Notes on Black Rock and Citadel

 

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As I drove down to London over the weekend to see some friends, I passed a large bill board advertising the services of Black Rock, a global investment manager. Their tag-line message is not particularly revelatory, but it really struck home and I have been contemplating it ever since: ‘OPPORTUNITY FAVOURS THE PREPARED MIND’.

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On a separate note, the weekend edition of the Financial Times ran an interesting article on recent disclosures of expenses by Citadel, a top-tier hedge fund.  Last year, the group paid more than $5.5bn in interest, fees, and other investment costs, and yet Citadel’s two funds have net assets of just $13bn (approx). These costs are unbelievably high and certainly help to explain why investment banks will often go out of their way to service hedge funds over other businesses (corporates).  The FT notes of Citadel ‘it’s costs are high because it’s managers trade frequently and take on huge leverage.’ Indeed, once debt is factored in, the group’s gross assets tally up to some $166bn, a leverage multiple of 12.5x. Frequent trading and excessive leverage often destroys small traders, but Citadel’s disclosure reminds me that is not leverage and frequent trading per se that is the problem, it is the trader and their strategy or behaviour, or both. If a particular strategy displays very strong performance metrics, I believe it is logical to exploit this proven advantage to the fullest extent possible, without going over the edge. 

Citadel was set up in 1990 by Ken Griffin, who is just 38 years old. The group has an annualised return rate of 26%. For more information on Citadel see this interesting article from Bloomberg.

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5 responses to “Notes on Black Rock and Citadel

  1. Man you got me thinking about this all week. Risk management is definitely NOT as simple as the popular books out there claim. Making the maximum amount of return possible would naturally resolve many worries.

  2. Hi Caravaggio, thanks for taking a look at my fledgling site – will have more to contribute once I get going in the New Year.

    Have been following your site for a while and am really rooting for you! I think your current situation encapsulates what every trader/investor/gambler/whatever has faced at some point (for example, my early forays into the market saw me get stuffed for £8k over 3 days when the tech bubble burst in early 2000 – I was earning £15k a year at the time!).

    I plan the first proper posts on my site to talk about some of the things I’ve learned from my experiences as a broker.

    One of the most important points I’m likely to impress is that I’ve seen soooo many unprepared punters, who think they’ve got the market cracked, completely lose their heads when they’re staring down the barrel and so, rather than take a big loss, they take a massive loss (note that I don’t qualify this at all with words like ‘sometimes’ or ‘usually’ – it ALWAYS happens to the unprepared and undisciplined. The frequency with which this happens is honestly frightening).

    What really sticks in my mind on what you’ve written so far is what you said on Nov 26th about having not yet had to look a big loss square in the face. From what I’ve read you’re still to have this experience and maybe it’s because you’ve introduced a handy money-mangement strategy, but as Apone said to his team in Aliens, “Stay frosty, people.”

    Anyway, all the very very best and hope you ride the weak dollar for all it’s worth!

  3. Rocko, making the maximum amount of return sure would be ideal.

    Without going in to the topic of risk management in great depth, I suppose I do buy in to the general wisdom of risk management for the most part, believing that an individual trade size of around 2% makes sense from a logical perspective. Indeed, looking at my old notes on Market Wizards, these top traders had a trade size of between 1-5%. Here is a selection of relevant quotes:

    Michael Marcus: ‘The first thing I would say is always bet less than 5 percent of your money on any one idea. That way, you can be wrong more than twenty times; it will take you a long time to lose your money.’

    Bruce Kovner: ‘My experience with novice traders is that they trade three to five times too big. They are trading 5 to 10 percent risks on a trade when they should be taking 1 to 2 percent risks.’

    Ed Seykota: ‘I intend to risk below 5 percent on a trade’

    Larry Hite: ‘Never risk more than 1 percent of total equity on any trade.’

    Generally I think applying a percentage rule will serve a trader well, especially if they are still ‘finding their way’ (mmmm, aren’t we all), and in this respect, risk management can be quite simple and effective. However, I also think it can be more profitable to tweak one’s risk according to the effectiveness of their strategy. Also, and this does not seem to be discussed all that often, is the issue of relating one’s trade size to the trade frequency of their approach. For example, if your approach only involves a handful of trades in the year, this may require you to take significantly more risk per trade than if you were trading 100x a month.

    Generally, I believe the heart of the risk management debate revolves around the issue of a trade-off between playing it relatively safe and exploiting an edge while you have it. If you play it safe, you have the assurance that you shouldn’t ever lose too much money, but then if your strategy ceases to be effective you may end up kicking yourself for not having made hay while the sun was shining. On the other hand you don’t want to risk too much and end up with a large drawdown. Choices, choices.

    After all this, I suppose I should make it clear that while risk management is one part of the game, I do have the firm opinion that the original strategy or approach is far more important in determining whether a trader will survive over the long run.

  4. “… exploiting an edge while you have it”
    I totally agree with this, once you’ve learned to survive the market, it’s time to move on to the phase where maximizing profit becomes the natural objective.

  5. Dave – Thanks for the comments and kind words. I have fallen from great heights trading fx but I think you trump me on speed of descent, losing £8k in three days. I wasn’t too far behind you though as I had taken out a £10k loan from the bank in early 2000, also with the objective of buying into the tech boom. Alas, it was as if my presence had poisoned the bull. I lost £1k almost immediately and bailed on what really was nothing more than a get-poor-quick scheme from the start. I haven’t thought about that incident for years, but it was an important experience.

    I look forward to reading your posts from the broker’s perspective. Your observation about trader’s taking massive losses instead of big losses resonates with my own experience. I found that I could be perfectly rational and disciplined during the calmer times, but when I was losing heavily I would call upon my strengths only to find they were nowhere to be seen. They deserted me when I needed them most, a dangerous illusion.

    Also, you are right that I am yet to experience a significant loss since I started this blog, but I will try my best to ‘stay frosty’. Thanks, and good luck on your own trading.

    PS – I have been trading the dollar from both sides recently, but if I was affording myself the luxury of medium-term fundamental trades, which I am not, I would be actually short GBP/USD.

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