“He’s the best,” said an industry contact, referring to Steve Cohen, when I asked him to recommend possible interview candidates. I would hear virtually the same assessment repeated several more times whenever Cohen’s name was mentioned by industry acquaintances. When I looked at Cohen’s numbers, I understood the reason for their ebullient praise. In the seven years he has managed money, Cohen has averaged a compounded annual return of 45 percent, with only three losing months in the entire period—the worst a tiny 2 percent decline.
These numbers, however, dramatically understate Cohen’s trading talent. Cohen is so good that he is able to charge a 50 percent profit incentive fee, which means that his actual trading profits have averaged approximately 90 percent per year. Despite stratospheric fees—approximately two and a half times the hedge fund industry average—Cohen has not had a problem attracting investors. In fact, his flagship fund is closed to new investment.
Cohen’s firm, S.A.C., which derives its name from his initials, is located in an office building whose architectural style can best be described as “Connecticut Corporate”—a low-rise, rectangular facade of glass squares. I expected to find Cohen sitting in a window-encased office with a glass and steel desk. Instead, the receptionist led me into a huge, windowless room with six long rows of desks, seating approximately sixty traders, each trader with an array of six to twelve computer screens. Despite its size, the room was so filled with people and equipment that it felt more cavelike than cavernous. The absence of windows created a bunkerlike atmosphere.
The traders were all dressed casually, with attire ranging from T-shirts and shorts, which was appropriate for the weather, to jeans or slacks and polar fleeces for those who found the air conditioning too cold. Cohen was seated near the middle of one row of desks, totally indistinguishable from any of the other traders in the room. (He was one of the polar fleece contingent.) Cohen has used his trading success to lure traders specializing in a whole range of market sectors. He has chosen to surround himself with traders, figuratively and literally.
When I arrived, Cohen was in the midst of a lengthy phone conversation—ironically, he was being interviewed by The Wall Street Journal. (“This is media day down here!” Cohen would later exclaim to a caller, referring to the dual interviews.) I squeezed a chair in alongside Cohen’s slot within the room-length desk while I waited for him to get off the phone. Throughout his phone conversation, Cohen kept his eyes glued on the quote screens in front of him. At one point, he interrupted his conversation to call out an order. “Sell 20 [20,000] Pokémon.” As an aside to the rest of the room, he said, “My kids love it, but what the hell.” He reminded me of Jason Alexander from Seinfeld—a combination of a slight physical resemblance, speech patterns, and sense of humor.
The room was surprisingly quiet, considering the number of traders. I realized what was missing—ringing phones; the order clerks had open lines to the exchange floors. Every now and then there would be a flurry of activity and an accompanying wave of increased noise. Traders continually shouted out buy and sell orders, news items, and queries to others in the room. Sample: “Anyone know—Is Martha Stewart going to be a hot offering?” Every couple of minutes, Cohen called out a buy or sell order to be executed, in a tone so casual that you might have thought he was placing an order for a tuna fish on rye, instead of buying or selling 25,000 to 100,000 shares at a clip.
What is the stock you shorted that has a product that your kids love?
Nintendo. They do Pokémon. Do you know Pokémon?
Afraid not. [This interview preceded the media crescendo that led to a Pokémon Time magazine cover.]
It’s a Japanese cartoon character that is very popular right now.
Why are you shorting it, if your kids like it?
Because I think it’s a fad. It’s a one-product company. [Looking at the screen, Cohen comments] I think the market may go a little higher, but I’m actually turning very negative.
Why is that?
The big caps are moving higher, but the rally has no breadth. The market is moving up on light volume. Also, people will start to get more concerned about Y2K as we get closer to the end of the year.
A Fed announcement concerning interest rates is scheduled for the day I am visiting. As we approach within fifteen minutes of the announcement, Cohen begins entering a slew of buy and sell orders well removed from the prevailing market prices. “In case the market does something stupid,” he explains. In other words, he is positioning himself to take the opposite side of any extreme reaction—price run-up or sell-off—in response to the Fed report.
Just before the announcement, the TV is turned on, just like in the movie Trading Places. (Although, for the record, the Trading Places sequence, which takes place on the commodity trading floor, is divorced from reality because the release of agricultural reports is deliberately delayed until after the close of the futures markets—but then again it’s only a comedy.) As the clock ticks down to 2 P.M., the tension and anticipation build. Cohen claps his hands and laughs, shouting in eagerness, “Here we go!” A minute before the announcement, a spontaneous rhythmic clapping—the let’s go [team name] beat one hears at sports events—ripples through the room.
