easy buying that much if
the market is falling in value down to your buy orders.
They Get Out When The Market Lets Them Get Out
Big hedge funds realize that they will not be able to enter and exit at the prices that they want.
They will not be able to get the full size of their orders at the bottom tick, or at the top tick in the
market. They can’t wait for the exact high and low, because even if they do catch it, they may
not be able to execute a lot of volume there.
Here is quote from Paul Tudor Jones in the Market Wizards interview:
Tullis taught me about moving volume. When you are trading

size, you have to get out when the market lets you out, not
when you want to get out. He taught me that if you want to
move a large position, you don’t wait until the market is in
new high or low ground because very little volume may trade
there if it is a turning point.
Hedge Funds Putting On A Position
If a big hedge fund is expecting a 2 day or 3 day reversal to occur, and they want to get a big
position in, they have to start building up a position early. Lets say the market is dropping and
they expect a bottom to form, they need to get in a portion of their position and start buying while
prices are dropping. Because if they wait for the price to stabilize first, or start rising, or do a
stop hunt to the bottom side first, there might not be enough liquidity and by then it may be too
late to get in the size of position that they want.
Example:
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If a hedge fund wants to put on a big gold position, it is a lot easier if the market is dropping
down towards your big limit orders. As then, their would be aggressive sellers willing to execute
your big limit orders. If the market bottoms out quickly within a day or two or three, and snaps
higher, it gets more difficult to get in a big long position, because you are required to chase the
market higher. You are required to execute more market buy orders and that will push the market
higher.
The same principles applies to any market.
For a hedge fund that wants to execute a big order and has a swing trading or longer term view,
then they generally prefer to scale into the market when it is moving opposite their intended
direction.
For example, lets say a hedge fund wants to buy $5 billion of AUD/USD, as a swing trade or
longer term view. They would prefer if they could buy the position when AUD/USD is falling a
lot rather than rising a lot. If AUD/USD is rising a lot, then getting a huge $5 billion order filled
will tend to drive the price even higher and result in substantial slippage. Chasing the AUD
higher would then turn the trade into betting on more momentum.
On the other hand, if AUD/USD is collapsing 100-200 pips, then it gets very, very easy to get
your order filled at a better price than you expected. They would obviously try to do analysis to
make sure that were the price to keep dropping it would be temporary and reverse higher at some
point in the near future.
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This is part of what Warren Buffett does when he buys stocks. Every time the stock market
is collapsing 5% or 10%, etc, he is typically buying several tens of millions or hundreds of
millions of dollars of stocks.
That is why every time the stock market retraces, all the news outlets want to know what Buffett
is doing. They ask him and he typically says he is a buyer on the declines. Then they ask him
how much he bought. He will say something like a few tens of millions or a few hundred million
dollars worth of stock last time I heard him.
In the grand scheme of things, if the stock market is collapsing and Buffett is buying a few
hundred millions every day, then it is meaningless in terms of whether he can support the market.
Buffett buying a few hundred million is not going to change the direction of the market. The
market macro forces need to change direction by themselves. It takes billions of dollars every
day to support the market.
Take the Facebook IPO example. The stock wanted to break $38 and go lower, but the bank
underwriters placed huge buy orders near $38.00 so the price would not drop below there. The
news/sentiment/fundamental/macro sellers were hammering the bids, but the price did not break
below $38 as the underwrites were bidding for tens of millions of shares. The price barely
bounced higher from $38, so they were failing in their efforts to stabilize the stock. They bought
hundreds of millions of Facebook stock, even perhaps a few billion in order to keep the price
from falling below $38.
Were they going to spend $1 billion dollars every day to support the stock? Of course not! That
would be taking on enormous risk.
The day after the Facebook IPO, the stock collapsed as the foolish buying near $38 dried up and
the stock dropped 13% in one day. Anyone who bought near $38 was fighting the news/
sentiment/fundamental/macro forces and got annihilated.
Now sometimes Buffett is right and it is a temporary retracement in an uptrend and he makes
money. Other times he buys way too early such as in 2008 where the market kept on collapsing
lower and Buffett temporarily lost half his net worth.
This is just one way to get their orders filled. They can get their orders filled as the market is
moving away from their intended direction. That is one inefficiency. For example, if the market
is collapsing, but they expect it turn around, they can buy it on the way down and try to catch the
falling knife.
Of course there always exists the other type of trade where the market is for example breaking
out to new highs and a hedge fund keeps buying the fresh highs and expects the momentum to
continue higher. That is the other way they can get their orders filled. There are those breakout
and momentum inefficiencies as well.
Late Friday Inefficiency
For example, I have noticed that on several occasions the EUR/USD usually likes to grind higher
on Friday afternoons if there has been a fundamental value change or good reason for it to
happen and a short squeeze occurs. It just likes to keep grinding higher blowing through stops
and option barriers along the way.
If you are a smaller player in the market, then you can take advantage of this inefficiency by
waiting to take profit on your long EUR/USD position. You can wait a few more hours and take
profit on a long EUR/USD position somewhere between 2-5pm NY Time. Because if you take
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profit on your long EUR/USD position and sell 1-5 million USD, you can get such a transaction
done. Even though liquidity may begin to drop and spreads start to go up, it may still be worth it
holding off until late NY afternoon to take profit. You may be able to squeeze another 30-100
pips out of the market during that time because your orders are small and will not move the price
that much. You can find liquidity for your orders.
On the other hand, if a big hedge fund is sitting on a 500 million dollar long EUR/USD position
and wants to take profit before the weekend, they can’t wait until the late NY session. They need
to get the transaction done in the European Session / New York Session Overlap which is
somewhere between 3-11 AM EST. They know this, as Paul Tudor Jones mentioned as well back
in the 80’s with the quote from Market Wizards above.
They need to get out of their positions, when the market lets them, in other words when there is
liquidity. The big hedge fund may know that prices may rise in the late NY session, but because
they are running a large position and need it to be liquidated before the end of the day, they will
look to dump the position in Europe trading or in in the early NY session. That way their impact
on the prices will be minimal. They can probably get the transaction done with a 5-10 pips
spread cost.
Contrast that with if they try to liquidate the $500 million position in late NY trading. That 500
million order could move the price 20 pips, 30 pips, 40 pips or even more. You aren’t really
going to find $50-100 million liquidity available per pip in the late NY session. Finding $50 –
100 million liquidity per pip is far easier in the London / Early NY session.
Realized Profits Are Better Than Paper Profits(most of the time)
Huge paper profits are decent.
Huge paper profits with liquidity to take that profit are even better.
Huge paper profits with liquidity to take profit and not move the price against you are the best.
The reason why I said realized profits are better than paper profits most of the time is because I
do not want you to be in a trade and you have a 100 pip paper profit, and then you all of a sudden
remember the quote “realized profits are better than paper profits” and then go to take profit on
your position. That is not what the quote is designed to teach. That could be taking profits too
early if the ODVE turns into a MDMM.
What it means is that if you have a paper profit, and intend to close out a trade because your
system told you to, then the realized profit is better than the paper profit, because converting into
realized profit requires liquidity for big hedge fund managers.
Just follow your trading rules to exit whenever the best possible order flow exit occurs, but
always remember that once you choose to exit, or are close to exiting that position, then the
realized profit is better than the paper profit because realized profit cannot change, while paper
profit can evaporate if the market moves against you, or you get slipped on your orders.
Waiting For Liquidity
Sometimes hedge funds like to wait for the market liquidity where they can cover their position at
a low impact to their paper profits. They want to preferably cover their positions in order to
convert paper profits into realized profits without affecting the price too much. They can use
strategies like stop hunting, waiting for news releases moving the market, or just a strong
trending day and liquidate positions into that strong trending day.
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Large hedge funds need to look for opportunities to turn their paper profits into realized profits.
One option are the concentrations of liquidity, like stop runs, option barriers. Other options are
news releases that move the market in their favor. They can liquidate into those.
Paper profit is NOT realized profit. A very big, profound difference. In order for hedge funds to
turn paper profit into realized profit, they need liquidity.
A hedge fund can try to move or manipulate the price for a few minutes, or maybe a few hours if
they are really ballsy, but at the end of the day they need someone to unload the positions to.
Liquidity Tests
You may have come across certain situations in the market where you can notice that after a huge
bullish move, the market only likes to pull back just a little bit, or consolidate near the highs. Or
perhaps the dips in the market may get bought very aggressively, with the bearish moves
struggling to move the market down. Vice versa in a bearish market.
Hedge Funds can run liquidity tests. They can execute orders of a few hundred million dollars or
$1 billion to see what the impact on price would be. They can use market or limit orders. They
want to see how price responds to the orders, how price responds to the liquidity vacuum that
exists after huge market orders are placed in the market.
For limit orders the hedge fund can see how fast the market fills the huge limit order. Is the
market going to take it’s time partially filling the limit order over the next few hours? Or is it
going to chew right past it within a few minutes and keep moving? The way the market responds
to these orders gives the hedge fund potentially more information. This is another small
advantage, sometimes large advantage that hedge funds have. They can test the market with
orders to see how it responds and this can give them valuable information on the strength of the
trend, market sentiment, etc.
The hedge fund can generate some order flow to see how the market responds. How fast do the
orders get filled? How much does price move? How fast does the market fill the
liquidity vacuum after large orders? Does the market even fill it at all, or is there a price
cascade?
Very useful information for a day trading hedge fund if used correctly. It gives them another tool
to gauge sentiment, sensitivity, and liquidity. It is not a tool that retail traders have because they
cannot move the market like the big hedge funds do.
Bailing Out Of A Position
Lets say a hedge fund has a $3 billion dollar long position in USD/JPY lets say. Lets say an
unexpected Japanese earthquake hits the market and USD/JPY falls 200 pips within one day. The
hedge fund looks at its paper losses and sees that they are around $70 million dollars in the red.
Lets say they take a look at them in the afternoon New York session. The hedge fund needs
liquidity to bail out of its position. It is probably not going to go into the late NY session and go
dump $3 billion in USD/JPY onto the market. The hedge fund knows that yes, they are taking
losses, but if they go do that, then the market can drop another 100+ pips against them as they
unwind their position.
A lot of times, what they will do is re evaluate the situation. They are going to attempt to
determine whether the drop in USD/JPY is a one day false move and if USD/JPY stands a chance
to rebound. They are going to determine whether BoJ intervention is likely or not. They are
going to try to determine how much order flow is going to be generated by Japanese repatriating
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their money back to Japan. They are going to try to determine whether the fundamentals have
changed against their position. They are going to try to determine if the market is overextended
to the downside and if a reversal upwards may come.
If they determine that they need to bail out of the position to staunch losses, then the hedge fund
may wait until the Tokyo open, where there is some decent liquidity to bail out of a portion of
their position. They may choose to bail out of all of it, or out of a portion and the rest they may
wait until the European open, where there is even more liquidity from the London banks.
They prefer not to dump the $3 billion position in a low liquidity session, because they could
move the price 100 pips or more against them. On the other hand if they can hold out to the
Tokyo or European Open, then they will be able to dump their position within a 30 pip spread,
depending on how fast they choose to exit their trades and how the macro situation is at that
moment in time.
Also, if the hedge fund decides to dump a $3 billion position in low liquidity, the market may end
up tripping some stops, further fueling the move against them. Also there is also the possibility
that once the stops get tripped, it turns into a further sentiment/psychological shift against their
position. Remember when I talked about stops being tripped potentially causing a change in
sentiment/market psychology for a few hours. An even worse scenario can happen if the stops
being tripped causes the market to trip a cascade of stop loss orders and the market goes for the
jugular move, based on the hedge fund’s own liquidation in low liquidity market conditions.
The risk they take by choosing not to close our their trade during the late NY session is that the
market continues to move against them during the session and on into the Sydney session and on
into the Asian session. So if the hedge fund is down 2o0 pips by the late NY session, they choose
to hold it towards the next London session, the market may have already moved 100 pips against
them. Add in another 30 pips to bail out of their position, so they take an addition 130 pip loss in
addition to the 200 pips they were down. Total 330 pip loss. These are the risks the hedge fund
takes when making these decisions.
If, on the other hand the market only moves 30 pips against them by the time the market reaches
the next European liquidity session, then add in another 30 pips to bail out of the position, so they
would only lose another 60 pips, in addition to the 200 pips. Total 260 pip loss.
These are the risks, rewards, and liquidity considerations that the hedge fund needs to make.
There are also times when the pain tolerance point of a very large market player is reached and
they just decide to dump positions no matter if they are at fire sale prices. Sometimes the
managers in big banks and hedge funds just tell their traders that they are done taking losses and
want to get out of the market at any price. They want to just cut their losses. They cannot take
the pain anymore of the losses and want to reduce their exposure. Their pain tolerance point has
been reached.
That is why sometimes you may ask why would anyone be getting in at current market prices? It
is because some people have just been caught so wrong by the market and their pain tolerance
point has been reached. Or a certain hedge fund blew up and they are forced to liquidate their
positions at any prices.
Similar situation when a hedge fund is staying out of the market and watching a huge trend
passing them by. They would like to get it, but perhaps the market keeps missing their entry
point. They get frustrated as the market keeps trending. Eventually they decide to put on a
position because the pain of missing the move is greater than the pain of any potential losses they
may take. In such cases the hedge fund is succumbing to their need to be in the market instead of
following their system.
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George Soros vs Julian Robertson
Two of the biggest currency trades occurred in George Soros’s Quantum Fund and Julian
Robertson’s Tiger Fund.
Soros shorted $10 billion worth of British pounds in 1992. Julian Robertson was long $18 billion
worth of USD/JPY in 1998. Soros profited $1-2 billion dollars by shorting the pound. Robertson
lost $2-3 billion by being long USD/JPY. Why did Soros succeed in that moment in time, while
Robertson failed at the other moment in time?
Comparing these two trades, gives you enormous insight into:
• Order Flow Generators / Scenarios

• Liquidity
• Global Macro
• Central Banks
• Macro Players
• Redemption fears
• Sentiment/Fundamental value shifts
• Huge spread in USD/JPY liquidity vacuum.
You can extract large profits from the market. There are endless opportunities. But you can
never beat the market every day. No such thing exists. You can never attempt to control the
market.
Chart of GBP/USD during 1992:
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Soros won because he had the overwhelming, immediate, massive, aggressive news/sentiment/
fundamental/macro traders on his side. After he was done shorting $10 billion worth of the
British pound, there were plenty more billions selling the pound as well. The macro order flow
was protecting his trade from going too much into the loss as there were very large limit sell
orders to sell the GBP. And the macro order flow was slowly whittling away at the Bank of
England’s intervention efforts as the macro order flow was issued GBP sell orders into the GBP
limit buy orders of the BoE. Eventually the bearish pound macro order flow won out and the
pound crashed.
Soros felt completely comfortable placing such a big trade because he felt that he had:
• The macro correct

• The timing correct
And also he felt that he both had the liquidity to get into the market and that after the pound
crashed, there would be liquidity to get out of the market. Even if the price gaped 1,000 pips
lower, that would of been perfectly fine because the reason the price was gaping lower was
because the fundamental value of the GBP was significantly lower than the market. Soros could
easily place limit bids in the market and there would be some other market participant that was
long GBP and wanted to panic to get out of the market. Or there would of been some other
macro player that wanted to short GBP and are just late to the party.
Chart of USD/JPY during 1998:
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Julian Robertson lost money for a few reasons:
• Got the macro wrong