The Fed announcement of a ¼ percent hike in interest rates is exactly in line with expectations, and the market response is muted. There is a small flurry of trading activity in the room, which quickly peters out. “Okay, that was exciting, let’s go home,” Cohen jokingly announces.
Cohen methodically types quote symbols into his keyboard at the rate of approximately one per second, bringing up companies that are not on one of his numerous quote screens. The market begins to rally, and Cohen considers buying but then decides to hold off. Ten minutes later the market reverses direction, more than erasing its prior gains.
How much of what you do is gut feel?
A lot, probably at least 50 percent.
I attempt to continue the interview, but it is virtually impossible with all the distractions and interruptions. Cohen is intently focused on his computer screens, frequently calling out trades, and also taking phone calls. The few questions and answers that I manage to record contain nothing that I wish to retain. The remainder of the interview, with the exception of the final section, is conducted in the more sedate environs of Cohen’s office.
When did you first become aware that there was a stock market?
When I was about thirteen years old. My father used to bring home the New York Post every evening. I always checked the sports pages. I noticed that there were all these other pages filled with numbers. I was fascinated when I found out that these numbers were prices, which were changing every day.
I started hanging out at the local brokerage office, watching the stock quotes. When I was in high school, I took a summer job at a clothing store, located just down the block from a brokerage office, so that I could run in and watch the tape during my lunch hour. In those days, the tape was so slow that you could follow it. You could see volume coming into a stock and get the sense that it was going higher. You can’t do that nowadays; the tape is far too fast. But everything I do today has its roots in those early tape-reading experiences.
Did your economics education at Wharton help at all in your career as a stock trader?
Not much. A few things they taught you were helpful.
Like what?
They taught you that 40 percent of a stock’s price movement was due to the market, 30 percent to the sector, and only 30 percent to the stock itself, which is something that I believe is true. I don’t know if the percentages are exactly correct, but conceptually the idea makes sense.
When you put on a trade and it goes against you, how do you decide when you’re wrong?
If I am in the trade because of a catalyst, the first thing I check is whether the catalyst still applies. For example, about a month ago, I expected that IBM would report disappointing earnings, and I went short ahead of the report. I was bearish because a lot of computer and software companies were missing their numbers [reporting lower-than-expected earnings] due to Y2K issues. Customers were delaying the installation of new systems because with the year 2000 just around the corner, they figured that they might as well stick with their existing systems.
I went short the stock at $169. The earnings came out and they were just phenomenal—a complete blowout! I got out sharply higher in after-the-close trading, buying back my position at $187. The trade just didn’t work. The next day the stock opened at $197. So thank God I covered that night in after-hours trading.
Has that been something you were always able to do—that is, turn on a dime when you think you’re wrong?
You better be able to do that. This is not a perfect game. I compile statistics on my traders. My best trader makes money only 63 percent of the time. Most traders make money only in the 50 to 55 percent range. That means you’re going to be wrong a lot. If that’s the case, you better make sure your losses are as small as they can be, and that your winners are bigger.
Any trade stand out as being particularly emotional?
I held a 23 percent position in a private company that was bought by XYZ. [Cohen asked me not to use the actual name because of his contacts with the company.] As a result, I ended up with a stock position in XYZ, which I held for four or five years in my personal account without the stock doing much of anything.
XYZ had a subsidiary, which had an Internet Web site for financial commentary. They decided to take this subsidiary public. XYZ stock started to run up in front of the scheduled offering, rallying to $13, which was higher than it had been at any time I held it. I got out, and was happy to do so.
The public offering, which was originally scheduled for December, was delayed and the stock drifted down. A few weeks later, they announced a new offering date in January, and the stock skyrocketed as part of the Internet mania. In two weeks, XYZ went up from $10 to over $30.
I couldn’t stand the idea that after holding the stock for all those years, I got out just before it exploded on the upside. But I was really pissed off because I knew the company, and there was no way the stock was remotely worth more than $30. The subsidiary was going public at $15. If it traded at $100, it would be worth only about $10 to the company. If it traded at $200, it would add only about $20 to the company’s value. The rest of the company was worth maybe $5. So you had a stock, which under the most optimistic circumstances was worth only $15 to $25, trading at over $30.
I started shorting the hell out of the stock. I ended up selling 900,000 shares of stock and a couple of thousand calls. My average sales price was around $35, and the stock went as high as $45. On Friday, the day of the offering, XYZ plummeted. On Friday afternoon I covered the stock at $22, $21, and $20. I bought back the calls, which I had sold at $10 to $15, for $1.
This trade worked out phenomenally well. But when you go short, the risk is open-ended. Even here, you said your average price was around $35 and the stock did go as high as $45. What if it kept going higher? At what point would you throw in the towel? Or, if your assessment that the stock was tremendously overvalued remained unchanged, would you just hold it?