• Did not cut the trade fast enough
• Got the liquidity wrong
• Market participants sniffed out his position
The first problem that started the losses is that he got the news/sentiment/fundamental/macro
order flow wrong in the market. He had this theory in the middle of 1998 that since interest rates
were low in Japan that the Japanese savers would sell JPY and convert it to foreign currencies so
they can get more on their investments. Obviously, that didn’t happen as USD/JPY as the price
kept on going lower. Or it did happen, but that bullish order flow in USD/JPY from those
Japanese savers was overwhelmed by the bearish USD/JPY order flow from the risk aversion
caused by the LTCM collapse and the Russian default and devaluation.
He got the macro wrong and the market moved against him causing him the initial losses. The
second mistake was that he did not cut the trade fast enough. He could of been paring back the
position and cutting back at his long exposure so that by the time the price hit near 110.00, he
Page 46
would of been out of the trade completely, or he would of only been long a few billion of USD/
JPY instead of being long a gargantuan $18 billion.
Soros was caught on the wrong side of the USD/JPY as well during 1994. Rumours had it that he
was long $25 billion of USD/JPY in early 1994. But by the time the St Valentines Day Massacre
came in February, he had pared back that long position. He was only long $8 billion of USD/JPY
because he was getting out of the position as the market moved against him. Druckenmiller who
was running the Soros funds at that time, was much more price sensitive. He had a large $25
billion dollar position, but he was very price sensitive. If the market started moving against him
he started cutting the position fast.
So that when the USD/JPY did drop 500-700 pips it did cause big losses to the tune of a few
hundred million. But since he did not have a $25 billion dollar USD/JPY long position, he didn’t
take a $2 – 3 billion dollar loss like Julian Robertson did in 1998. Remember the rule that the
bigger the position, the faster you have to cut it if the market doesn’t go your way.
The third mistake was that he got the liquidity wrong. Not only did the market move against
him, it moved against him in an illiquid way. There is one thing for USD/JPY to move against
you by 100-200 pip per day and for there to be liquidity to get out. It is completely more horrific
if USD/JPY moves against you by 500 pips in one day and there is no liquidity to get out because
spreads have gone higher and the liquidity per pip availability has dropped. Back then I heard
reports that the normal market in USD/JPY had around $20 million per pip in liquidity. But
during the Russian default and devaluation that dried up to only around $1 million per pip
liquidity.
The fourth mistake was that the market participants had figured out that he was long USD/JPY by
a large amount. When they figured that out, the USD/JPY dropped even more and the liquidity
dried up even more. This was due to the fact that normally there may have been some market
participants bidding in USD/JPY trying to play the bounce and retracement higher. But if those
market participants that would normally be bidding get a sense that there is an elephant stuck
long $18 billion of USD/JPY and they are bleeding billions of dollars, they can pull that liquidity
from the market place. They figure, why should they bid for USD/JPY at 120.00 when there is
this big hedge fund stuck long 18 yards of USD/JPY and if he dumps it prices can crater another
1,000 or 2,000 pips?
If you think a gorilla/elephant in the market wants to sell and will cause prices to crater, then you
want to make sure you are not buying, and that you may actually decide to go short and sell first.
So they pulled liquidity and the spreads widened, and the USD/JPY collapsed near to 110.00
Hedge Fund Decision Time
There are times when hedge funds decide to put on a large position. They want exposure in a
certain currency pair and have already made the decision to put on a position. Now they just
need to execute the orders and fill them. But they may decide to wait until the liquid session to
start placing there huge orders. By liquid session it can mean the London Open 3 AM EST.
There exists potential for the huge move that the hedge fund is expecting to happen before the
liquid session beings. The move, the breakout can happen in the late NY
session, Sydney session, Asian session. The move can happen before a hedge fund has the ability
to put on its position.
This forces the hedge fund into a decision. Does it jump up into the move during the European
Session when prices have moved substantially already? Or does it just admit that it missed the
opportunity and keep the cash on the sidelines?
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When you start thinking about the market in terms of potential for hedge funds to get in late to a
move, then that can give you a nice reason “why” the market is moving. Traders naturally crave
a reason why the market is moving. And sometimes it is because hedge funds have wanted to put
on a position, but price has already moved, and they decide to chase the market with large order
flow.
Yet other times they can choose to keep the cash on the sidelines. This reserve order flow can be
deployed when certain the currency pair has consolidated and then certain news comes out at a
later point in time for a catalyst to cause the market to move again.
This hedge fund thinking helps you think about the the potential for large orders to get in late to a
breakout and sustain it or cause a false breakout, as well as order flow sitting on the sidelines
waiting to jump in if the right scenario or triggers are met.
Hedge Funds Exiting Trades
Hedge funds can run large positions that have large paper profits accumulated. But those paper
profits need to be turned into realized profits at some point in the future. And there are times
when a hedge fund wants to take profit quickly – all of the profit very quickly within one day or a
few days time window. Why are there some times that they want to take profit quickly? Because
they may judge the market to be trading at an attractive price, or perhaps they feel a market turn
is coming very quickly and the window is narrowing to take their profit. Also it is possible that
there are other hedge fund running the same positions and they want to be first to start dumping
their positions and taking profit on them. Because if they wait to take profit and the other big
hedge funds start taking profit first, then the latter and last hedge funds to dump their positions
and take profit can be left with greatly diminished profits.
Therefore, there are some days where a huge move happens and it is mostly related to profit
taking, because a large hedge fund is dumping their entire position all in one day. Sometimes
they do it over the course of a few days. In this case where they are dumping positions all in one
day, the hedge fund decides not to be passive with limit orders. Because limit orders may not get
filled. So they get aggressive and start issuing market orders and get the profit taking done all in
one day or within several days.
This huge liquidation and profit taking pressure can cause other market participants to start
thinking about taking profits. If a hedge fund has a huge long position that they need to take
profit on, they start selling. Selling starts driving the price down. Disappointed bulls start
wanting to bail out of their positions. The market starts breaking through key support levels as
more stops are getting tripped. As those key support levels are getting breached even more profit
takers start coming into the market who perhaps were using larger trailing stops. Those trailing
stops get hit as well.
Now throughout this process there are usually always some bargain hunters coming in to support
prices. But the bargain hunters can be unaware as to the extent of the selling and profit taking
pressure in the market.
Financial Instruments Can Be Unrelated But…
Securities and financial instruments may be unrelated, but the same investors, funds, banks,
traders can own them. So they are linked in that way. So for example if a hedge fund owns a
whole bunch of stocks, it may also own a bunch of gold as well. If stocks drop precipitously, but
gold goes up hedging some of the losses, that can help to alleviate the paper losses in the stock
market. But if the hedge fund gets redemption requests they need to start selling some of the
assets whether the stocks or gold in order to raise cash to meet the redemption requests. The
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hedge fund needs to make a decision whether to sell the beaten down stocks or the gold position
which has appreciated in value.
There are two differing views.
On one hand the long stock position is currently a loser, while the long gold position is a winner.
Thus the hedge fund may decide to sell the stocks and pile into gold. After all, gold is going
higher so why sell a currently winning position? They start thinking about getting out of the
losing trade and piling into the currently winning trade.
The other option they can take is if the believe that stocks will go higher and that will dampen the
safe haven bid of gold, causing gold to correct downward, the hedge fund can decide to sell some
of the gold holdings in order to raise cash. Then they use that cash to meet the redemption
requests. The can hold onto their long stock positions and are anticipating a rebound in their
value. Some of the hedge funds may have researched their stocks to death and it can be painful
to sell them at fire sale or depressed prices. Psychologically it can be difficult for them. Thus, in
the above scenario the hedge fund may sell the winning position in gold and keep the stock
position which is showing a paper loss.
Another reasoning is to sell the gold position since it is showing a profit. If their stock positions
are very big, then they may not want to dump their stocks into an illiquid market and push the
market against them even more. Selling gold into an upward moving market and cashing in the
trade can be more easier in such a situation.
That is why there are times when you see a particular financial instrument / market making a
movement that you perhaps did not expect it to make. Sometimes there is position liquidation
going on because a hedge fund may have suffered losses in some other market and they are trying
to raise capital by liquidating some other positions which were showing them profit. Markets are
linked not just by certain common global macro forces. They are also linked because you have
hedge funds running similar positions some of the time. They are linked by liquidity
considerations.
Market Value vs True Profit and Loss
Everyone is familiar with the market value of their positions. When you are in a trade and lets
say you have a 100 pip profit with one standard lot in the EUR/USD, well your positions is
marked to market and the paper profit is $1,000 dollars. This is operating under the assumption
that if you were to liquidate your trade, you would get the price shown on your trading platform.
Now for most retail traders and during normal market conditions you are going to get the price
that is shown on your screen when you execute a market order to close your position. Thus when
your position’s profit and loss is fluctuating up and down as the price moves up and down, that
this is true unrealized profit and loss because most of the time retail traders are placing small
orders and market conditions are normal and you are going to get your fill.
But when you enter the hedge fund world with hundreds of millions of dollars or billions of
dollars in positions things change drastically. Every hedge fund and big bank keeps track of what
the market value and profit and loss of their positions are. They always keep tabs on that.
However, those calculations are usually done assuming that the entire order can get filled at the
current market price.
With your knowledge of order flow and liquidity you know that you cannot execute hundreds of
millions of dollars of orders and billions of dollars of orders without moving the price. Hedge
funds know this, thus when calculating profit and loss assuming the current market price, it is not
actually the “true unrealized profit and loss.”
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Because the process of turning an unrealized profit or loss into a realized profit and loss,
sometimes requires you to push the market against you, thus suffering less profit than you would
have had otherwise, or more losses than you would of had otherwise.
For example, lets say a hedge fund is long $5 billion EUR/USD from 1.4000. The current market
price for the Euro is at 1.4500. The hedge fund’s unrealized profit is therefore $250 million
dollars. That is obviously assuming that they can liquidate the entire position at the price of
1.4500. There is no way they can liquidate the entire $5 billion dollar position at 1.4500. It most
cases it is not going to happen. Therefore the “true profit” and true “market value” of the
position is less when you take into consideration the liquidity of the market.
Different “True Profit”
In the above example with the hedge fund being long $5 billion Euros, it can have a few different
market values, depending on how fast the hedge fund wants to take profit, and what liquidity is
available in the market place.
For example if the hedge fund wants to take profit on the long $5 billion Euro position all within
ten minutes, well they may move the price 300 pips away from 1.4500 if they want to take profit
that fast. Thus their profit on that trade would be far less than the $250 million profit if they got
filled at 1.4500. They would be getting various fills 100 or 200 or 300 pips away from 1.4500
down to 1.4200. Lets assume the average price for exiting the trade was 1.4350. Thus the hedge
fund that thought it had a $250 million profit, only made a profit of $175 million, because it
wanted to liquidate that position all within a short time frame of ten minutes. Now in reality,
most hedge funds do not want to liquidate a position that fast and they try to structure the exit
strategies differently. But you should always think about the market from an order flow and
liquidity mindset.
In the same example above, lets say the hedge fund wanted to dump the same $5 billion position,
but do it over the course of a few hours. That way, they can potentially gradually dump the
position and get a far better price. Instead of accepting an average price of 1.4350, the hedge
fund gets an average price of 1.4450 lets say. Thus they make a profit of $225 million, still 25
million less due to the fact that they wanted to execute a large order.
There are so many other variables that you can throw into this mixture. You can add the potential
for some news to come out pushing the price of EUR/USD higher which can help the hedge fund
dump the position at a better profit, as macro buyers can step into the mix and provide liquidity
for the hedge fund dumping the position. Or some unfavorable news can come out and EUR/
USD starts dropping hard, and the hedge fund now needs to compete with other macro hedge
funds to get their sell orders filled.
Add in some potential stop losses into the mixture, and option barriers and there is an added
element of order flow that can help or hinder the hedge fund looking to unload a massive
position.
Thus the true value of the hedge funds holdings in their portfolio can be vastly different
depending on what the liquidity in the marketplace is and how fast the hedge fund wants to
liquidate or enter their position.
The true value of their positions constantly changes as there is different liquidity in the different
sessions. For example a hedge fund’s currency position will typically be of higher value during
the European Open at 3 AM EST, as opposed to the late NY session at 4 PM EST, due to the fact
that liquidity is far better in the London open. That is assuming that a huge macro move doesn’t
occur that moves prices hundreds of pips between sessions.
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They also need to consider how fast they want to liquidate or initiate their positions. Do they
want to get the position liquidated or initiated within ten minutes, 1 hour, a few hours, a few days
or a few weeks? These are all important considerations for a hedge fund manager, while the
retail forex speculator doesn’t need to worry about them.
For example, the media loves to report on Warren Buffett’s stock portfolio. Lets say it has a
value of $70 billion dollars. How do they compute that value? Well they just assume that the can
sell all his positions at the current market price. They use the current market value of the stocks
in order to get the value of the portfolio. When in reality that is not the “true value” of the
portfolio. If Buffett wants to sell $70 billion of stocks, he is not going to get $70 billion dollars
back. Unless of course he does it gradually and it is a bull market that can absorb such a large
amount of stock coming into the market. If Buffett wanted to liquidate his $70 billion dollar
portfolio all within one day, he is going to lose tens of billions of dollars most likely. If he wants
to liquidate his entire portfolio within a few days or a few weeks, he may lose a few billion
dollars in the process of converting his trading positions into cash.
Now obviously, Buffett is not dumb. He is not going to liquidate all his stocks in a single day.
That would be really dumb and he is not going to do that. He likes to hold may of his stocks for
months or years and any changes he will do gradually. Also, if he wanted to buy tens of billions
of stocks, he isn’t going to do it all in one day. He would do it gradually as well.
However, there is an important lesson here – a macro lesson. This is of paramount importance.
You must understand this:
While there may not be a single individual market participant that is crazy enough to dump $70
billion of dollars in aggressive orders to liquidate their stock portfolio or in any financial
instrument/market, there are certainly groups of market participants that are willing to execute
tens of billions of dollars of aggressive orders in a single day or single moment in time to either
the bullish or bearish side. These groups of market participants I call the news/sentiment/
fundamental/macro players. These players, for the most part, create the ODVE, MDMM and GM
moves in the markets that you see.
When the S&P craters by 5% in a single day, then you can bet that there were tens of billions of
dollars in aggressive sell orders that were executed. They may not have come from one single
individual, but it didn’t matter. The result is the same. The volatility is the same. If Warren
Buffett was going to liquidate $50 billion in stocks in one day, he may move the market 5%
against him. If the news/sentiment/fundamental/macro participants go to liquidate $50 billion in
one day of S&P futures in an aggressive manner, then they can move the market 5% as well. The
volatility is the same.
The only difference is that the order flow is coming from a lot of different market participants
that all happen to execute the transactions at the same moment in time. That may be $5 billion
from one hedge fund, $3 billion from another hedge fund, $1 billion from a pension fund, $1
billion from another mutual fund, $100 million from a high net worth individual, another $50
million from another person, another $20 million from someone else, etc. Pretty soon, you get to
the billions and tens of billions of dollars range. If they all execute the aggressive order flow in a
truncated period of time – then you have volatility. Then you have the volatility that you are
looking for.
Same thing if the S&P rises 3% in a day. There were tens of billions of dollars that were
executed to move the market higher.
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And that is your job as a trader. To capture the volatility. To identify when the macro move is
going to occur and ride the panic or greed of the market. To capture the volatility wherever in the
world it can be found.
Getting Big Orders Filled in a Single Day
How does a big hedge fund get a multi billion dollar order filled in a single day?
There are a few ways:
1. Show all of the massive limit orders at a single price. They generally don’t want to do this
because it exposes them to other traders front running their massive limit orders.
2. Show all of the massive limit orders spread out among a range of prices spaced a certain pips
apart.
3. Show a few limit orders at a single price, but set price alerts, so that if the market reaches the
level, they can start executing market orders to fill the rest of the position.
4. Don’t show anything. Set price alerts. If the price alert is triggered, then start executing
market orders to fill their position
5. Don’t show anything. Set price alerts. If price alert is triggered, then place massive limit
orders near the market price and wait for the market to fill them if possible.
Inefficiencies Difference
Hedge funds will typically try to extract profit from different inefficiencies and different kinds of
moves than small retail traders. The small traders are usually focusing with tunnel vision on the
small inefficiencies such as the intraday news trading, the stop hunting, etc. The small trader
could take advantage of every type of inefficiency, whether they are the ODVE, MDMM, or GM
moves. However, most of them will probably gravitate towards the day trading only. I know that
is why I did when I first started. I rarely held a trade for more than one day. But now more and
more I try to hold trades for longer periods of times when appropriate. Whether that means two
days or a few days, or a week, or more. Of course I had to improve my knowledge of global
macro and my knowledge of position sizing, etc, in order to make the switch.
The large hedge fund is usually not going to put as much attention on the small intraday moves.
They will focus their attention on the MDMM and GM moves. They do this for a few reasons.
Firstly, they are managing a lot of money and when you place big orders into the market, you
may get slipped more, so you need to compensate for that by capturing bigger moves. A hedge
fund that is placing a $2 billion dollar order into the market cannot be expecting to scalp 30 pips
out of the market. If they were trading $50 million, then they can scalp 30 pips out of the market.
But since they are trading such a large size, they need to play for the bigger fluctuations. When
they are attempting to allocate billions of dollars into the market, they need to play for bigger
moves. And some bigger moves are longer term in nature.
Secondly, it isn’t just about the slippage. The big hedge fund know that the big money is in the
big swings. The greatest trades in history were not small 30 pip intraday scalp trades. The
greatest trades in history were either ODVE, MDMM, or GM moves. Always remember this.
The greatest trades were not intraday scalp trades for 20 pips. The greatest trades were the the
volatility moves that lasted one day, or several days or several weeks or months.
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The greatest trades of the future will also be in the same form of volatility moves. The ODVE,
MDMM and GM moves. The only difference is that the participants and scenarios can be
slightly different. However, the volatility is the same.
The hedge fund has to be constantly worrying about liquidity, so when they have big positions
on, they want the market to move hundreds of pips preferably. That gives them a nice cushion to
work with.
Contrast this with the small trader who doesn’t care about liquidity because their orders are so
small. This is why there are so many trading books and courses out there being sold that claim to
teach some day trading or intraday scalping system. They claim that you can scalp the market
with a few contracts and day trade your way to $500 profit days every day. That you can scalp 2
or 3 points off the S&P, or how you can scalp 5 pips and 10 pips off the Euro.
Such people are missing the bigger picture. I do not want my trading life to revolve around
scalping the S&P for 2 points or the Euro for 10 pips. That is both boring and it is counter
productive since the big money is made in the big swings. I want to capture the 100 pip moves,
the 300 pip moves, the 500 pip moves, etc. To capture the 5%, 10%, 20%+ moves in the
underlying financial instrument. That is what the big hedge funds try to do as well.
When was the last time you heard of a billionaire from strictly day trading? Or only from stop
hunting? Not many of them exist.
They don’t exist because the top traders and hedge funds have to place longer term trades,
whether they last a few days or a few weeks. They know that with the size of positions they run
which can total hundreds of millions or billions of dollars that they need to capture inefficiencies
that last for a few days, weeks, months or years. The multi day momentum moves and global
macro moves. That allows them to build up a big position over the course of many days and then
liquidate it over the course of many days when the trade ends.
The traders who make the most money are NOT the stop hunters. They are NOT the option
barrier hunters.
The people who make the most money are the news/sentiment/fundamental value / global macro
changes traders. Why? Because the global macro traders embraces the news and information
flow, scenario analysis, expectations, explosions of volatility, etc. And because they fully
embrace those principles and habits, they can capture the big moves. For they have already
played out the scenario in their head. They have the global money flow and liquidity model in
their mind of how the various market participants can interact and how the move can play out
over a longer time period. Then it is just a matter of timing the trade and seeing the right triggers.
The person still stuck in the stop hunting world who doesn’t want to learn more will struggle to
understand and capture the big market moves, and thus will have their maximum achievement
capped. They can still make money, sometimes a lot of money, but they will have their trading
potential capped.
Big hedge funds know that they cannot extract sufficient profits from the small 30 pip or 50 pip
movements. They know that if they execute too large a size for those inefficiencies they will
destroy their own profitability. For example if a hedge fund wants to take advantage of a 30 pip
mispricing and executes a $1 billion dollar order, that could move the market 10 pips going in
and 10 pips exiting, thus reducing the profits from 30 pips down to 10 pips.
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Which is why the big hedge funds when they want to place large orders attempt to take advantage
of larger market movements. They go for the multi hundred pip and thousand pip movements.
That way, even if they execute large orders they will not destroy that inefficiency.
What do you think the big hedge funds and all of Wall Street are trying to figure out? Why do
they have such large research departments and analysts, etc? What are they making predictions
for on the news channels? You think they are trying to catch the next 20 cent or 70 cent move in
a stock? You think they are trying to catch the next $5 ounce move in gold or $1 barrel move in
crude oil? You think they are trying to catch the next 20 pip or 50 pip move in a currency pair?
No!
Just imagine if an analyst came on a business channel and talked about how the EUR/USD is
going to move 40 pips higher by the end of the day. That would be really funny.
That is why they are attempting to catch the big moves, for most of them know the big money is
in the big moves. Not all of them realize this, but a fair amount of them realize it. The .05 cents,
.20 cent moves in stocks may pay some bills, but the wealth is created by the big moves – The
$40 move in stocks, the $10 per barrel moves in crude oil, the $150 /oz moves in gold, the 1,000
pip moves in currencies. In other words they are not playing for a 0.20% fluctuation in the
underlying financial instrument. They are playing for a 5%, 10%, 20% + move in the underlying
financial instrument.
Why Do Short Term Inefficiencies Still Exist?
Did you ever want to know why the intraday and short term inefficiencies still exist? The stop
hunts and news trades. Why do they still work year after year? Won’t some big hedge fund
come in and exploit all the inefficiencies and make them go away? Not that is not the case.
Most of the big hedge funds don’t care about small news trades or stop hunting. That is peanuts
for them. It is pocket change for them. They don’t really care about stop hunting for $150,000 or
placing a news trade to make $75,000. It is peanuts for them. They are going after the huge
global macro moves. That is what they are trying to figure out. They want to find the markets
that are going to make the big moves, the 5%, 10%, 20%, 40% moves and place a large bet on
them.
I am not saying they don’t stop hunt, many of them surely do, in order to make some easy
pickings, or to get better prices for their positions. I am just saying that chances are George
Soros is not staying up at night trying to exploit short term inefficiencies. He wants to try to
catch the big global macro moves because he has billions of dollars in capital that he needs to
deploy and put to work.
George Soros
Sebastian Mallaby describes George Soros in More Money Than God:
Soros saw no point in knowing everything about a few stocks in

the hope of anticipating small moves; the game was to know a
little about a lot of things, so that you could spot the places
where the big wave might be coming.
I interpret that as meaning that he knows just enough order flow generators and triggers across a
wide range of financial instruments so that he can catch some of the global macro moves that can
occur just a few times per yer across different financial instruments.
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This means that he is probably not going to go into deep analysis to spot and capture the one day
volatility explosions, multi day momentum moves. That means there are plenty of inefficiencies
for traders who are willing to do the research to capture the 30-500 pip movements. There isn’t a
lot of competition, for Soros is not looking to capture such small moves.
If you time the trades correctly, then you can even trade them with a fair amount of leverage.
Not Enough Liquidity
There are people out there who believe that hedge funds day trade with billions of dollars and
scalp for 5 and 10 pips on those big trades and keep doing that every day. They can’t do that
because there is just not enough liquidity for them to do so. When they go to execute a billion
dollar trade in the EUR/USD that could move the price 5 pips or 10 pips or more, depending on
how fast they execute the order and what the liquidity situation is. When they go to liquidate the
billion dollar position they need to move the price against them as well. Which is why when a
hedge fund runs billions of dollars of positions they are attempting to look for a big move.
Because that big move will allow them to turn their unrealized profit into a realized profit.
So then you may ask why do the global macro opportunities exist if so many big hedge funds are
trying to spot them? The reason is threefold:
1. Some hedge fund get the global macro views wrong. It happens, they are wrong on the global
macro outlook. Remember the principle that there are billions of dollars of positioning already in
the market, that if they get the scenario wrong, they will be forced to unwind.
2. Other hedge funds get the global macro view correct, but bet on the wrong financial
instruments. If they play the wrong financial instruments, that that means the real moves in the
proper financial instruments will still exist.
3. They are correct in the global macro outlook, bet on the correct financial instruments, but even
after they do so, there is still plenty of liquidity available for other market participants to place
similar bets as well. Take Soros breaking the Bank of England in 1992. He wasn’t the only one
in that trade. So was Bruce Kovner with a few billion. So was Paul Tudor Jones with a few
billion. So were the various banks with a few more billion. They all had room and liquidity to
profit, because the inefficiency and move was so very big.
Some of the biggest trades in history almost always have multiple players and hedge funds
involved. When Soros was breaking the Bank of England, Soros put on that trade. So did Paul
Tudor Jones and Bruce Kovner. There was plenty of liquidity to go around! Why was that so?
Because the news/sentiment/fundamental/macro order flow was just so massive that it generated
such a huge move and allowed a lot of people to jump on the bandwagon.
Big Macro Hedge Funds Don’t Care about Stop Hunting
Since stops/hunting only make up around 3-15% of the price action usually, the hedge funds
know that the big money is made with the global macro moves.
The big hedge funds can lose $20 million, $100 million, or $200 million in a day. They are
generally not going to care about stop hunting for a $100,000 here and there. I mean some do it,
but many of the big hedge funds focus on the global macro moves.
The big banks stop hunt, because they handle a lot of orders and have inventory of financial
instruments that they like to dump into the stops. For them making $100,000 on a stop hunt or
even $30,000 on a stop hunt is pretty decent for them. They get to make some money and clear
out their inventory.
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George Soros doesn’t care about making 10 or 20 pips on a stop hunt. He doesn’t care about
making 30 pips on a small news trade.
Why doesn’t Soros care about such things? Because if he has on a $5 billion dollar currency
trade, that $500,000 per pip. Every 100 pips is worth $50 million dollars. Thus, he doesn’t care
about a 5 pip or 10 pip or 20 pip stop hunting move with a smaller position size that can make
him $50,000 or $100,000 or $200,000. That is peanuts for him as he has tens of millions at stake
every 100 pips. He cares about getting the macro correct in the form of the 300 pip, 500 pip,
1,000 pip moves, etc.
Soros is not going to try to explain every 20 pip movement of price. He knows that will drive
him crazy.
I know too, because I tried to explain every 20 pip movement of price. Not even banks can
predict everything and they have access to more information flow than you.
Instead, large hedge funds go for the big global macro moves. They are looking for the 500 pip,
1000 pip, 1500 pip and more trades.
When George Soros broke the Bank of England, and made $1 billion dollars, he didn’t care about
the stop losses that were triggered. He didn’t care about the option barriers. He didn’t care about
the moving averages. He didn’t care about the fibonacci. He was going for an even bigger
global macro move. When George Soros made another few hundreds of millions off the Swedish
Krona devaluation in 1992, he didn’t place a multi billion dollar bet on the market gunning for an
option barrier, or a few stops. He was going for the big global macro move – the devaluation of
40%.
Soros isn’t going to get out of bed for a 30 pip move. Heck not even a 100 pip move. Maybe a
1,000 pip move will pique his interest. Even then, don’t think that he will be playing the
currency markets every day with big position size. Soros hasn’t captured nowhere near every
macro move in the currency markets.
There are No Secret Stop Hunting or Option Barriers
When I first started learning about order flow trading, I thought I had to find the secret stop
losses and option barriers. I assigned mystical qualities to them. After many months I realized
that I shouldn’t assign too much meaning to them. I shouldn’t think too highly of them. I figured
out I should think very highly of the global macro volatility.
The reason why you do not hear Soros or other big hedge funds talking about stops or option
barriers is not because they are trying to keep them a secret. The real reason is that they are
looking for the big moves. And in the big moves the stops/option barriers only make up a small
portion of the move. The news/sentiment/fundamental/macro order flow makes up the majority
of the move. So they just focus their time and effort on that. They know the big money is made
with the news/sentiment/fundamental/macro order flow. If the stops/barriers only make up
5-10% of price movement in a global macro move, then why should he spend too much time
focusing on that? He won’t spend much if any time on that. Instead he will focus his time on
finding the next global macro move. He will spend most of his time focusing on the news/
sentiment/fundamental/macro market drivers. Instead of spending 90% of his time focusing on
only stop/option barriers, Soros will focus 90% of his time on the global macro moves.
Soros doesn’t care about a 30 pip stop hunt, or front running an order that can move the market
20 pips. The market makers care about those types of trades, but big global macro hedge funds
don’t. I am not saying hedge funds don’t stop hunt. They can absolutely do it. But the majority
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of the money made by the global macro hedge funds is not in stop hunting – it is in global macro.
From Soro’s perspective, he made many billions from global macro moves. Why would he try
to stop hunt for a $200,000 profit on one trade, or $1 million on another one. The amount of stop
hunts needed to make the money that one, successful, huge global macro move makes for Soros,
makes it more attractive for the global macro hedge fund to focus on global macro moves.
They are generally not going to clutter their mind with hunting stops. They are going to clutter
their mind with knowledge about how to find the next global macro move. The next 5%, 10%,
20% move in a currency pair or financial market.
George Soros doesn’t sit there staring and reading IFR, forexlive, etc. Part of the reason is
because he doesn’t really care about the small moves. Soros likes to think about catching the big
global macro moves, which don’t really require IFR, forexlive, etc.
I have never read about Soros talking about stop hunting. I have only read about him referencing
option activity one time during 1995 in the USD/JPY.
Soros describes the situation in his book Soros on Soros:
The yen had been trading in the range of Y105 to Y95 to the
dollar. Japanese exporters were so confident that the range
would be maintained for the rest of the fiscal year ending in
March 1995 that they bought so called knock-out put options in
very large quantities. When I say large quantities, I mean
tens of billions dollars’ worth. Knock-out put options are
very strange animals; they give you the right to sell a
currency at a certain striking price, but you lose that right
the moment the market price falls below a certain point. In
this case, the striking price on the typical contract was Y105
to the dollar or the top of the trading range and the upset
price was Y95, or the bottom of the trading range – a very
attractive proposition to the exporters provided the dollar
stays within the range. It was also attractive to the sellers
of the options because it enabled them to sell additional “out
of the money” put and call options at Y105 and Y95 to the
dollar. When the dollar fell below Y95, the option writers had
to cover their yen commitments in a hurry and the Japanese
exporters found themselves without a hedge for their dollars.
Their combined selling drove the dollar down to Y88 in a
couple of days. It was a crash in the currency market
comparable to the crash of 1987 in the stock market and for
much the same reason: When there is a large imbalance in
option positions, it can cause a crash.
Here is a chart of USD/JPY during that time period so you can see the volatility:
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It was rumored that Soros was long USD/JPY when the above happened and he lost a few
hundred million in the debacle. No wonder he was so critical of the option activity.
Stop Cascades are Not A Panacea
The reason why stop cascades during illiquid times is not the best volatility for a large hedge
fund is because they cannot get a big order executed in and out. Yes the stop hunters make
money, even decent money during those stop hunts and stop cascades. But the big money for the
hedge funds, the hundreds of millions and billions of dollars are made in the multi day
momentum moves and the global macro moves where liquidity exists to both get in and out in
size.
The stop hunts, even stop cascades do not have scaling potential. They can’t exploit the stop
cascades during illiquid times with $1 billion dollar orders. On the other hand, gradual moves
and volatility over many days, weeks, and months can definitely be much more scalable. So the
big macro hedge funds prefer that type of volatility.
Top Traders
Why don’t the top traders running hedge funds just lay off most of their employees, shut down
their trading firm, trade from their own home, with their own money and just watch the charts,
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moving averages, price patterns, forex robots, if they are so good? After all, you should be able
to find the chart and price patterns and moving averages just as well trading your own account at
your own home.
There are a few reasons.
Firstly, they are managing other peoples money so that requires a certain infrastructure to support
that.
Secondly, running a large amount of money typically requires a certain research staff to help
identify potential mispricings around the world and in different financial instruments. They need
to research staff to help them be plugged into macro flow all over the world. When you are
attempting to decipher the news/sentiment/fundamental/macro order flow for a wide variety of
currency pairs, markets and financial instruments to find the next big move, you sometimes need
a few people to help you.
Lastly, they manage a large business because it allows them to be plugged into the information
flow in the marketplace. Someone who has $500 million or $1 billion or $5 billion or $10 billion
will typically get access to a lot more information flow than someone who is just running $10
million dollars. Therefore, it is not just their trading skills that give then a big advantage. It is
also because they get access to more and better information flow that also gives them another
edge in the market.
Retail Forex Traders Inefficiencies
Speed, order flow, information flow, actually gunning the stops, etc can be a great advantage to
hedge fund managers. But for smaller retail traders, their best bet is to obtain a interpretation
advantage.
Interpretation advantage meaning that you are able to assimilate all the information such as stops,
option barriers, market sentiment, news, market positioning, global macro etc in order to know
where the small intraday inefficiencies will be, when the one day volatility explosions will occur,
when the multi day momentum moves will occur, and when the global macro moves will occur.
A lot of hedge funds that are mediocre rely on their big size to push the market around and try to
obtain an order flow and information flow edge, no matter how slight it will be. Usually these
are only good for short term day trades.
The banks like to trade using their customer order flow.
But once you get into one day volatility explosions, swing trading, etc, then it is all about if you
have an interpretation advantage. Most people don’t. Even some large hedge funds rely on
their short term day trades like a crutch. For they have no skill in capturing the multi day moves
or longer term moves.
This is where the retail traders can take advantage. They can develop an interpretation
advantage, and have skills in assembling all the facts and information in order to place profitable
order flow trades. This interpretation advantage should last you your whole trading career.
Hedge Fund Does Not Want To “Lose Their Position”
Hedge funds, especially the big macro hedge funds do not want to “lose their position.” What
does this mean?
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If a hedge fund has a position(trade) in the market and are expecting something big to happen
that will move the market, they are expecting an explosion of volatility, they do not want to lose
their position.
This means that they do not want to get shaken out of their positions and get stopped out before
the market decides to make the huge expected move. Because if the hedge fund gets stopped out
or shaken out by minor fluctuations, they end up taking a sizable loss and then “lose their
position.” They lose their desired exposure to the market. They cannot participate in any market
move if it occurs.
This is a problem because if they have taken a loss, and now do not have a position, the market
can start moving in their favor, because they lost their position.
And it is extraordinarily difficult for a hedge fund, which has just taken a huge loss to put on the
same trade in the same size as before. It is difficult to put on the same big trade as before.
Psychologically and financially it is difficult.
Psychologically because they are thinking about what if the market move against them and they
take another huge loss. There is fear of losing another huge chunk of capital. Financially, it is
difficult because after the hedge fund takes a big loss they may face redemption requests from
their investors. They do not want to have another big losing month, because if they do, then that
can trigger another round of huge redemption requests, further eroding the capital base of the
hedge fund.
Thus, they do not want to lose their position as long as they believe the big move is going to
happen in their favor and if it is within their risk limits. The hedge fund will attempt to structure
the trade entry and exit to take this into account. Typically by scaling in and out of the market.
Now they can definitely just pile into the market all at once if they believe the big movement is
imminent. That is what Soros did when he broke the Bank of England. He ramped up his shorts
on the British Pound from $1.5 Billion to a $10 Billion dollar short position within a day or two.
Soros believed that the big move was imminent and he wasn’t going to try to scale in over a
week or two. He wanted to be aggressive and get in all at once.
Of course there are always times when a hedge fund has a large trade on and they realize they are
wrong and get out of the trade even if they aren’t losing much money on it.
All this stuff about “not losing your position” applies to when you expect the market to make
some decent volatility. If you have a very good reason for a big move to happen, such as a 500
pip or 1,000 pip or more move. Typically some sort of multi day momentum move or global
macro move. If the market is going to stay choppy and not make any decent move, then I would
be glad to bail out of my positions. I don’t want to be involved in a market and try to hold on to a
trade if it is going to be stuck in a choppy range.
Because if a hedge fund doesn’t want to lose their position, but the move they are expecting is
only a one day volatility explosion, and then the move fizzles out, then the hedge fund was wrong
and then has to bail out at a small profit, break even or loss, depending on when they realize that
the big MDMM or GM move is not going to happen.
Mediocre Risk Reward, Why Big Trades Then?
While hedge funds love to have the highest possible reward risk ratio, sometimes in the forex
market it is difficult to place their stop losses in such a way where the reward risk ratio is
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extremely high. You need good entry technique, and large market volatility in your favor after
you establish your position in order for you to have a nice reward risk ratio.
But if a hedge fund has a huge $2 – 10 Billion dollar position in the forex markets, it becomes
very difficult to find huge reward risk ratio trades for those types of size. Finding high reward
risk ratio trades is easier the smaller the position size. For example is is a lot easier finding a 10R
trade for a $50 million dollar position in the currency or any other market than it is for finding a
10R trade using a $5 billion dollar position size.
Finding a 20R trade in the forex market using a very large position size is very difficult.
There was one such opportunity in 2008 where the JPY crosses dropped precipitously, and EUR/
USD, GBP/USD, and AUD/USD dropped a lot. But those opportunities do not necessarily come
every year.
What this means is that when a hedge fund wants to place a large position on in the currency
markets, they will try to go for a smaller R:R. They are not going to go for a 20R trade with $5
billion dollar position, because those do not come around too often. So what they do is, in order
to have access to a decent maximum opportunity set, they will look for trades that are 4R or 5R
or 6R, etc. Those occur much more often than the 20R trades. If a hedge fund wants to place a
$5 billion dollar trade, it is a lot easier finding such a trade that has a 5R profit rather than trying
to search for a 20R profit.
If you think about it, it is logical. If they have a big trade on with a 300 pip stop, then finding a
20R trade, which is a 6,000 pip move. 6,000 pip moves do not happen that often. On the other
hand, if they are using a 300 pip stop and are only going for a 4R trade, then that is a 1,200 pip
move. 1,200 pip moves are much easier to find than a 6,000 pip move.
Or if they use a 100 pip stop, then finding a 4R trade is 400 pips of volatility. 400 pip moves are
much easier to find than 1,200 pip moves.
There are not that many markets and inefficiencies where you can go and place a $5 billion dollar
order. It is difficult to go buy $5 billion worth of a stock and expect a 20R payoff. The liquidity
may not be there. On the other hand, in the forex market, you could get in a $5 billion dollar
order over several days or even in one day in a liquid currency pair. And if the market move
1,000+ pips, then you can get a decent reward to risk ratio.
Lets take USD/JPY for example. The USD/JPY is highly liquid most of the time, but it is not
usually as volatile as a stock. The higher liquidity in USD/JPY allows a hedge fund to place a $5
billion dollar order if they want to. However, the USD/JPY is not as volatile as a stock. They
cannot be expecting to go for a 20R trade. They may be only going for a 3R or 4R or 5R trade.
If they had on a 200 pip stop, then a 600 pip move would be a 3R trade.
On the other hand, if the hedge fund was trading a stock, that stock is probably not as liquid as
USD/JPY. So the hedge fund needs to put on a smaller position size. Lets say a hedge fund buys
$50 million worth of a stock. They can perhaps expect a 10R or 15R or 20R trade, as the stock
can be more volatile than USD/JPY on an underlying basis. If a hedge fund bought $50 million
of a stock at $40 with a stop at $36. Every $4 move is equal to 1R. So a 10R trade would mean a
$40 move in the stock. A stock could move that amount in a year or so.
That is why the liquidity of the currency markets means that the hedge funds are willing to accept
a smaller reward to risk ratio than in other markets.
When George Soros broke the Bank of England in 1992, his reward risk ratio on that trade was
not an astronomical 30:1 or 20:1. Soros risked about $200-400 million dollars in order to make
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anywhere between $1-2 Billion dollars. Which means his reward risk ratio was only between 5:1
– 10:1. He could not expect to make a 20R trade, as those are very rare when hedge funds put on
a position of $10 billion dollars. Since Soros found an inefficiency and was able to put on a $10
billion dollar trade he was forced to accept a lower reward risk ratio than a smaller speculator
would of had.
Why? Because unloading $10 billion into the market could move the market a few hundred pips.
It also depends on the news/sentiment/fundamental/macro market participants. If you have the
macro correct, then that can cushion any losses you take in a position unwinding.
On the other hand a smaller speculator could of placed the same trade Soros did, but they could
of fine tuned an entry with a 50 pip stop lets say, and have a reward risk ratio of 10:1 or 20:1 or
30:1 on that same trade.
Why? Because they are trading with smaller size. A smaller hedge fund could of placed the
same trade with $10 million instead of of $10 billion. Since it is a much smaller size, they can
get in and out of the market very quickly, they can have much higher reward risk ratio trades.
That is how liquidity and large trading size can affect your trading system.
Rational Reasons
There are very rational reasons why a big hedge fund typically avoids the smaller inefficiencies
like the ODVE, or intraday inefficiencies. Especially if they trade in stocks, or across multiple
instruments. They typically will have on numerous small or medium sized positions. They
generally do not want to bet their entire fund on one idea, or one trade. They are afraid of having
one trade gap them and causing big losses. While currencies will typically only move or gap
around 1-3% per day, stocks can routinely gap 1-3% or even more. They don’t want to bet their
entire fund on one stock because it could gap 10% or 20% or 30% and that is too much risk for
them. So in order to reduce the risk of catastrophic losses they take a large number of small bets.
And in order to make meaningful returns with these large number of small bets, they need
to capture bigger moves.
Thus, they look for multi day momentum moves, and global macro moves as opposed to one day
volatility explosions and other day trades. They look for the next 10 point, 20 point, 30 point
move in individual stocks instead of a quick day trade for 1 point. They look for the next 500
pip, 1000 pip, 3000 pip move in currencies instead of some 30 pip or 50 pip day trade.
They move to the longer term inefficiencies out of necessity. So they tend to not focus and block
out the ODVE’s and intraday inefficiencies and just focus on the swing trades and global macro
trades. This means that there are a lot of intraday and ODVE inefficiencies available.
That doesn’t mean that you should ignore the ODVE and only focus on the MDMM or GM
moves. I like to do a bit of everything. One of my market beliefs is that the short term tactical
trading leads to a higher chance of capturing of the big global macro moves.
The Invisible Hands
The Invisible Hands – The Equity Trader:
When I started trading, I was primarily focused on price