A basic principle in going short is that there has to be a catalyst. Here, the catalyst was the offering. The offering was on Friday, and I started going short on Tuesday, so that I would be fully positioned by that time. If the offering took place, and the stock didn’t go down, then I probably would have covered. What had made me so angry was that I had sold out my original position.
So you got redemption.
I got redemption. That was cool.
What happens when you are short a stock that is moving against you, and there is no imminent catalyst? You sold it at $40, and it goes to $45, $50. When do you get out?
If a stock is moving against me, I’m probably buying in some every day.
Even if there’s no change in the fundamentals?
Oh sure. I always tell my traders, “If you think you’re wrong, or if the market is moving against you and you don’t know why, take in half. You can always put it on again.” If you do that twice, you’ve taken in three-quarters of your position. Then what’s left is no longer a big deal. The thing is to start moving your feet. I find that too many traders just stand there and let the truck roll over them. A common mistake traders make in shorting is that they take on too big of a position relative to their portfolio. Then when the stock moves against them, the pain becomes too great to handle, and they end up panicking or freezing.
What other mistakes do people make?
They make trades without a good reason. They step in front of freight trains. They short stocks because they are up, as if that were a reason. They’ll say, “I can’t believe the stock is so high,” and that’s their total research. That makes no sense to me. My response is: “You have to do better than that.” I have friends who get emotional about the market. They fight it. Why put yourself in that position?
But the XYZ trade that you told me about, wasn’t that fighting the market?
The difference is that there was a catalyst. I knew the offering was scheduled for Friday. I knew what was going on. I also knew what I expected to happen. It was actually a well-planned trade, even though I was pissed off at having liquidated my stock position so much lower.
What else do people do wrong?
You have to know what you are, and not try to be what you’re not. If you are a day trader, day trade. If you are an investor, then be an investor. It’s like a comedian who gets up onstage and starts singing. What’s he singing for? He’s a comedian. Here’s one I really don’t understand: I know these guys who set up a hedge fund that was part trading and part small cap. Small caps are incredibly illiquid, and you have to hold them forever—it’s the exact opposite of trading!
How do you interact with the traders who work for you?
I have different traders covering different sectors for a number of reasons. There are a lot of people in the room, and it would be cumbersome to have different traders trading the same names. Also, since we’re trading over one billion dollars now, we want to cover as many situations as we can. This firm is very horizontal in nature, and I’m sort of orchestrating the whole thing. You could say I’m the hub and the traders are the spokes.
How do you handle a situation when a trader wants to put on a trade that you disagree with?
I don’t want to tell my traders what to do. I don’t have a corner on what’s right. All I want to do is make sure they have the same facts that I do, and if they still want to do the trade, then they can. I encourage my guys to play. I have to. I’m running over one billion dollars. I can’t do it all myself.
How do you pick your traders?
A lot of the traders who work here were referred to me. I have also trained people who have grown up within the system. I’ve had people who began as clerks and are now trading tens of millions of dollars, and doing it very well.
One thing I like to do is pair up traders. You need a sounding board. You need someone who will say, “Why are we in this position?” There is a check and balance, as opposed to being in your own world.
We also have teams where the trader is teamed up with an analyst of the same industry. I like that idea because it helps the trader learn the subtleties of the industry and understand what factors really move the stocks in that sector.
Are these trading teams informal or are they literally pooling their trading capital?
No, they’re working together. Their livelihood depends on each other.
Have you seen improvements in the trading performance by using this team approach?
The results speak for themselves.
Was the team approach your idea?
It was an evolutionary process. Most traders want to trade everything. One minute they are trading Yahoo!, the next Exxon. They’re traders! My place operates very differently. I want my traders to be highly focused. I want them to know a lot about something, instead of a little about everything.
That means they can’t diversify.
They can’t, but the firm is diversified. As long as they can trade the short side as well as the long side, I don’t think anyone in this room thinks being focused on a single sector is a negative.
Are you looking for any special skills when you hire potential traders?
I’m looking for people who are not afraid to take risks. One of the questions I ask is: “Tell me some of the riskiest things you’ve ever done in your life.” I want guys who have the confidence to be out there; to be risk takers.
What would make you wary about a trader?
I’m concerned about traders who wait for someone else to tell them what to do. I know someone who could be a great trader. He has only one problem: He refuses to make his own decisions. He wants everyone else to tell him what to buy and sell. And then when he’s wrong, he doesn’t know when to get out. I’ve known him for a long time, and he’s done this all along.
Do you give him advice?