action, so my trading was very short-term and very technical.
There was little fundamental input, with the exception of
observing how stocks reacted to news. After three or four
years, however, I started hiring analysts to help us become
more fundamental in our approach so that we could manage more
capital. More capital meant running bigger position sizes for
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longer periods, which required a fundamental understanding of
companies.
Interesting Information
Big hedge funds can test the market to gather interesting bits of information. For example they
can:
• Test the market to see if the market fills their order all in one shot, or in little driblets
• How much does the market move on a big order?
• How big are the reactions against the positions after it is filled?
• How long are the reactions after the position is filled? How long does the trade stay under
water?
They can use this as additional forms of information to help them enter a new position, manage
an existing one, and exiting a trade.
For example if a hedge fund is stuck long $10 billion of a currency pair. They are in the profit by
500 pips. They are looking to see when they should exit the position. Well, they issue a sell
order for $1 billion and see, how much does the market move? If the market only drops 10 pips
and rebounds higher very quickly, perhaps that means that the news/sentiment/fundamental/
macro players are supporting the market and it can move higher. On the other hand, if that $1
billion dollar sell order results in the market breaking 50 pips and triggering stops and the market
struggles to recover, then that can give the hedge fund a signal that they perhaps should look for a
quicker exit.
These are the interesting bits of information they can gather from the market because they have
the ability to move the market and run liquidity tests. They use this information to judge the
market’s sensitivity to the large order. This is a proprietary class of information that exists
outside of the charts, that only the hedge fund has because they are the ones who are executing
the big orders.
I have tried to replicate this information as much as possible. My proprietary news release
recording method is designed partially around attempting to decipher this information. The
market sensitivity lesson also helps to decipher this information. It isn’t perfect, but it is the best
I have developed as of this very moment. It is as close to the holy grail as I have ever found.
Position Sizes and Maximum Opportunity Set
Here is the relationship between the size of the trade and the maximum opportunity set. The
general principle is that the larger the trade, the lower the maximum opportunity set:
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Size of Trade Maximum Opportunity Set
$1 million Thousands per year
$100 million Hundreds per year
What this also means is that as the position size grows, usually the maximum reward risk ratio
drops as well. The reason this is so is because as you increase position sizes, you need to use
larger stop losses. Larger stop losses mean that all else being equal, your reward risk ratio drops.
Also because with larger stop losses, you need to capture more volatility. And as you now know,
the 3,000 pip moves occur less often than the 1,000 pip moves.
Size of Trade Maximum Reward Risk Maximum Opportunity Set

zz Ratio zz
$1 million 50:1 Thousands per year
$100 million 30:1 Hundreds per year
$1 billion 20:1 100 per year
Remember that these are just general principles. There are exceptions to every rule. For example
John Paulson shorted the housing market and risked about 8% of his fund and made 600% or so.
That was a reward risk ratio of over 70:1. Yet he was able to place it with a position size of a
few billion dollars.
Pyramiding Difference
There is a difference in how hedge funds and retail forex traders engage in pyramiding.
First of all, what is pyramiding? Pyramiding means that you add to your existing position as the
trade moves in your favor. You take advantage of the increase in your account equity from the
unrealized gains of the existing trade in order to take on a bigger position. Often it involves the
use of leverage.
There are some retail traders that do not engage in any pyramiding whatsoever. They like to get
their trade entry all at one price with one order. Then they never want to add to it. Then when
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they go to exit their trades, they can get out all at once or scale out. But scaling out of a position
is not pyramiding.
If retail traders do decide to engage in pyramiding, many of them to it in a dangerous way. They
can fall into a few different traps:
1. They pyramid by increasing leverage too much. Lets say that a forex trader has a $25,000
account and they have established a position for $100,000 currency units or 1 standard lot. They
are using 4:1 leverage. If the trade moves in their favor, they may decide to start pyramiding. If
they add in another 1 standard contract, they have on a position size of $200,000 or 2 standard
lots. They have jacked up leverage from 4:1 to 8:1, not taking into account any increase in
account equity. If they decide to add in another contract, that would be increasing leverage from
8:1 to 12:1. It could be a mistake, or it could not be. This depends on what your market beliefs
are. The retail trader’s expectations for returns is much different from a hedge fund manager.
The retail trader may be attempting to convert the trade that made a 20% return into a 100%
winner so that is why they are leveraging so much. The hedge fund is not looking to make 200%
on a single trade, so they are not going to leverage that much. The hedge fund may only be
looking to turn a trade that made a 3% return into a 4% winner or 5% winner or 6% winners, so
that is why they are leveraging less.
Therefore, the mistake that the retail traders make is that they are increasing their positions by too
much.
The hedge fund that decides to engage in pyramiding will only do so by small amounts. Lets say
a hedge fund has equity of $500 million. The fund is long $200 million of GBP/USD. They see
an uptrend and are taking advantage of it. If they decide to start pyramiding they are usually not
going to add in another $300 million long position in GBP/USD. They do not want to leverage
up too much too fast. Instead, they may decide to pyramid by smaller amounts. They may go
long another $30 million or another $50 million or $70 million. That way, they get the extra
benefit if the market does continue trending higher, but they are not exposing themselves to
excessive volatility and losses if the market moves against them. They choose to have lower
trading returns by using less leverage. That is their choice.
2. The retail trader usually likes to pyramid on a large percentage of their trades. While the
hedge fund knows that only a small percentage of trades every year have the liquidity, volatility,
win rate, and reward risk ratio characteristics necessary for successful pyramiding.
The retail trader may like to pyramid after every trade if it is up 100 pips or so. Every time the
market breaks out, they may feel the need to start pyramiding because they think a big move is
coming. When in reality, only a small number of trades in a given year are suitable candidates
for pyramiding. You cannot place 30 trades a month and expect to pyramid on each and every
one of them. The market cannot always keep breaking out and sustaining the move for a MDMM
or GM move. At some point the move comes to an end. At some point the market becomes
choppy. At some point the false breakouts occur.
Top Hedge Funds
The top hedge funds always know that only a small number of all the trades and investments they
make will be suitable for pyramiding into them.
The hedge fund manager does use pyramiding occasionally. But they use it a lot more
strategically and sparingly.
Also, many of them have a strong grasp of what the news/sentiment/fundamental/macro value of
the financial instrument that they are trading is. They have a strong grasp of the global macro
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and order flow forces affecting the markets and have a much better feel about when to “go for the
jugular.” They have a stronger feel for what is moving the market, what the expectations are,
what the scenarios are in the market. They have a stronger mental model of the global money
flow and liquidity model.
Why You Should Use Pyramiding
There are some retail traders that do not use pyramiding. And it is a shame. Because it is usually
by pyramiding certain key trades that you are able to make the big money and achieve superior
trading returns during the year.
When George Soros made 100% + in 1985, a large part of it was because he saw one big global
macro trade to short the dollar and applied pyramiding to it. He had other trades in the stock
markets and bond markets that made substantial amounts as well. But his biggest profits came
during the second half of 1985 came in the currency markets where he was short the dollar and
long the Deutsche Mark and the Japanese Yen. If he didn’t apply pyramiding, he still would of
had gains, but maybe not a triple digit year.
When George Soros made 69% in 1992, a large part of that came because he pyramiding his
short on the British Pound. He had on other trades that made substantial amounts as well, but
some of the biggest profits came because he leveraged that one single trade idea. If he didn’t
pyramid that trade, he may have only been up less than 40%.
It takes courage in order to pyramid on a trade. It requires you to say that you were right on the
market that it moved in your favor and that you will continue to be even more right as the
volatility will continue and you are going to add on more exposure. It is not easy to do such a
thing. Most people when they make a lot of money can get a bit queasy. It takes courage to say
that you made a whole bunch of money but the volatility will continue and you should hold out
and add even more exposure so that you can make even more.
For example if the USD/JPY is at 150 and you are short and it drops to 140 you may have a large
paper profit. It takes courage to do your market analysis and determine that the down move will
continue and/or will intensify and that you should stay short and pile in harder.
Or you are long a stock at $50 and it has risen to $100, you may sitting on a lot of profit. It takes
courage to do dispassionate market analysis and determine that the up move will continue and
that you should double up to ride the continuation of the uptrend.
Of course that doesn’t mean that if you are in a currency trade and it moves 1,000 pips in your
favor that you should pyramid into it. It is always possible that the market has reached its macro
exhaustion point and you should not apply pyramiding and you should take profit. If you are
long a stock at $50 and it rises to $100 the market may have reached the end of the volatility
move. It really depends on each particular instance. It depends on conditions. On underlying
conditions.
The key variables to consider when decided if you should engage in pyramiding are:
• Is the trade in the profit?

• By how much is the trade in profit?
• Is there going to be further news/sentiment/fundamental/macro order flow to move the
market further into a MDMM or GM move? Or is the market going to retrace back to your
entry?
• Are you showing a profit for the year in your trading account?
• How big of a profit are you showing in your trading account?
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Virtuous Cycle
There is something else to be said about what the profits from pyramiding can do for you. The
additional profit can help you enter a virtuous cycle where you can place larger trades as your
equity has increased. For example lets say you started off with a $1 million dollar account. You
do some trading for the year and are up 20% for the year without engaging in effective
pyramiding. You made $200,000 in your first year. Now, starting your second year your account
is at $1.2 million. Let’s say you make another 20% during the second year. You make $240,000
in your second year. That brings your account value up to $1.44 million.
What if during your first year, you were able to pyramid on certain trades. Instead of being up
20% for the year, you are up 50% for the year. You made $500,000 during the first year. Now
starting the second year, your account is at $1.5 million. If you make 20% during your second
year. You made $300,000. That brings your account value up to $1.8 million.
Successful pyramiding helps you to build your account faster. It gives you more capital to play
with. It gives you ability to compound faster. It gives you the ability to place more small trades
across a variety of different markets. Of course, this is only if you do it correctly and are on the
right side of the market.
Soros 1985 Plaza Accord Trade
Timeline:
August 16 – Soros placed $720 million bet against the dollar
September 9 – Soros feeling pain. His bet against the dollar has a paper loss of $20 million.
September 22 – Plaza Accord
September 23 – Markets open and Soros is up $30 million on his dollar short trade.
September 23 – 27: Soros adds $107 million to his bet against the dollar, but also buys $300
million worth of Japanese Yen and Deutsche Marks
October, November, Early Dec – Soros adds another $300 million to this bet against the dollar.
By December 6th, 1985, Soros is long a total of $730 million worth of Deutsche Marks and long
$826 million worth of Japanese Yen.
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Soros applied pyramiding techniques to his 1985 trade where he shorted the dollar.
He initially had on a $720 million dollar short bet against the dollar. Initially the trade went
against him and he had a paper loss of $20 million dollars. After the Plaza Accord came out on
September 22, 1985, the market gaped in his favor. After the weekend when the markets opened,
he went from a paper loss of $20 million to a paper profit of $30 million dollars. Soros thought
that there existed even more potential for the trade to go into his favor. He wanted to add more to
his existing position.
Therefore during the week after the Plaza Accord, Soros shorted another $107 million of dollars.
Over the next three months Soros pyramided even more as he was practicing the principle of
going for the jugular and when you start winning you bet more. Soros added another $300
million short against the dollar by the end of the year.
His hedge fund had around $650 million in assets under management when he began his “Real
Time Experiment.” When he began it in August 1985, according the The Alchemy of Finance he
was long $467 million of Deutsche Marks and $244 million of Japanese Yen. Lets say he was
leveraged 1:1 in the currency markets alone. After the Plaza Accord, he ramps up exposure in the
following weeks and months so that by December 6, 1985, he had equity of $867 million and was
long $729 million of Deutsche Marks and $826 million of Japanese Yen, making his leverage
there around 1.8 times his capital. He actually had other trades on as well in various other
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markets which amplified his leverage even more to be around 3-5 times capital during the time
period between August 1985 and the end of the year.
As you can see he didn’t wildly start increasing leverage in the currency markets from 1:1 and
then to 4:1 and then to 8:1, etc. He didn’t do that. He only increased his currency leverage from
around 1:1 to around 1.7x times his equity in his account.
Soros in the Plaza Accord Trade applied the principle talked about in Reminiscences of a Stock
Operator:
Remember that stocks are never too high for you to begin buying
or too low to begin selling. But after the initial
transaction, don’t make a second unless the first shows you a
profit.
In the Plaza Accord case, he was applying it to the currency markets. He saw the USD/JPY
going down and piled in harder. There were other traders in his office that were also short USD/
JPY in their own portfolios but they started to take profits. Soros felt that the downtrend was
intensifying and told them to stop covering their short USD/JPY positions. Soros knew that there
were certain situations in time where prices are never too low to begin selling or pyramiding your
position.
Stanley Druckenmiller describes another story where he was working for Soros and had an open
currency trade that showing a hefty profit. He was short $1 billion of dollars against the
Deutsche Mark (in other words he was long Deutsche Marks by shorting the dollar).
Druckenmiller describes the story in The New Market Wizards:
Soros came into my office, and we talked about the trade.
“How big of a position do you have?” he asked.
“One billion dollars,” I answered.
“You call that a position?” he said dismissingly. He

encouraged me to double my position. I did, and the trade went
dramatically further in our favor.
Soros has taught me that when you have tremendous conviction on

a trade, you have to go for the jugular. It takes courage to
be a pig. It takes courage to ride a profit with huge
leverage. As far as Soros is concerned, when you’re right on
something you can’t own enough.
As you can see the initial $1 billion dollar trade was showing a hefty profit. That allowed
Druckenmiller to play with the markets money a bit and pyramid his trade. He ended being right
as the market momentum continued in his favor and he made more money. Had the initial trade
been a loser, or the trade showing a big loss, you cannot add to the position. That is just bad
trading most of the time. Losers average losers.
Soros 1992 Breaking the Bank of England
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Shorting the British Pound in 1992 was Stanley Druckenmiller’s idea. Druckenmiller shorted
about $1.5 Billion against the pound by the end of August 1992. It took another week and a half
for the trade to really start working. Then On September 15, 1992, Druckenmiller saw a trigger
in the form of a news article, and that gave Druckenmiller the confidence to increase his trade.
Druckenmiller talks to Soros, and in that conversation, Soros told Druckenmiller to “go for the
jugular.” Druckenmiller did and ramped up his bet against the pound to $10 billion on September
15, and September 16, 1992 as shown in the arrows above.
Also note, that in both trades done by the Soros funds, he pyramided only after his initial position
showed him a profit. Soros did not average down. He would only add more to an existing
position only if it showed a profit.
Managing and Working A Position
Hedge fund managers, especially ones that engage in short term tactical trading, love to manage a
position and ‘tactically’ trade around it.
They can choose to take profits on positions in anticipation of a retracement, then re establish
their positions later. If they are right, this can juice trading profits and is a form of pyramiding
and further refining and timing the market.
They can choose to:
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1. Re establish their position size while maintaining same stop loss as before – For example, lets
say someone is long $1 billion worth of EUR/USD from 1.3000, with a stop loss at 1.2900. The
market rises to 1.3300, and the hedge fund expects the market to drop 100 pips, but still is
bullish. The hedge fund can choose to either take profit on that $1 billion position and look to re
enter on a retracement. Or it can choose to take partial profit of say $500 million and look to re
enter that $500 million on a retracement. Any positions entered on a retracement would have the
same stop loss as if they had kept the initial $1 billion dollar position, which was at 1.2900.
2. Re establish their position size while moving stop loss tighter – They can do the things in
number 1, the only difference being they use a tighter stop loss on the position that they got in at
the retracement. For example if their original position had a stop loss at 1.2900, any positions
entered on a retracement down to 1.3200 lets say, they could use a tigher stop loss at 1.3100
instead of placing the stop loss all the way down at 1.2900.
3. Establish Bigger position size, and keep stop loss level the same – The hedge fund can choose
to increase the position size during the retracements. The pyramided position would have the
same stop loss as the initial position. This has more risk as you are adding a bigger position
while not trailing up your stop from your existing position. You do have a paper profit on the
trade, but you have added a bigger position size which makes any fluctuations against you
causing larger losses. This is a form of pyramiding. The only difference being that the
pyramided position is being added when the market is in a retracement phase and not when it is
pushing fresh highs/lows, as Soros and Druckenmiller did in the above examples.
4. Establish bigger position size, while moving stop loss tigher – They can increase their position
size, while simultaneously moving their stop loss tighter on both the initial position and
pyramided position. This is less risky than technique 3 because the hedge fund is raising their
stop loss level on their initial position to one that has locked in a profit (assuming liquidity
permits). However, if the pyramided position gets stopped out, then that can cause losses to
cancel out some or all of the profits from the initial position.
Position Sizing Difference

When retail traders position size, they can usually just risk a certain % of their account on a
single trade. They do not take into account liquidity considerations because they assume that
they will be able to get out at the price that they set their stop loss at. Most of them do not
choose to vary their position size because they have difficulty figuring out which trades are better
than others and how to tell when the market environment is in their favor. They typically have
difficulty figuring out which trades are the higher potential win rates and higher reward risk ratio
so they can bet more on them. Since they struggle with that, they just usually choose one
standard risk per trade, whether that is at 0.50% or 1% or 2%, etc.
Hedge Fund Considerations
The hedge fund managers cannot just simply choose a certain % to risk per trade. It is not so
simple. They manage a lot of money, sometimes hundreds of millions or billions or tens of
billions of dollars.
There are definitely occasions where they can choose to risk a certain % of their account on a
trade. That is definitely possible.
But in order to choose that certain % risk, they need to do a more detailed analysis of the trade
opportunity. They need to determine what the liquidity of the financial instrument is, what
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scenarios can play out, what the liquidity will be if they try to exit at various levels, what global
macro forces are at play, what is the time span for their scenario or event playing out.
I list the variables below that hedge fund can use to determine optimal position size include.
Understanding these will enlighten you to how a hedge fund thinks:
• Liquidity of the financial instrument

• Where there stop loss/exit point is, in other words how much can the market move against
them
• How big of a move are they expecting
• What is the percentage probability that they will be correct in the trade. In other words
what is their conviction in the trade.
• What is the timeline that they expect the move to happen? Do they expect most of the
move to happen in 24 hours? 3 days? one week? six months? In other words how fast do
they expect the move to occur.
• What will the liquidity situation be like when they go to exit the trade. This is
a separate category as the liquidity at the exit can be different than the liquidity when they
entered the market and first established the position.
Let me give you a few examples to illustrate the above concepts.
Scenario #1 – USD/JPY:
Lets say a hedge fund has $5 billion of equity. They see an opportunity to place a trade. They
believe the USD/JPY is bottoming out and they want to go long. They can go through the list
above, although not necessarily in the same order listed above. They may start off with the
question, how much can the market move against them? Let’s say they the maximum loss is 200
pips. Then they ask what is the potential reward. Let’s say they believe the potential reward is
600 pips for a 3:1 reward risk ratio. Then they need to ask, how likely is that to happen? Let’s
say that they believe it has a 60% chance to happen. Then they can ask, well how fast is the
move going to occur? Let’s say they think it is going to happen over a two month period.
So far they have accumulated the following information:
Instrument: USD/JPY
Stop Loss Size: 200 pips
Maximum Reward: 600 pips
Reward Risk Ratio: 3:1
Potential Win Rate: 60%
How Fast: Two months
Now given the above set of information, they can proceed to figure out how much they should
risk. Let’s say they decide to risk 0.50% of their account. 0.50% of $5 billion is $25 million
dollars. Depending on what the rate of USD/JPY is, lets say it is at 80.00, then the hedge fund’s
position size for such a trade is $1 billion dollars.
Now they need to see if USD/JPY is liquid enough to handle the $1 billion dollar order. USD/
JPY is liquid enough. Will USD/JPY be liquid when the time comes to exit the trade? They
believe the market is normal right now and there are no signs of any massive risk aversion or
instability so they reasonably believe it to be so.
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Now they have more information:
Risk on trade: 0.50%
Potential Position Size: $1 billion
USD/JPY Liquid Enough?: Yes
Liquidity during exit?: Expect normal market conditions, so Yes.
Now having gone through that process, they can go long $1 billion of USD/JPY and set a stop
loss(probably mental) 200 pips lower. If they get stopped out, they will lose around $25 million
dollars. If the trade does go in their favor by the maximum amount, they would make $75
million dollars.
Scenario #2 – GBP/USD
Instrument: GBP/USD
Maximum Reward: 1,500 pips
How Fast: 4 weeks
Now given the above information, they can figure out how much they should bet. Compared to
the previous trade in scenario #1, this GBP/USD trade has a higher potential reward risk ratio,
higher potential win rate, and the volatility will come faster within four weeks instead of two
months. So lets say the hedge fund decides to risk 2% on such a trade. 2% of $5 billion is $100
million. The position size would be somewhere around $3.3 billion.
Is GBP/USD liquid enough to handle that? Lets say yes and that it will also be liquid enough on
the exit.
Now the more information would be:
Potential Position Size: $3.3 billion
GBP/USD Liquid Enough?: Yes
Liquidity during exit? Yes
Now having gone through that process they place the trade. If they get stopped out they lose
around $100 million. If they win the full amount, they make $500 million.
The key principle I wanted to show in this example, is that the higher the reward risk ratio, the
higher the potential win rate, and the faster the move occurs, then generally the larger position
size you can put on. It doesn’t necessarily have to be all three. It could be one of the three, or a
combination of some or all of them. Just remember that all else being equal, the higher the the
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reward risk ratio, the bigger trade you can place. All else being equal, the higher the potential
win rate, the bigger trade you can place. All else being equal, the faster the volatility comes, the
larger position you can put on.
This is of course assuming that the financial instrument can handle that position size.
That is generally what traders do. If they believe a trade is going to have a high potential win
rate, high potential reward risk ratio, and that the volatility is going to come very fast, they will
probably want to put on a large position. That is what Soros did when he broke the Bank of
England.
The vice versa also can happen. If you have a trade is low potential win rate, low potential
reward risk ratio, and the move could take a long time to happen, then the smaller position size
you would put.
Scenario #3 – EUR/NZD:
Instrument: EUR/NZD
How Fast: 1 month
A hedge fund looks at the above preliminary information and wants to risk 0.50%. For a $5
billion dollar hedge fund that would be a position size around $1 billion dollars. Is EUR/NZD
liquid enough to handle that much? No it isn’t able to handle that big of a position. If it cannot
handle such a big position for the entry, then it probably is not going to be able to handle it for the
exit either.
Now the more information would be:
EUR/NZD Liquid Enough: No
Liquidity during exit: No
Why wouldn’t the EUR/NZD be liquid enough? Well, the EUR/USD may have liquidity of
around $20 – 100 million per pip during normal market conditions. But the EUR/NZD may only
have liquidity of $1 – 10 million per pip. So getting in a large $1 billion dollar position would
cause a lot of slippage and not make the trade worth it.
Now since the EUR/NZD is not liquid enough, the hedge fund needs to make a decision. Either
they will forget about the trade and go look for another one in a more liquid market. Or they will
still take the trade, but just do it with a smaller position size.
Lets say they choose to place the trade and decide to use a position size of $100 million.
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Now the new information would be:
Risk on trade: Around $2.5 million or 0.05% of account
Potential Position Size: $100 million
EUR/NZD Liquid Enough: Yes
Liquidity during exit: Yes
So they place the trade. But since the were forced to use a smaller position size to take into
account the illiquidity of the currency pair, they are only risking 0.05% of their account.
The general principle to learn is that the more illiquid the currency pair / financial instrument, the
smaller the position size. Is it possible to place trades with a large position size in more illiquid
or medium liquidity instruments? The answer is yes. But you need to compensate for the
illiquidity by having to expect a very,very, big move. So in the above EUR/NZD, the hedge fund
could of placed a $500 million dollar trade, if they thought something really big would happen.
If they thought the market would move 5,000 pips and the potential win rate was high and the
potential reward risk was high, and the move would happen in a decent amount of time. The
higher the potential win rate, the higher the potential reward risk ratio, and the faster the move
happens, then that helps to establish a bigger position size in more illiquid markets as you have a
bigger cushion if you are correct. But, there are still liquidity constraints.
Scenario #4 – EUR/USD:
Instrument: EUR/USD
How Fast: 1 day
Lets say a hedge fund looks at the above information and wants to risk 0.5% on the trade. 0.5%
of $5 billion is $25 million dollars. That would mean a position size of around $6 billion dollars.
Can the EUR/USD handle that? It can, but you would move the market a lot more than 40 pips.
Hedge funds can place a trade for $6 billion in the EUR/USD, but it can’t be a day trade. There
has to be potential for the market to move 1,000 pips if they want to place such a big trade.
Placing a $6 billion dollar order could move the market 50-100 pips, which would destroy the
intraday inefficiency that this hedge fund wants to take advantage of.
So the information would be:
EUR/USD Liquid Enough: No, because it would destroy intraday inefficiency
Liquidity during exit: No, because it would destroy intraday inefficiency

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So again, they need to decide whether to forget about the trade and try to find a 1,000 pip move
in a liquid market, or to place the trade with smaller position size. Let’s say the hedge fund
decides to place the trade with a smaller position size. Let’s say they settle on using a $400
million position size.
The new information would be:
Risk on trade: Around $1.6 million or 0.032% of account
Potential Position Size: $400 million
EUR/USD Liquid Enough: Yes
Liquidity during exit: Yes
So they can place the day trade with $400 million. If they lose, then they lose $1.6 million or
0.032% of their $5 billion dollar account. If they win, they will get 5x their risk which is around
$8 million dollars.
The general principle here is that intraday trades require a smaller position size. Why? Because
they generally target small amounts of 50 pips, 100 pips, 200 pips. This is why even if their is a
high potential win rate, high potential reward risk ratio, and even if the move can happen fast,
there still needs to be an analysis of how big an impact will the orders have on the market. If the
hedge fund executes their orders aggressively and finds out that they destroy the inefficiency they
are trying to take advantage of, then they cannot place the trade, or they can place it only with a
smaller position size.
How do they do that analysis? Well they have to make reasonable estimates for how much per
pip liquidity there will be. Then they need to make estimates for what are the most liquid time
periods of the day and see if they are willing only to place trades on those liquid time periods, or
not.
Take another example of if you plan to place a day trade between 3 AM – 10AM EST time during
the London/NY session. If you spotted an opportunity for a intraday move of 50 pips in the
EUR/USD, well perhaps you can position size for a few hundred million since there could be
decent liquidity during the London open and during the overlap with the NY session. You could
have time and liquidity to bail out around 10 AM EST with such a position size. On the other
hand, if you saw that the EUR/USD was going to move 50 pips during the late Friday session of
Noon EST – 5pm market closing time, then you could not take advantage of it with such a large
position size. Assuming that you want to be flat going into the weekend, you would have to
acknowledge that there will be drastically lower liquidity during those hours and have to use a
much smaller position size, say perhaps 20 million instead of a few hundred million.
That is the general rule. If the market is liquid going in and going out, then you can have a
bigger position size. If the market is only liquid going in and will be illiquid at the time you want
to get out, then you have to cut your position size. If the market is illiquid going in AND illiquid
going out, then you would have to further cut your position size. These are the general trading
principles.
General Principles
The general principles would be:
The bigger the win rate, the higher the position size
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The bigger the reward risk ratio, the higher the position size
The faster the volatility comes, the bigger the position size
The more liquid the financial instrument, the higher the potential position size
The more liquidity available during the entry and more liquidity throughout the timeline of the
trade, more liquidity during the exit, the higher the potential position size
If there is low liquidity during the entry, but there will be high liquidity during the exit, there
exists potential for a higher position size. An example of this would be investing in a startup
company. Lets say for example Facebook. Investing in a startup would be an illiquid
investment, but if you are correct on your analysis that they will do well and IPO, then you may
want to put in a bigger position size as there will be ample liquidity on the exit.
The lower the win rate, the lower the position size
The lower the reward risk ratio, the lower the position size
The slower the move, the slower the volatility comes, the lower the position size
The less liquid the financial instrument, the lower the potential position size
The less liquidity available during the entry, and less liquidity through the timeline of the trade,
the less liquidity during the exit, the lower the potential position size
If there is high liquidity on the entry, but low liquidity on the exit, then the lower the potential
position size. An example of this would be the people who invested and bought mortgage backed
securities in 2006 and early 2007. There was plenty of liquidity going in, but liquidity dried up
when the crisis came. In such a situation, if you deem there to be an opportunity, then you can
still place a trade, but you need to factor in the potential shift from being a liquid financial
instrument to an illiquid financial instrument and therefore choose a smaller or much smaller
position size.
Core Position
There are many times that a hedge fund may have a “core” position. What is the definition of a
core position?
They like to have some sort of ‘core’ position on. Core position, meaning a moderately sized or
small sized position that reflects their view of the macro situation, their view of the market and
where they think it will go. Nothing too big nor too small. A medium sized position so they can
feel the market out. If the market starts moving immediately, then at least they have put on a
medium sized position and can participate in the move. They can choose to pyramid in such
trades as well if they think the momentum is strong enough.
Let’s say someone believes the stock market is going to go up. They can have a core position
being long certain stocks. Now from that core position they can do different things. If the market
moves against them, they can either choose to add more to their position and average down if
they still believe in the long side. Since they started off with a very small position, averaging
down is not going to hurt them much. They can choose to do nothing and keep their current
exposure. Or they can choose to start reducing their exposure.
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If the market moves in their favor, they can choose to pyramid into the trade an buy more. Or
they can choose to do nothing and keep their current exposure. Or they can choose to reduce
their exposure and start taking profits.
It all depends on how they view the underlying market conditions.
They want to maintain, or have a certain level of exposure. Thus they maintain a core position,
even if it is very small.
The hedge fund can take small positions or core positions because many times they practice the
principle of “you can’t know until you bet.” Many of them believe that you cannot get the best
market feel unless you have some exposure to the market, even if it is small.
Sometimes the hedge fund manager doesn’t know the timing or price of a move. But they feel it
may happen in a general time and range. So they place a moderate “core position” to gain
exposure.
Ex – They may see the the EUR/USD dropping, but feel the sovereign debt issues are overblown
and the market already pricing in a lot of bearishness. So they take a bullish stance on the Euro.
But they don’t know the timing of the move. They don’t know if the recent support level may
hold or if the market may make a false breakout downward first, then decide to go up. Or the
Euro may be posting a down day, but the hedge fund is unsure if the next day, or two days, or
three days will be down days, or if the market is going to rise starting the following day.
Therefore faced with this uncertainty, they could do nothing. But if they view the potential pay
off as big enough, and the potential win rate sufficient enough, they can decide to place a small or
moderate position, also called a “core position”, in order to gain their desired exposure that they
want. Then if the market offers up a better price to get in, they can gradually start adding to the
position until they get to their desired maximum exposure for that trade.
This phenomenon can explain why there would be liquidity at certain levels where you think it
would be crazy to put a position on. Lets say you think a support level is going to break. And
you are confused as to who is potentially providing liquidity. Well a hedge fund that is scaling
into a long trade can potentially have a few orders there. You may know, because of your
superior order flow knowledge that the market may drop over the next few hours or day or two,
but they are unsure, and that uncertainty is leading them to start off with a moderate position first,
then evaluate it later to determine if they should add more or end the trade.
Trading Around A Core Position Size
Some hedge funds also like to trade around a core position, adjusting it’s size either larger or
smaller as they take into account the daily information flow, overbought and over sold levels,
stops being blown through and providing attractive levels to take profits, etc.
This is similar to what was talked about in the pyramiding difference lesson.
A lot of money can me made and a lot of money can be saved through the art of position
adjusting. And position adjusting is most definitely an art form. What is position adjusting?
Let us say you have a short position in USD/JPY of 5 standard lots at an average price of 83.00.
The market is trading at 82.00, but you sense that a decent rally may occur before the next down
push through your superior knowledge of market sentiment/order flow/and information flow.
Then you can choose to start position adjusting.
You can do a few things:
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1. You can cover the whole 5 lot position and go flat if you want to. Then you would wait to re
enter on a retracement if you still feel the trade is valid.
2. You can cover the whole 5 lot position and reverse to go long. (assuming your initial position
was short)
3. You can cover part of the position and look to re enter the market at a better price.
What this does is amplify profits, and reduces loses, only if you do it right, and get the timing
right. If you get it wrong then it can cut into profits, or cause losses.
This offers you a new potential stream of trading opportunities that you can capitalize on.
Like everything else in trading you need to develop and nurture that killer feel of the market and
mastery of the order flow, information flow, market sentiment, scenario analysis, global macro,
and why price moves.
You need to do it right, or else the opposite will happen and you will reduce profits, or suffer
more losses.
It is sort of like another form of leverage, except you are turning over your position more often.
It amplifies both your gains and losses. It amplifies your current skill level.
It can be a very powerful strategy to master. Just don’t try to flip positions one too many times
during the course of the day.
Paul Tudor Jones does this a lot. When he shorted the Japanese stock market in 1990, he rode the
down move for a few months. Then even though he expected the market to crash through the
recent support he expected a decent rally to come first, so he went lightly long. He figured why
should he hold through a retracement that is going to wipe out half his paper profits? He figured
he might as well play the retracement and go long to make a profit. Then a few months later, he
took profit on the long position and flipped to being short and rode the Nikkei index as it went
down and crashed through support.
Risk Per Trade
The typical retail traders likes to use leverage in each and every trade that they make. When they
trade, they typically place trades that have sizes that are multiples of their account size. They use
leverage in each trade.
For example if a retail trader wants to place a trade in the EUR/USD with a 50 stop, and 2% risk
per trade, and has a $50,000 account size, what would be the retail traders position size?
Given those inputs, the retail trader would have a position size of 200,000 units, or 2 standard
lots. If the account is only $50,000 and the retail trader is placing a trade for 2 standard lots, they
are using 4:1 leverage on that trade. 4:1 leverage concentrated in just a single trade.
The hedge fund manager most of the time does no such thing. You will rarely find them risking
2% of their fund per trade. Let me explain why.
When a hedge fund risks a large % per trade, then they do not have any flexibility to place a new
bet or pyramid into the move. They have already attained maximum exposure, and they have
already concentrated the bet in a single market/financial instrument. They are already at
maximum exposure throughout the whole hedge fund. Assuming the maximum exposure is 2%
at risk at any one time.
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Their only option in such a case is to decrease exposure.
If they spot an opportunity in another market, whether commodities, or stocks, or currencies, they
cannot place a trade there, because they have already attained maximum exposure.
On the other hand if they have only risked 0.10% or 0.50% on a trade, then they have room and
capital to place a trade in a new market or pyramid into positions. They have that flexibility.
There are certain exceptions of course. For example if a hedge fund is up 70% for the first half
of the year, and they determine that a huge global macro move is going to occur, then it is
possible that they decide to “go for the jugular.” They may decide to leverage up a little bit on a
big trade and risk 5% or 10% on a single trade. With a potential payout of 3-5 times what they
risked. Therefore, if the hedge fund loses the trade, they are still up 50%+ for the year. If they
win the trade, then they can be up over 100% for the year. But they usually only like to do this
when they already have a buffer of trading profits from the first quarter or first half of the year.
For example when Soros broke the Bank of England, one of the reasons he placed such a big bet
was because he already had a 12% profit for the year. Soros had a 12% profit for the year going
into September 1992. Therefore he could “play with the profits.”
Hedge Fund Manager ‘Personal Book’
Large hedge fund managers typically run their own pot of capital called a ‘personal book’ that is
usually a good chunk of the firm’s assets. The people who run the top hedge funds are typically
not the only risk taker. They will not manage all the money by themselves. They will allocate
money to various other traders and other teams within the firm to risk money in the markets and
find the good trades. The hedge fund leader will still retain a large pot of money since they
are supposedly one of the best traders. This allocation of capital is called their “personal book.”
Steve Cohen’s Personal Book
http://nymag.com/daily/intel/2011/05/the_feds_examine_steve_cohens.html
http://online.wsj.com/article/SB10001424052748703859304576305403465193910.html
Steve Cohen’s hedge fund has around $14 billion assets under management. Steve Cohen
doesn’t personally make decisions for the whole $14 billion dollars. It is almost impossible. It
would be a gargantuan task. Instead he gets allocated a chunk of capital, typically in the $2-3
billion dollar range. And then he places bets that go into his personal book which is called
Cohen’s “Big Book.” He can manage that capital all by himself, or have a team that helps him
with that.
So when you hear stories on the news about how so and so hedge fund manager lost money on
this stock, or made money on another financial instrument, sometimes it was not their personal
decision or personal trading that led to the gain or loss. While they do have oversight and can see
the exposure their firm is taking, they will not always overrule their other traders. The other
traders and portfolio managers are managing another sizable chunk of capital and can make their
own decisions.
So if you hear a story about how a hedge fund managers firm lost $30 million dollars for example
on a stock, or lost -5% for the year, it may have been as a result of the hedge fund managers
personal book, or not. The loss may have come from another internal portfolio manager or
another group of traders within the hedge fund.
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This leads to inefficiencies, because the top hedge fund managers cannot stay on top of every
single position that the firm takes. Even if Steve Cohen was a master at order flow and tape
reading, he would be a master of his personal book, which only represents $3 billion dollars of a
$14 billion dollar firm. They can try to apply their trading principles across the whole firm, but it
is still not completely efficient.
The top hedge fund managers may be control freaks, but still cannot make 100% of the decisions
for all of the firms capital.
Paul Tudor Jones Personal Book
Paul Tudor Jones maintains a similar “personal book.” If his firm manages $10 billion in capital,
then Jones may manage $2-3 billion in his personal book.
In the year 2008 Jones saw the trouble with the equity markets. He was bearish on the U.S. stock
market. He played this in his own personal book by shorting the stock index futures. When
Lehman brothers declared bankruptcy, the stock indexes fell by 5% in a single day. He made
hundreds of millions for his own personal book. The estimates put it that he was up 20% in his
personal book for the year 2008. If his personal book was $2 billion, that meant he was up $400
million. If his personal book was $3 billion, he was up $600 million.
Therefore, you would expect that since Jones did so well in his personal book that he posted a
decent return for the year 2008? That would be normal to think so.
But in reality, Jone’s firm posted a 4% loss for the year 2008.
The reason was because his other traders and portfolio managers at Tudor Investment lost money.
They were betting on risk appetite and were engaged in all these illiquid instruments in emerging
markets. Tudor lost $1 billion in emerging markets in 2008. Jones profits in his personal book
helped to offset some of the losses, but the whole firm was still down 4% for the year.
The book More Money Than God, describes the experience of Paul Tudor Jones in
the Monday after Lehman’s bankruptcy and weeks after:
When the markets opened on Monday, Paul Tudor Jones experienced

the extreme highs and lows that only he was capable of. One
the one hand, he was perfectly positioned in his own trading
book; he had seen the wave coming, and he rode it down, as the
S&P 500 fell 4.7 percent by the close of trading that evening.
On the other hand… The loans in the emerging market portfolio
immediately lost around two thirds of their value, costing
Tudor over $1 billion.
It was the lack of liquidity that finally resulted in the big losses.
As Jones admitted in More Money Than God:
Oh my God. I see how these guys in ’29 got hurt now. They
were not just sitting there long the market. They had things
that they couldn’t get out of.
How does this help? Well certain hedge fund managers farm out part of their portfolio to internal
managers. And they are not necessarily on top of their every movement and every exposure. So
it is entirely possible that the hedge fund managers personal trading book is showing a profit as
they are in harmony with the order flow and information flow, but that its other internal managers
may be wrongly positioned. And those wrong positions can consist of being on the wrong side of
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a global macro move, on the wrong side of a breakout, on the wrong side of a intraday stop hunt,
etc. In other words there are all sorts of reasons why large supposedly “smart” hedge fund
managers can be positioned wrongly in the market. All sorts of hedge fund orders that can
provide liquidity for you to exploit inefficiencies.
The people on the other side of the hedge fund’s poor trades and losses, profit.
It opens you up to different possibilities, inefficiencies, new order flow generators, scenarios, that
you can input into your mental global money flow and liquidity model. Things that previously,
may have been invisible to you.
Why Can Many Hedge Funds Hold Positions Through 5-20% Paper Losses On Their
Whole Portfolio?
Most smart hedge funds choose to keep draw downs low in the 5-10% range. However, there are
some hedge funds choose not to dump their positions even if they are down 5% or 10% or 20%
for the whole account?
Many choose to hold out as they may believe that it is just a brief dip or pullback. A unfortunate
retracement, or temporary flash crash. They may think that the fundamental value has not
changed. So they do not want to get shaken out.
Also, some of them have researched their positions exhaustively, and it can hurt to unload those
stocks and other positions that they deemed to be a bargain.
If a hedge fund has a certain stock that dropped 5% or 10% or 20%, they can still hold through
that if they have positioned sized a small amount for it. Now if all their stocks start dropping at
the same time because there is a global macro move that is bearish for all equities, then that
would obviously be a problem.
How does this knowledge help you?
When a hedge fund is down 5-20% that means some positions went wrong, horribly wrong
against them. You could use that knowledge to research new inefficiencies as if the hedge fund is
down 5-20%, there was someone on the other side of those trades that could of made a lot of
money. If a hedge fund is down 5 – 20%, then usually that means that there were plenty of
ODVE, MDMM and GM moves that they were on the wrong side of.
Now with the forex market, it is a bit different than stocks. It is generally much more difficult for
a currency pair to move 20%. A nice growth stock can easily move 20% in a short while. While
a currency pair is not that volatile from a percentage terms point of view. There are hundreds and
thousands of potential stocks to choose from that can potentially move 20%. With currencies,
there are only 10-30 currency pairs, so finding one that is going to make a 20% move is kind of
difficult because it does not always happen.
However, when the currency pairs do get volatile, that can offer the hedge funds a
nice opportunity to profit if they catch it with a large position size.
This is why you will not really find many large hedge funds holding through a 2,000 pip
retracement. That is just plain stupid. If a currency pair goes 20% against you in actual currency
pair values. Actual currency pair values meaning that if AUD/USD is at 1.00 parity, and it moves
20% against you, meaning a move of 2,000 pips.
You will not find many hedge funds holding through such periods, because they would generally
throw in the towel by then. Because it is very difficult for a currency pair to make a 20% move,
then recover from that to make up the loss within a reasonable time (less than one year).
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On the other hand with stocks, it is entirely possible for a stock to lose 20% of its value and then
gain it again all within one year or a few months or a few weeks or even a few days depending on
the stock.
Also ,the hedge fund will most likely not have the whole hedge fund betting on a single stock.
So if a stock within it’s portfolio is down 20%, then the whole hedge fund may not be down 20%.
It may be down less because of other nice picks in the portfolio. Or it may even post a gain, if
the other trades are working out better and can cover one stock position dropping 20% in value.
But with the forex market, some big hedge funds can bet their whole fund on a single trade on
rare occasions. And thus they are not going to hold through a 20% move against them in
currency pair terms. They are not going to hold through 2,000 pip moves against their position.
When George Soros broke the Bank of England, he didn’t expect that trade to move against him
too much. Perhaps only 100-300 pips against him if it went bad.
Vary Position Size
Reminiscences says:
It is a wise thing to have the big bet down only when you win,
and when you lose to lose only a small exploratory bet.
A lot of hedge fund managers, especially discretionary managers, will tend to vary their position
size depending on certain conditions.
The book Hedge Fund Market Wizards describes this varying of position sizes:
In favorable situations, you will want to bet more than

in unfavorable situations.
Varying the position size can be as important as the entry

methodology. Trading smaller, or not at all, for lower
probability trades and larger for higher probability trades can
transform a losing strategy into a winning one.
Stanley Druckenmiller once said about Soros:
I learned a lot at Soros, but not what I thought I would learn.

I did not learn what makes the yen go up or down, or what
makes the stock market go up or down. Soros’s great gift was
how to use leverage, and how much money to have down based on
the risk/reward and your sense of conviction. His view on the
yen or the euro was better than random, but not much. And yet
he was still one of the great money managers ever because he
knew how to bet his convictions.
Isn’t that something? Druckenmiller said one of the important things he learned working for
Soros was how to use leverage and how to position size.
As Dr. Van Tharp said in the book Super Trader:
Probably fewer than 10% of all traders and investors understand

how important position sizing is to trading performance, and
even fewer understand that is is through your position sizing
methods that you meet your objectives.
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And as Dr. Tharp said in Trade Your Way to Financial Freedom:
Position sizing is one of the most important aspects of trading

yet so few people teach it. It’s that part of your system that
helps you achieve your objectives.
In my first two years learning how to trade, the forum gurus kept telling me to risk a small
amount per trade and to keep that amount constant. There are some really good reasons for this.
For example, so you can gather statistics on your trading methodology while the risk is kept at a
constant amount. This helps to produce better statistics as your risk per trade is not jumping up
and down wildly like many beginning traders do. So you can be more unemotional about
implementing your strategy so you don’t change your risk per trade according to your rookie
“feel” of the markets. It is decent advice. Decent advice for mediocre traders.
The best traders do not follow such rules. They know it is nonsense. Some of the top traders
such as George Soros, Paul Tudor Jones, Steve Cohen, etc, they all practice flexible position
sizing. They vary their risk per trade and position size depending on the type of trading
opportunity they see, the market environment and their conviction on the trade.
The top traders are masters at position sizing.
They can:
1. Risk 0.01% on a trade, or risk 0.30% or risk 0.60% or they can risk 1% on a trade
2. Scale up or down according to their “macro conviction”
3. Scale up or down according to whether they have a good profit for the year or whether they
are in a loss
For example, Soros is not going to risk 0.50% on each and every trade he makes. He isn’t going
to always risk 0.50% on a stock trade or 0.50% on a currency trade. He will vary the position
size. Sometimes he bets 0.01%, other time it is 0.05%, other times he risks much, much more.
Back in 1985, Soros risked a few percentage points on his short dollar trade going into the Plaza
Accord meeting. When Soros broke the Bank of England, he also risked somewhere between
2-12% of his fund on the trade.
Range of Possible Risks
Another thing the top traders can do is that they may not have an exact set amount that they risk
per trade. They may instead use a “range of possible risks.” For example, the average trader
may position size for a 0.50% risk. The hedge fund manager, especially if they have a big
position on cannot limit his risk to an exact number due to the increase in possibility of slippage
and liquidity considerations. Instead they will position size in such a way, and have their stop
loss within a “certain range.” Then, if the price moves against them within that range, they
will reevaluate the situation and see if they want to keep the trade. If they still like the trade, they
may let the trade run to the outer end of their risk range for that particular trade.
For example, lets say a retail trader is short the EUR/USD from 1.4000. They position size and
have their stop loss at 1.4100 so that if the price moves there their stop will be hit and lose 0.50%
of their account. Now take the hedge fund trader who is also short EUR/USD, but is short a $2
billion dollar position. They don’t want to set a $2 billion stop loss into the market because that
can be a lot of slippage. Instead they create a “range of possible losses” where if price enters this
area, they start to think about whether they should cut the position or not. So lets say the stop
loss range is between 1.4100 – 1.4250. They position size so they know what their loss is if they
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liquidate at 1.4100, and what their loss is if they liquidate at the outer end of the risk range at
1.4250. They make sure they are comfortable with both amounts. Thus, they may have a range
of possible losses between say 0.20% – 0.50%, depending on where in the stop loss zone they
decide to liquidate if the price stays there and does not move in their favor.
So in the above situation if the price moves to 1.4100, and the hedge fund manager
re evaluates the situation and still like the short trade, he can keep it on. If the price keeps
moving against him and moves to 1.4200, then again they re evaluate their position. If they still
want to keep the trade, they still have a little bit more room up to 1.4250. Thus they have a range
of possible losses that they can take. Other times the price may move to 1.4100 and they may not
like the trade and liquidate it right there and not wait for it to hit the maximum stop loss point.
Managing Stop Loss Size
The retail trader and hedge fund think about risk in different ways and how to deal with it. An
amateur usually approaches trading without caring about risk, liquidity or volatility in the market.
The hedge fund will always want to care about the risk, liquidity and volatility.
Lets take an example of a stock trade and see how they both will position size for it.
Lets say a stock is trading at $20. Both the amateur trader and the hedge fund believe that the
stock can rise to $50 per share. They both want to buy at $20 and place their stop at $13. That is
a reward risk ratio of slightly above 4:1. They both think it has a win rate of 50%.
How does the amateur play it? They may allocate all their equity to the trade. For example, if
they had $100,000 in a trading account, they would divide $100,000 by $20 and then go buy
5,000 shares. If the stock moves down to $13 and stops them out, they would lose $35,000 or
35% of their account. If the stock goes up to $50, then the amateur would make $150,000 or
150% return from that single trade.
That is how the amateurs play the stock market. They go charging in to one stock with all their
money. Or they go spent a large % of their capital buying way out of the money options hoping
that the market is going to reward them by moving a large amount.
I have heard plenty of stories of people treating the market like a lottery ticket. The only
difference being, they may spend $20 on the lotto every week, but with their trading account they
can risk thousands or tens of thousands of dollars on highly leveraged trades or desperate
gambles. I had a few friends and acquaintances who tried to become traders around the same
time I started. I heard stories of them opening an account with $5,000 or $10,000 dollars only to
start placing trades with 50:1 and 100:1 leverage. They blew up real fast and they gave up on
trading. I heard another story of a stockbroker that gave one of his clients a loss for $300,000
because they bought up large positions in way out of the money options and they expired
worthless.
The hedge fund is going to think differently. They are going to acknowledge that given a 50%
win rate and R:R of 4:1, it is a trade worth placing. But they will define their risk to a small
amount. If a hedge fund has $100,000, they may decide to risk 0.50% of their account. 0.50%
risk of $100,000 is $500. $500 divided by the stop size of $7 per share gives them a position size
of around 71 shares of stock. That way, if the stock does drop to $13, the hedge fund only loses
0.50% of their equity. If the stock rises to $50, then the hedge fund would make slightly over 2%
of their account on the trade.
Notice the position sizing and expectation difference. The amateur is crazy and wants to risk
30-40% of their account for a chance to make 100-200% with a single trade. The hedge fund is
far more likely to risk 0.50% on a trade for the chance to make 2% with a single trade. If the
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hedge fund wants to get to a triple digit return, they can do that by finding more of these types of
trades and placing a lot of them. Finding more trades where they can risk 0.50% to make 2%.
Finding trades where they can risk 1R to make 4R and have a 50% chance of doing it. If they
have a good year and capture a lot of them, then it is certainly possible to do it.
The amateur is looking to make a 150% return in a single trade instead of spreading out that risk
among many trades over a period of time.
The amateur doesn’t care about the volatility. The hedge fund on the other hand knows that it
chooses how volatile it wants to be.
How Much Can You Make in a Single Trade?
The top hedge funds acknowledge that every time they place a winning trade, it isn’t going to
make them 1% or 2% or 5% or 10% return on the equity in their account. Part of the reasons for
this is that they use lower leverage, have lower return expectations, use lower position sizes, run
into liquidity constraints, etc.
They also acknowledge that there are certain trading inefficiencies in the market that can only be
traded with a small position size, that may only generate a 0.10% or 0.20% or 0.30% return.
They know that is OK! That is fine for them. For if they can go and harvest a lot of these small
profits they can make a lot of money. These small profit moves occur quite often as there is a
large maximum opportunity set for them.
Here are the general principles at work:
For a large hedge fund:
Opportunity to make “X” in a Single Max Opportunity Set for Forex

Trade zz
0.10% 300
0.30% 200
0.50% 100
1% 70
2% 50
5% 30
10% 10
The principle is that the larger amount of profit you want to make in a single trade, well, the less
maximum opportunity set there is. For a large hedge fund, finding a trade that can make 10% in
a single trade is very hard. There may only be 10 of them per year in the forex market. Why is
this so? Well you should remember the information from the Key Money Management,
Position Sizing and Psychology lesson.
In order for a large hedge fund to make 10% in a single trade, then that is going to require a
decent or very large reward risk ratio. And as you are trying to find trades where the reward risk
ratio is very high, then the maximum opportunity set decreases. Also, if a hedge fund is going to
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try to make 10% in a single trade, they are probably going to need to risk a decent or large
amount, and they would only want to do so if they believe the perceived win rate to be very high.
And as you are searching for trades where the win rate is high, that decreases the maximum
opportunity set.
Then as you learned in the Inefficiencies Difference lesson, the larger the size of the trade, the
lower the maximum opportunity set.
That is why it is difficult for a hedge fund to make 10% in a single trade. They usually choose to
try to capture a lot of small trades as the maximum opportunity set is larger for them and they can
spot them easier. It is a lot easier for them to find a trade that will make them 0.10% than it is
finding a single trade that will make them 10%.
Of course they can expand the maximum opportunity set by adding in more markets such as
stocks and futures:
Opportunity to make “X” in a Single Max Opportunity Set for Forex +

Trade zz Futures + Stocks
0.10% Thousands per year
0.30% 800
0.50% 600
1% 400
2% 300
5% 200
10% 100
Remember, these are just general principles. There is no way I can know or anyone else can
know the exact number for the maximum opportunity set.
Now obviously, retail traders have the ability to be a lot more flexible and nimble. They have a
larger maximum opportunity set. Why? Because the retail traders has the ability to find a 50 pip
move, or 100 pip or 200 pip move and leverage it by 5x or 10x. Thus, they have an easier time
finding trades that make them 5% or 10%. Their maximum opportunity set is higher. Of course
they are using more leverage, so their volatility of returns and drawdowns will be higher as well.
A large hedge fund cannot find a 100 pip move and leverage it 5x or 10x. They can’t do that
because the market handle handle such large orders.
For example, the opportunity set for a retail trader could look like this:
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Opportunity to make “X” in a Single Max Opportunity Set for Forex
Trade zz
0.10% Thousands per year
0.30% 800
0.50% 600
1% 300
2% 200
5% 100
10% 50
Of course, the retail trader can further expand the maximum opportunity set by adding in more
markets such as stocks and futures:
Opportunity to make “X” in a Single Max Opportunity Set for Forex +

Trade Futures + Stocks
0.10% Tens of thousands per year
0.30% 4,000
0.50% 2,000
1% 1,000
2% 800
5% 700
10% 500
This is the reason why it is very possible for a someone trading a small account, say $50,000 to
be able to achieve stunning rates of return in the triple digits and quadruple digits. This is
because they have an extremely large maximum opportunity set from which to find trades and
extract profit. If you have a small trading account and wish to turn it into a large trading stake,
then always remember the above information.
Examples of Big Hedge Fund Trades

Here are some examples of big hedge fund trades. Remember that there are literally hundreds
and thousands more examples that you can look up on your own to further hone your skills. The
key thing to realize is to not spend too much time on the charts. It is obviously very good finding
the charts of the historical trades. The point is not to spend time on the chart patterns or technical
indicators or anything like that. You get historical charts so you can see the volatility moves –
the ODVE, MDMM and GM moves. There is a big difference between looking at charts in order
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to find the chart patterns, layering technical indicators on them, and, looking at charts to see the
volatility moves. Big difference between the two.
I look at charts every day. I look at intraday charts all day long to make my life easier. I do a
daily recap of the charts at the end of the day. However, the trick is to spend at least 50% or
more of your time on the order flow, liquidity, volatility, news, expectations, sentiment, scenarios,
positioning, global macro analysis, etc. While I am looking at charts and seeing the prices tick up
and down, I am constantly playing out the scenarios and expectations of the market participants
inside my head.
Lets begin:
1985 Plaza Accord – Soros
Soros leveraged himself during the 1985 Plaza Accord Trade. He placed a trade that in total,
exceeded the funds equity by tens of millions of dollars. Hence, he was using leverage.
Why did he do that? Because he thought a big move was coming. A big global macro move.
His initial reasons for shorting the dollar was because it had been strengthening for several years
prior, and that had caused a loss of competitiveness in U.S. exports. This eventually caused the
trade deficit to keep growing. But the dollar was not weakening because interest rates were still
high. The high interest rates were still propping up the dollar. But by the middle of 1985, the
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Fed was cutting interest rates and interest rates were 2% lower than they were from the previous
year.
Soros knew that if U.S. growth accelerated, then U.S. interest rates would go up and that would
prop up the dollar and cause it to rise. That was the bullish scenario.
There was also a bearish scenario. Soros summed up his bearish case against the dollar in the
summer of 1985 in the book More Money Than God:
On the other hand, if banks entered a cycle of credit

contraction, in which falling collateral values and reduced
lending fed back on themselves, the trouble in the banking
sector could slow the economy sharply and push interest rates
downward.
Also, Soros believed that oil prices would fall and that would be bearish for the dollars as well.
That sounds contradictory since in the current market environment (2011) most people are used
to crude oil being inversely related with the dollar. But back in the 1980’s the thinking of Soros
was different, perhaps in order to be in harmony with the market sentiment and sensitivity at the
time. Soros believed that the fall in oil prices would cause inflation to be lower, which would in
turn mean interest rates in the U.S. should be lower and that would in turn hurt the dollar.
Soros decided that the bearish dollar scenario would be more likely and be more forceful, so he
shorted the dollar and bought primarily the Japanese Yen and Deutsche Mark in August of 1985.
Initially his trade went against him by a few hundred pips as a few good U.S. economic releases
pointed in the direction of a better U.S. economy. However, the huge 1985 Plaza Accord meeting
came on September 22, 1985 and saved his trade.
A big move sparked by a news release.
The Plaza Accord injected fresh, massive bearish momentum into the market. The governments
of the major countries including the United States, Japan, United Kingdom, West Germany, and
France all agreed that it was in the best interests of the global economy for the U.S. dollar to
weaken. No one was expecting such an announcement to come and it shocked the market. The
USD/JPY gaped lower several hundred pips.
Now the governments could cause the U.S. dollar to weaken by three ways:
1. There is the initial shock value of the announcement. That is what caused the USD/JPY to
initially drop in the subsequent days following the announcement.
2. The second way is they can actually intervene in the market and start issuing orders to sell the
U.S. dollar and purchase foreign currencies.
3. The third way is that the Federal Reserve can lower interest rates, while the foreign central
banks keep interest rates steady and/or raise interest rates. That would cause other market
participants to sell the U.S. dollar because the dollar was propped up by the high U.S. interest
rates. But if the Fed lowers the rates and foreign central banks are raising rates or holding them
steady, then that causes people to sell the dollar.
Soros interpreted the news correctly and leveraged up more. He pyramided his position in the
week following the Plaza Accord by buying more Yen and D-Marks and shorting the dollar.
He was correct as USD/JPY started sliding thousands of pips over the next few months and years,
with very few retracements.
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Soros pyramided some more and bought a few hundred million more of Yen in early November
1985 because he saw a trigger that would cause fresh downward momentum in USD/JPY. Soros
describes this in The Alchemy of Finance:
The Japanese central bank surprised me and the rest of the

market by raising short-term interest rates. I took this as
the beginning of a new phase in the Group of Five plan in which
exchange rates are influenced not only by direct intervention
but also by adjusting interest rates. Accordingly, I piled
into the yen. When the yen moved, I also bought back the marks
I had sold.
Even Soros knew about the capital sitting on the sidelines waiting to come into the market with
fresh positions if a certain scenario developed. He interpreted the above scenario as being that
catalyst and he positioned himself accordingly.
He just kept on buying Japanese Yen and D-Marks and shorting the dollar.
The dates of his increases in exposure in 1985 as were reported in The Alchemy of Finance were:
August 16 – Initial dollar shorts and long Yen and D-marks
Sept 28 – Shorted more dollars and bought more Yen and D-marks
Oct 18 – Shorted more dollars and bought more Yen and D-marks
Nov 1 – Shorted dollars and bought Yen
Nov 22 – Buys more Yen and D-Marks
Dec 6 – Buys more Yen and D-Marks
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The chart shows the arrows that show Soros’s trading activity from Alchemy.
As you can see from the chart, once the Plaza Accord event happened, pretty much no matter
what day you decided to short it, you would of made money. It was the easy money being short.
However, what was not easy was knowing how long to stay short and whether you should of
pyramided and how much to pyramid.
He followed the principle espoused in Reminiscences of a Stock Operator:
Men who can both be right and sit tight are uncommon.
1987 Bet Against the dollar – Soros
From the book More Money Than God:
A week or two after Black Monday, Soros spotted an opportunity

to short the dollar, and he put on a gutsy, leveraged position
as though nothing untoward had happened. The dollar duly fell,
and the gamble paid off. Quantum ended 1987 up 13 percent,
despite having languished in the red only two months earlier.
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Soros lost a lot of money during the 1987 stock market crash. Estimates put the losses at
between $300 and $800 million dollars. Soros regrouped and was looking for where the next
opportunity was. Where was the next explosion of volatility going to be?
Soros rebounded after the 1987 crash, with a nice leveraged bet against the dollar. He caught a
very nice multi day momentum move / global macro move.
He put the pieces of the macro situation together and determined that the dollar was going to fall
in value. Why did he think so? Soros never said for sure, however, from my research, it also
seems that Bruce Kovner was in the same trade as Soros. Both Soros and Kovner went short the
dollar in the aftermath of the 1987 stock market crash.
Bruce Kovner gave his macro reasoning in the Market Wizards:
It was then that it all coalesced in my mind. It became

absolutely clear to me that given the combination of a need for
stimulative action, dictated by the tremendous worldwide
financial panic, the reluctance of the Bank of Japan and German
Bundesbank to adopt potentially inflationary measures, and the
continuing wide U.S. trade deficits, the only solution was for
Treasury Secretary Baker to let the dollar go. Someone had to
play the stimulative role, and that some one would be the
United States.
As a result, the dollar would drop and it would not be in the

interest of the other central banks to defend it. I was
absolutely convince that was the only thing Baker could do.
There were two possible scenarios. Either there was going to be risk aversion and the dollar was
going to rise in value due to the safe haven bid, or the Fed would cut interest rates to cushion the
economy and that would cause the dollar to fall in value. The dollar safe haven bid did come. It
only lasted for 2-3 days as USD/JPY rose from 142 to 144. Then after that dollar safe haven bid
order flow was finished, the bearish dollar order flow came in to push the market lower. USD/
JPY dropped from 144 to 122. That is a 2,000 pip move.
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1990 – Paul Tudor Jones shorts the Nikkei 225
Show off PTJ shorted the Nikkei 225 index. From Late 1989 and the rest of 1990.
Why did Jones short the Nikkei? Jones had this scenario that if the Nikkei fell early in the year, it
would cause Japanese fund managers to sell stocks and switch to bonds since they wanted to
show returns of 8%. Therefore, Jones reasoned that if the Nikkei fell early in the year, the fund
managers would not have a cushion of previous equity returns, and they would sell stocks and
buy bonds which were yielding 8%.
Stanley Druckenmiller gives further reasons in The New Market Wizards:
In late 1989 I became extremely bearish on the Japanese stock

market for a variety of reasons. First, on a multi year chart,
the Nikkei index had reached a point of over extension, which
in all previous instances had led to sell-offs or, in the worst
case, a sideways consolidation. Second, the market appeared to
be in a huge speculative blow-off phase. Finally, and most
important – three times as important as everything I just said
– the Bank of Japan had started to dramatically tighten
monetary policy.
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Therefore you can break down the reasons into two categories: The reasons that initially led to a
“setup” that put the trade on your radar for a potential short. Then the reasons that were a
catalyst for the market falling and causing the entry into the trade.
The putting the trade on your radar would be:
1. Nikkei index was at a point of over extension of a multi year chart

2. Nikkei was in a speculative blow off phase
Then the catalysts would be:
1. Bank of Japan raising rates a lot, which could dampen the economy
2. Nikkei falling early in the year causing big portfolio shifts from stocks to bonds
From More Money Than God:
With almost uncanny accuracy, he anticipated Tokyo’s

fluctuations on the way to it’s final destination. Based on
his knowledge of the patterns in previous bear markets, he
predicted in January that the Nikkei’s fall would be followed
by a weak rally; and when the Nikkei stabilized in the spring,
he duly switched from a heavy short position to a mild long
one. Sure enough, the Nikkei rose 8 percent in May and Jones
profited again, even though he was fully convinced the rally
was temporary.
Jones sat for an interview in May 1990 with Barron’s and said this from the book More Money
Than God:
For the moment, Jones said, he was lightly long Japan, but he
planned to be short again by late summer. Sure enough, Jones’s
timing proved excellent: Tokyo’s market fell steeply from July
through early October. That year, 1990, Jones estimated that
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he returned 80 percent to 90 percent on his portfolio, largely
on the strength of his trading in Tokyo.
1992 Breaking the Bank of England – Soros, Kovner, PTJ, Bacon
Many European currencies were part of what was called the European Exchange Rate
Mechanism or ERM for short. The idea behind this was to reduce the exchange rate variability in
order to prepare Europe for the creation of a single currency. They figured that if the currency
pairs remained in a manageable range, it would make the unification of Europe and the
introduction of the Euro easier.
Now you may ask, how would the governments manage the exchange rates? Well, they have a
few ways. The governments can execute orders and intervene at certain price points in order to
attempt to keep the exchange rate within the specified ERM range. Or, the other way is that they
can use interest rates to influence the currency pair.
For example, lets take the U.K. and Germany in the form of the GBP/DEM exchange rate. Lets
say the British Pound was too strong against the Deutsche Mark as signaled by the GBP/DEM
rising too much in value. Then the governments and the central banks can adjust interest rate
policy in order to attempt to correct this imbalance. The Bank of England can lower interest
rates, or the Bundesbank can raise interest rates, or they can do both. That would cause macro
order flow to sell the GBP/DEM.
Or if the GBP/DEM was too low, then the Bank of England could raise rates, or the Bundesbank
can lower rates, or the central banks could intervene to buy GBP/DEM, or a combination of all
three.
That is how the governments of Europe attempted to keep the ERM together.
A problem arose however. What if the countries in Europe grew at different rates and had
different inflation rates, thus causing disparities in interest rates? How would the ERM handle
that? That was the flaw in the ERM. The ERM only worked in a near equilibrium environment
where the economic growth rates, and inflation rates, and thus interest rates were roughly the
same across the different European countries. For many years, the ERM worked fine, up until
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the macro forces and disparity in the growth rates, inflation rates, and thus interest rates got too
big and caused the ERM to collapse.
This situation came to a head in September 1992.
In 1992, Germany was raising interest rates heavily in order to combat the inflationary pressures
from the German reunification. This occurred during a period of time where the rest of Europe,
particularly Britain was in recession.
Thus, Germany was raising interest rates, and Britain was in recession, which should normally
mean that Britain should have lower interest rates to combat the recession. That interest rate
disparity should have caused the GBP/DEM to drop in value.
Druckenmiller saw the potential for the trade in August of 1992. He figured since Britain was in
recession, that should have caused the BoE to lower interest rates. However, the BoE was not
lowering interest rates because the GBP/DEM was trading at the bottom end of the ERM trading
band. In order to keep the British pound within the ERM limits, the BoE was artificially keeping
interest rates higher than they should be. If the BoE was following normal economic theory
without regard to the pounds exchange rate value, then the BoE would of been cutting interest
rates to combat the recession in Britain.
Druckenmiller saw that there was potential for an explosive situation. That is when
Druckenmiller shorted $1.5 billion of GBP/DEM by the end of August 1992.
He figured that there would be a lot of news/sentiment/fundamental/macro sellers in GBP/DEM

and that the market would break out to the bottom side. He figured that the economic disparity
was so great between Britain and Germany, that the trade would barely go against him because
there would be a lot of macro sellers.
He was betting on a number of different scenarios that could cause the GBP/DEM to fall, many
of which were related to each other:
1. Bank of England lowers interest rates

2. Britain runs out of reserves and cannot intervene anymore
3. Britain negotiates devaluation with their other European partners
4. Britain withdraws from the ERM
5. Germany raises interest rates
In the coming weeks during the end of August and September, both Druckenmiller and Soros
were interpreting the information flow and gathering the pieces of the macro puzzle to see which
scenario was going to win out. Would the GBP/DEM go down because of any or a combination
of the above scenarios? Or would somehow the European monetary authorities keep the GBP/
DEM within the trading band?
The bullish scenarios for GBP/DEM at that time would have been:
1. Bank of England raises rates and sustains them

2. Britain somehow attains hundreds of billions of reserves and keeps intervening to support
the pound
3. Other central banks help out to intervene and support the pound as well
4. Germany lowers interest rates
Druckenmiller figured that since England was in a deep recession, they would struggle to hike
interest rates as that would cause an even bigger economic downturn and cause discontent with
the British population. Druckenmiller knew the BoE only had a few tens of billions of dollars to
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support the pound. Another key variable that Druckenmiller had to figure out was whether
Germany was going to lower interest rates or not and if so, by how much. The answer became
clear in early September.
On September 8, 1992, the president of the Bundesbank declared that he could not guarantee the
future course of interest rates. That gave a signal to the market and to Druckenmiller that the
German central bank was not going to bow to British pressure to lower interest rates.
In reality, as I discuss below, Germany did end up lowering interest rates a week later, however,
that the GBP/DEM exchange rate was not sensitive to it and did not rise in value as the macro
sellers in GBP/DEM were too strong.
Chart of the GBP/USD:
Another part of the analysis, had to do with the concept of market sensitivity. The market
started off being fairly sensitive to intervention efforts by the BoE. However, after a few days
and few weeks, each subsequent intervention effort by the BoE was met with a more muted
response. For example, when the BoE intervened on September 3, the pound actually rose by a
decent amount, say 200-300 pips. However, in each subsequent intervention by the BoE, the
pound failed to respond as vigorously.
This gave a signal in the form of a sensitivity shift. If the market was becoming less sensitive to
BoE intervention, then perhaps intervention was failing and the pound was going to drop further?
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On September 14, the BoE intervened again, with the added benefit that the Bundesbank actually
did lower interest rates by 1%. However, sterling only rose by a small amount. That was further
market sensitivity evidence that the pound was headed for a collapse.
The pressure on sterling heated up and the situation came to a head on September 16.
Druckenmiller was attempting to leverage himself up and ramp up his $1.5 billion trade against
the pound to $10 billion between September 14 – 16, 1992.
The Bank of England intervened again on September 16, but the pound didn’t bounce higher
because the macro selling by Druckenmiller and other market participants was heating up. The
finance minister of Britain, Norman Lamont, saw that intervention was failing and then decided
to request permission to hike interest rates from the prime minister. Eventually interest rates
were hiked by 2%, but again the pound did not rally. The market sensitivity of the pound to
Britains efforts to lift its value through interest rate hikes became zero.
Then Britain proceeded to attempt to raise interest rates again on September 16, by another 3%.
Again the pound was not sensitive to such news. By the evening of September 16, Britain
announced that it was exiting the ERM. The pound then collapsed a thousand pips. Even during
the last day, the British government was telling the public that they would not leave the ERM.
This convinced some market participants to try to prop up the pound and go long expecting the
ERM to hold. When Britain announced they were exiting, those market players removed their
bids and may have even turned into macro sellers.
Soros was not the only one to short the pound. Word got around that the Quantum fund was
doing some big trades and other people piggybacked on the trade. Bruce Kovner was short the
pound. Paul Tudor Jones was short the pound. Louis Bacon was short the pound. Other bank
currency trading desks were short the pound.
It was some of the easiest and quickest money they ever made in their entire lives. If you ever
hear stories about the good old days of trading back in the early 1990’s, this trade was one of the
reasons why.
1998 USD/JPY Collapse – Julian Robertson loses billions
Julian Robertson was long an eye popping $18 billion worth of USD/JPY in the summer of 1998.
He certainly wasn’t betting big on a chart pattern. He was betting on a certain scenario
unfolding.
Robertson summarized his hypothesis and trading thesis from the book More Money Than God:
Japan was deregulating its financial markets, allowing

investors to shift money abroad; and with yen interest rates at
just over 1 percent, it seemed obvious that Japanese savers
would seize the chance to earn more on their investments. As
Japanese capital flooded abroad, the yen would head down.
Robertson left his investors in no doubt that he would short
Japan’s currency.
Robertson was expecting bullish order flow to come into USD/JPY from the market participants
listed in the above quotation. That was his expectation. That was his hypothesis. That was what
he was betting $18 billion dollars on.
However, that was not what happened. Risk aversion and deleveraging kicked in. Traders
started to unwind the carry trade and USD/JPY started to head lower. The horror started between
August 17-21, 1998 when Russia simultaneously defaulted on his debt and devalued the ruble.
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USD/JPY moved lower 400 pips between August 17-21, 1998. The market knew that Russia
was having problems. What they did not expect was that Russia would both default and devalue
their currency. Usually, if a country gets into big economic trouble and cannot pay it’s debts, it
will either choose to devalue their currency, or choose to default on their debts. Not both. Russia
chose to do both and that was a shock to the market. Also, there were a lot of hedge funds that
were loaded up on all sorts of long Russia positions and they were using leverage, etc. So there
was a concentration of positions, as well as leverage that was all betting on a scenario that the
world would stay calm. However, there was a shock to the market and the risk aversion flared up
as people had to get out of their concentrated positions and start deleveraging.
The crisis continued into late August and September as trouble was brewing that a large hedge
fund might collapse called Long Term Capital Management.
The horror continued and lasted all the way up until October 8, 1998 when USD/JPY hit as low
as 112.00. By the end, Julian Robertson had lost over $3 billion dollars in bad currency bets.
Why did USD/JPY begin sliding again in the first week of October from 136.00 to 112.00? The
reason is because the market was expecting the Fed to start cutting interest rates aggressively.
The Fed cut interest rates on September 29. The market expected the Fed to cut rates further as
the risk aversion intensified, thus causing USD/JPY to fall further.
The drop was also intensified by the fact that the market thought that Julian Robertson would
panic and dump his huge $18 billion USD/JPY long position on the market, as I talked about in
the liquidity difference lesson.
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2000 Dot Com Bubble – Soros loses billions
The tech boom confounded a lot of different investors and traders. On the one hand, you had a
lot of inexperienced retail investors and traders that just bought any old tech stock and watched it
soar in value and they were making triple digit returns. I heard stories of some people making
hundreds of thousands of dollars in 1998 and 1999. There were day traders operating out of their
kitchen tables. Others were still holding down their day jobs and just trading part time turning a
few thousand dollars into a few hundred thousand dollars. They had no skill, but they didn’t need
skill. They just needed to press the buy button and then watch as the tech boom drove stocks
to stratospheric heights.
There were other money managers that correctly identified the boom and rode it as well using
huge amounts of money. Anyone who owned a technology mutual fund did very well during
1998 and 1999.
There were others that tried to fade the trend. There were plenty of stories of some money
manager that tried to short a tech stock and watched as it rose in value two fold or three fold.
Others played it more cautiously and did not try to short the tech boom, but instead just stayed
on the sidelines.
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What did Druckenmiller, the chief investment officer of the Quantum fund do? Initially in the
first half of 1999 Druckenmiller tried shorting the tech stocks. After losses of a few hundred
million dollars, Druckenmiller got out of that short trade. The Quantum fund was down 18% by
May 1999.
Since Druckenmiller was a macro trader, he knew that the money was made in the volatility, no
matter which way the market went.
Volatility is volatility no matter where it occurs. The only thing you need is volatility and
liquidity and getting the direction right and timing right no matter what financial instrument you
play.
Eventually he decided to play the tech bubble and went long. By the end of the year, he had
more than recouped his losses. The Quantum Fund was up 35% for 1999.
When the next year arrived, Druckenmiller knew that the bubble had to burst eventually. He had
to carefully weigh his desire to sell at the right time and avoid big losses, versus the fear that he
might sell too early and watch the tech boom continue for another year and he would under
perform his peers.
Here is an article that describes what happened: “How the Soros Funds Lost Game of Chicken
Against Tech Stocks”
http://www.colorado.edu/Economics/courses/econ2020/4111/articles/soros-fund.html
http://www.marketwatch.com/story/how-soros-funds-lost-game-against-technology-
stocks-2000-05-22?pagenumber=1
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Druckenmiller rode the tech boom in early 2000 as he decided to keep his long exposure. He is
up 2% for the year in early march. Druckenmiller was riding a stock called VeriSign that he
bought at $50 a share in 1999 and it was sitting at around $250 by early March 2000.
Druckenmiller decided to double up on the stock and buy more of it, drastically increasing his
long exposure. It seemed that Quantum’s investment in VeriSign was valued at $300 million, and
then Druckenmiller decided to buy another $300 million of the stock to make him long $600
million of VeriSign.
When the tech bubble started to pop in March 10, 2000, the Quantum Fund was not prepared as
the performance of the fund was very highly correlated with what the Nasdaq did. Soros was
down 11% by March 15, 2000.
VeriSign stock soon plunged to $135 by early April as there were was no more bullish news/
sentiment/fundamental/macro buyers to drive the price buyer. It was a horrifying scenario
because the Quantum Fund had loaded up on more of it right before it dropped. Soros had paper
losses of $300 million on the stock if he did not pare back his position on the way down. Soros
confronted Druckenmiller and told him:
VerSign is going to kill us. We should take our exposure down.
Eventually the tech bubble continued to pop and Soros was down 21% for the year by April 28,
2000. Not all of the losses came from riding the tech bubble for too long. Some of the losses for
the year 2000 came from ill timed bets going long the Euro.
How could this happen? The quote below explains a lot:
The Invisible Hands – The Equity Trader:
Even good traders tend to revert to chasing momentum when they

get frustrated or are in a slump.
2002 – Dan Loeb Shorts Technology
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Dan Loeb, another hedge fund manager tried to play the short side of the market and had visions
of being like Paul Tudor Jones timing the crash of 1987.
http://nymag.com/nymetro/news/bizfinance/finance/features/10426/index3.html
In October 2002, Loeb watched $60 million disappear in one

swing. He was shorting technology, hoping for a final sell-
off. He had visions of the legendary hedge-fund manager Paul
Tudor Jones II, who was said to have perfectly timed the crash
of 1987. Unfortunately, Loeb’s timing was off. He’d caught
the bottom. “Fuck! Idiot!” he’d yelled at himself.
Dan Loeb shorted the tech sector a few days before it made the huge low point in October 2002.
As the market rallied almost every day in October, Loeb lost $60 million on his poorly timed
short trade.
What difference was there between Paul Tudor Jones shorting in 1987 and Dan Loeb shorting
tech in October 2007?
Well for starters, the market Paul Tudor Jones was shorting was only down 20% off of the highs.
When Dan Loeb was shorting tech, the Nasdaq was already down around 75% from it’s highs in
2000. Meaning that a lot of the bearish news/sentiment/fundamental/macro order flow had
already been generated. There was very little capital sitting on the sidelines waiting to short the
tech sector. There was very little capital that was stuck long looking to liquidate, because they
had already liquidated on the huge decline from the year 2000.
The market was already pricing in catastrophe for the tech sector. In order for his short to have
worked out the expectations which were already heavily negative had to reach even more
extreme. The bearish sentiment had to become even more extremely bearish for his trade to have
worked out.
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Also, Paul Tudor Jones short benefited from the fact that there were plenty of stop losses which
were triggered on the way down. There were plenty of people who were stuck long and had to
bail out. Or from people who used ‘portfolio insurance’ which was nothing more than selling
stock index futures once losses reached a certain point. And those sell orders were market orders.
There were key market support levels below which significant stop loss levels were triggered.
There was a stop cascade element to the trade.
Dan Loeb’s tech short on the other hand did not have any of those features. The market was
already down 80%. It was grinding lower little by little making new lows. All the big stops were
already triggered by the huge 75% drop from the Nasdaq 2000 highs. Sure there are still some
stops left from bargain hunters trying to catch a bottom. But they certainly weren’t that big
compared to the 1987 situation.
Dan Loeb shorted tech near the bottom. He had certain expectations attached to that bearish
stance. He was betting on more extreme bearish sentiment, on more extreme bearish
expectations about the tech sector. When that did not materialize, some profit taking kicked,
along with some moderate news/sentiment/fundamental/macro players supported prices and he
got squeezed out of his short.
Late 2007 / Early 2008 – Paulson Shorts the banks
After John Paulson personally made $4 billion shorting the housing market, he did not just stop
there and do nothing else. He started searching for the next big trade. The next explosion of
volatility. He wasn’t searching for the next 30 pip move. Nor was he searching for the next 300
pip move. He was searching for the big global macro move. And he determined the next trade to
make in 2008 was to short the banks.
How did Paulson come to that conclusion? Well, he just extracted billions of dollars out of the
market and was concerned about where all that money was coming from. If he, and other hedge
fund mangers made tens of billions of dollars betting against the housing market, then someone
must of been on the other side of that and taken serious losses. Paulson was asking the right
trading questions. Paulson wasn’t asking what the chart pattern or price patterns were. He
wasn’t asking about what the moving averages were saying. He wasn’t asking about where the
fibonacci clusters were. He wasn’t asking about where the next hot forex robot is.
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Paulson was asking who his counterparties were. Paulson was asking who was stuck on the other
side of his trades. Paulson was asking why would they provide liquidity to him. Paulson was
asking what would shatter his counterparties expectations and force them to adjust their massive
positions if a global macro scenario would occur.
Paulson asked the great trading question:
If we’re making all this money, who’s on the other side?
The book The Greatest Trade Ever summarizes it:
If Paulson was sitting on a stunning $10 billion of gains that

year, who was facing dramatic losses? Which firms were hiding
deep problems, and what would the consequences be?
Eventually Paulson did his research and concluded that the banks were exposed to all these
housing related losses and decided to short them. Paulson shorted shares of Fannie Mae and
Freddie Mac is September of 2007. He also shorted shares of Bear Stearns, Merrill Lynch,
Citigroup and Ambac Financial Group.
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Then in 2008, Paulson also shorted many U.K banks including Royal Bank of Scotland,
Barclays, LLoyds Banking Group, HBOS. I am not 100% sure on the timing of the trades, but
they happened before the major collapse in the fall of 2008.
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He made hundreds of millions from shorting the banks.
http://dealbook.nytimes.com/2008/09/24/paulson-bets-big-against-british-banks/
http://www.telegraph.co.uk/finance/recession/4360580/John-Paulson-makes-280m-from-RBSs-
decline.html
Paulson also made a few billion more going long the banks in the year 2009 and 2010. Ironically,
he gave back a lot of profit from these trades, when he was stuck long the banks and financial
companies in 2011 and many of his funds were down 30-50%.
2011 – Paulson loses billions
Why was John Paulson down 30, 40 or 50% in 2011? He started off in the beginning of the year
with a thesis, a hypothesis. He was betting on a scenario, a macro scenario. He thought the
economic recovery would continue, that there would be an “orderly resolution of Europe’s
sovereign credit issues.” They bet tens of billions on this macro scenario of risk appetite in
various financial instruments. They could of expressed this view in various equity markets
buying up shares of banks.
How do I know that was the scenario he was betting on? Well just by looking at what stocks he
owned, and how much he owned of them, you can kind of tell what scenario they are betting on.
If someone owns billions of dollars worth of bank stocks, oil companies, or any equities in
general he is certainly betting on continued growth and risk appetite. If a person expects the
economy to be sluggish, or for there to be a higher risk of a recession,or believe the stock market
to stay flat or go down, they do not own billions of dollars worth of stocks.
Also, you can read his year end investment letter back in January 2011, which was for the year
2010.
http://articles.businessinsider.com/2011-01-28/wall_street/30089679_1_economic-recovery-
stellar-returns-fund
http://www.marketfolly.com/2011/02/john-paulsons-year-end-letter.html
http://www.zerohedge.com/article/complete-john-paulson-2010-year-end-letter
As you can see Paulson emphasized by underlining the words “do not want to be under invested.”
This was someone who really thought the stock market would take off in 2011. And he was
betting billions of dollars on this scenario with what he called “high quality assets at deeply
distressed prices to maximize gains in an economic recovery.”
They already were in their positions worth tens of billions of dollars. They couldn’t generate any
more order flow. Thus, they were relying on other market participants to validate their view.
Which type of market participants? Certainly not the stop hunters or hedgers. They were betting
huge sums on a macro scenario, therefore they were hoping that future news/sentiment/
fundamental/macro order flow would come in to validate their view.
When that didn’t happen and the news/sentiment/fundamental/macro order flow started to move
against him, he started to see losses. You don’t usually go from being flat on the year to -40% in
one shot. It is a gradual process over many months. You can tell when he was on the wrong side
of he order flow when he is down -10%. Then he is faced with a decision. Does he stick with the
same macro view? Or does he start cutting his risk and realizing the losses? Should he flip and
go short?
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What is going through their mind is what if this dip down is temporary? And what if we cut our
positions right at the point the market is going to bottom out and start the rally? They are
thinking what if this 10% draw down is just noise and the market is trying to shake them out?
Then when they are down 20%, they think the same thing. When in hindsight that wasn’t even
the optimal decision. Just cutting the bullish trades when they were -10% was not the optimal
decision. The optimal decision was cut the trades, reverse and go short! That way instead of a
50% loss, they would of had a 20-30% gain.
If he was first to identify the shift in news/sentiment/fundamental/macro order flow then he

would of been short the bank stocks, not long.
What positions did Paulson lose billions of dollars on? Some of the stocks that he had on huge
long positions were: Sino-Forest, Bank of America, Hewlett Packard, Citigroup, Transocean,
Suntrust Banks.
Here are the charts below:
Paulson suffered losses of several hundred millions of dollars, whether or not he bought the stock
at a high or low prices. For even if he bought it at a low price, he had massive paper profits that
evaporated, which turns up in his performance statistics as a loss.
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Paulson suffered losses of at least $400 million from Bank of America alone.
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Paulson lost at least another $200 million from his ill timed bet on Hewlett Packard, weeks
before it started gaping down.
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Paulson lost over $300 million dollars from being long Citigroup.
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Paulson lost over $400 million dollars from Transocean stock falling.
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Paulson lost another $200 million dollars from Suntrust Banks.
It is important to note that Paulson didn’t have to lose all that money. He could of easily
acknowledged that he had bought a whole bunch of stocks at the wrong time and decided to fully
sell all his positions and go flat. That was not what he did.
He did reduce his exposure as he sold a lot of shares on the way down in order to cut some of his
losses. But it was not enough as the losses mounted into the hundreds of millions and billions of
dollars.
It is kind of hard to admit that you got the complete global macro picture wrong. Even when
prices are moving against you it is kind of hard to admit it. It just depends on what type of trader
/ investor a person is. A John Paulson may have wanted to stick with his trades in the hope of a
market turnaround. Someone else like a Paul Tudor Jones, who is a much more price sensitive
trader may have cut all his positions when the market broke out against him. Jones evens likes to
reverse and go short if he senses his initial long trade was wrong. He is just a more price
sensitive trader.
Sushil Wadhwani who worked with Jones in the 1990’s talked about Jone’s flexibility:
You’d talk to Paul in the morning his time and he’d be long
something. The next day, that market would have gone down and
you would fear he had lost money, but when you spoke to him
again you would find that he had changed his mind and had gone
from long to short. That’s tremendous flexibility. It’s very
important in this game that one doesn’t get hung up and
anchored to a view.
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Louis Bacon also talked about the different types of traders / investors:
Those traders with a futures background are more ‘sensitive’ to

market action, whereas a value-based equity traders are trained
to react less to the market and focus much more on their
assessment of a company’s or situation’s viability.
There is another story about how George Soros was short a stock called Resorts International in
1978. The stock started moving higher and it caused losses for Soros. He covered and flipped to
a long position in Resorts International. In the end he covered back his losses and make a small
profit.
There was another large trader with a large short position in Resorts International in 1978 named
Robert Wilson. Wilson was short 200,000 shares of Resorts at $15, thus the short position was
valued at $3,000,000. Wilson stayed doggedly short as the stock rallied to 20, then to 30, then to
40, then to 50, then to 60, then to 120. Then in a week and a half the stock surged from 120 to
180. Wilson finally covered all his short position. He had lost a whopping $20 million dollars.
Soros on the other hand started off with his bearish hypothesis. The market moved against him.
He felt he was wrong so he covered his shorts. Then he re evaluated the situation and felt that
the bullish story was the more likely scenario and he went long. As they say when you are taking
losses, if you go flat, you see things differently.
For more information on Robert Wilson you can read this article:
http://www.thestreet.com/story/920199/1/the-itsci-streetside-chat-robert-wilson.html
There is another story of George Soros where he was arguing with a trader over the direction of
the market during a weekend. Soros felt very bearish and had an elaborate theory for believing as
such. The market rallied violently over the next few days. This trader was worried about Soros
as he expected him to have losses and asked him how he fared. Soros responded that he had
changed his mind, covered and went very long and made a fortune.
As Soros once said:
My approach works not by making valid predictions but by

allowing me to correct false ones.
Going back to John Paulson. It was not as if there was not enough liquidity for him to bail out of
his positions. There was plenty of liquidity for him to completely get out of his trades if he chose
to. But he did not choose to completely sell all of his stock. He chose to only sell a portion of it
and it hurt him as the stocks kept sliding.
If he really wanted to, there was plenty of liquidity for him to sell all his stock and go short if he
so chose to do so. Yes, he did own billions of dollars worth of a single stock. Yes, you cannot
unload that much in a single day without moving the market heavily against you. But the great
thing is that sometimes the market gives you plenty of time to get out.
Take for instance in the Hewlett Packard situation:
Page 121
Paulson had a huge $1 billion dollar position that he built up around $40. HPQ gaped down on
May 17th, 2011 and Paulson was instantly down $100 million dollars. If he re evaluated the
situation and determined that he was on the wrong side of the news/sentiment/fundamental/macro
order flow, he had plenty of time to sell out his position. Paulson had 45 trading days where
HPQ was stuck in the $33 -37 price range. He could of easily just taken a $100 million dollar
loss, but instead chose to hold on and the loss ballooned to hundreds of millions of dollars.
If Paulson was really in harmony with the order flow, then he would of not only bailed out of his
long trade completely, but actually reversed and went short! If he shorted the stock from $33,
that is still plenty of profit on the way down to $22. He would of made back some of his losses.
Just because he did not choose to do that, does not mean that he couldn’t do it. He always had
the option. At that particular moment in time, with that particular trade, he just didn’t realize it
and interpret the information properly.
Remember the great trading quote:
Not everyone is going to interpret things in the same way, at

the same time, as you do, and it’s important to understand
that. – Bill Lipschutz
Page 122
It happens with every trader, even great trader. In his case however, it cost Paulson’s funds
hundreds of millions of dollars.
Page 123

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Bonus Section 2

Hedge Fund Mindset Mastery

Hedge Funds and Big Banks Are Not Gods

So why didn’t Buffett catch those same trades as well?

As Robert Ringer said in the book To Be or Not to Be Intimidated?:

And as such there is no shortage of money out there.

Seismic Differences Between Hedge Fund

More Order Flow Generators, Market Participants, Scenario Knowledge

This hedge fund mindset mastery can be an extremely powerful edge.

Price Action Trading is a step above technical indicator trading.

Order flow trading is a step above price action trading.

Global Macro is an even higher level of order flow trading

Not Everything Is Applicable Every Second Of Every Day

Hedge Fund Size Typical Leverage Used / Returns Looking To

$1 million 1x – 20x 10-500% per year

$100 million 1x – 10x 10-200% per year

$1 billion 1x – 5x 10-150% per year

$10 billion 1x – 3x 10-70% per year

$30 billion 1x – 2x 10-50% per year

Retail Traders ($1,000 – 5x-500x 100% – 10,000% per year

Concentrated Positions, Correlated Low Risk, Multiple, Uncorrelated Positions

Typically don’t care about liquidity Always thinking about liquidity

Believe that stops/option barriers are the Believe that news/sentiment/fundamental/

Bet on technical indicators/chart patterns. Always bet on a scenario / macro view /

Get margin calls Never get anywhere close to a margin call

Size of Trade Maximum Opportunity Set

$1 million Thousands per year

$100 million Hundreds per year

$1 billion 100 per year

$5 billion 20 per year

$10 billion 10 per year

$30 billion 4 per year

Now why is this so?

Blowing Trading Accounts?

High Leverage = Cannot Handle Fluctuations

I took all of the firm’s capital and put it into T-bill

On another occasion in the Trader Documentary, Jones lost 5% or so or around $5 – 6 million

High Leverage – Large Hedge Fund vs Small Speculator

High Leverage = Big Orders = Potential Front Running

Big Blowups Require Big Volatility

Prime Brokers Will Not Let It Happen

What Do Retail Forex Traders Do?

How Do Hedge Funds Survive Large Market Movements?

• How big or small they position sized

How does this help you?

Reason For Leverage Use In The Currency Markets

Paul Tudor Jones

So again, I’m probably the exact same trader as I was 15 years

Temporary Leverage, Never Permanent

$100 million 1x – 10x

Retail Traders ($1,000 – $50,000) 5x-500x

Low Risk Per Trade

Hedge Fund Size Returns Looking To Generate

$1 million 10-500% per year

$100 million 10-200% per year

$1 billion 10-150% per year

$10 billion 10-70% per year

$30 billion 10-50% per year

Retail Traders ($1,000 – $50,000) 100% – 10,000% per year

Speculation is a business. It is neither guesswork nor a

Speculation is a hard and trying business, and a speculator

A man must give his entire mind to his business – if he wishes

Stanley Druckenmiller was rumored to go to sleep at 8:30 PM EST on weekdays in order to wake