Yeah! It doesn’t matter. He still does it. He finds a new way to make it look like he’s making his own decisions, but he really isn’t. Ironically, if he just made his own decisions, he would do great. Obviously, on some level he’s afraid. Maybe he is afraid of looking stupid.
You have had quite a run—years of mammoth returns and a sizeable amount of capital under management. Are you ever tempted to just cash in the chips and retire?
A lot of people get scared and think that since they made a lot of money they’d better protect it. That’s a very limiting philosophy. I am just the opposite. I want to keep the firm growing. I have no interest in retiring. First, I have nothing else to do. I don’t want to go play golf. You know the old saying: “Golf is great until you can play three times a week, and then it’s no fun anymore.” Second, I enjoy what I’m doing.
I’ve grown the company in a way that has kept my interest. We’ve expanded from just traditional trading to a whole range of new strategies: market neutral, risk arbitrage, event driven, and so on. Also, my traders teach me about their sectors. I’m always learning, which keeps it exciting and new. I’m not doing the same thing that I was doing ten years ago. I have evolved and will continue to evolve.
Do you have a scenario about how the current long-running bull market will end?
It’s going to end badly; it always ends badly. Everybody in the world is talking stocks now. Everybody wants to be a trader. To me that is the sign of something ending, not something beginning. You can’t have everybody on one side of the fence. The world doesn’t work that way.
Any final words?
You can’t control what the market does, but you can control your reaction to the market. I examine what I do all the time. That’s what trading is all about.
These turn out not to be his final words for the interview. After my visit, I called Cohen with some follow-up questions. This phone portion of the interview follows.
How would you describe your methodology?
I combine lots of information coming at me from all directions with a good feel for how the markets are moving to make market bets.
What differentiates you from other traders?
I’m not a lone wolf. Many traders like to fight their own battles. I prefer to get a lot of support. The main reason I am as successful as I am is that I’ve built an incredible team.
Hypothetically, what would happen if you were trading in a room on your own?
I would still be very profitable, but I wouldn’t do as well. There is no way I could cover the same breadth of the market.
What about the timing of your trades? Why do you put on a trade today versus yesterday or tomorrow, or for that matter, at a given moment, as opposed to an hour earlier or later?
It depends on the trade. I put on trades for lots of different reasons. Sometimes I trade off the tape—the individual stock price action; sometimes I trade off the sector; and sometimes I trade based on a catalyst.
When I was there last week, you were bullish on bonds. Since then, prices initially went a little higher but then sold off. Did you stay long?
No, I got out of the position. The basic idea is that you trade your theory and then let the market tell you whether you are right.
I have heard that you have a psychiatrist on staff to work with your traders.
Ari Kiev. He works here three days a week. [Kiev is interviewed in this book.]
How did this come about?
Ari’s experience includes working with Olympic athletes. I saw some similarities: Traders also work in a highly competitive environment and are performance driven. I felt that the inability of some traders to achieve success was usually due to personal flaws rather than a consequence of bad ideas versus good ideas. All traders have something holding them back.
Has the counseling arrangement with Ari been helpful?
I’ve seen results. If you look around, baseball players have coaches, tennis players have coaches, and so on. Why shouldn’t traders have coaches?
Of the tens of thousands of trades that you have done, do any stand out?
One time, I shorted a million shares of a stock and it dropped $10 the next day. That was pretty good.
What was the story there?
Without naming any names—or else the company will never speak to me again—there were a number of other stocks in the sector that were under pressure, but this stock was going up because it was being added to the S&P index. I figured that once the index fund buying was completed, the stock would sell off. The day after I went short, the company reported disappointing earnings, and the trade turned into a home run.
Any positions you ever lost sleep over?
Nah, I think I sleep pretty good. I don’t lose sleep over any positions. Maybe a better question might be: What was the worst day I ever had?
Okay, what was the worst day you ever had?
One day I lost about $4 to $5 million.
What happened on that day?
I don’t even remember. The reality is that if you trade long enough everything happens.
What is gut feel? It is just an expression for intelligence that we can’t explain. I have seen gut feel firsthand in a number of traders—traders who can view the same information as everyone else and somehow see clearly which direction the market is likely to go. Watching Steve Cohen, you are left with the unmistakable impression that he has a real sense of where the market is headed. This sense, or gut feel, is nothing more that a distillation of the experiences and lessons drawn from tens of thousands of trades. It is the trader as a human computer.
So-called gut feel is a combination of experience and talent. It cannot be taught. Novice traders cannot expect to have gut feel, and experienced traders may also not possess it. Even many of the Market Wizards don’t possess gut feel; in many cases, their trading success is due to a different talent—for example, a skill for market analysis or system building.
Although Steve Cohen’s trading style cannot be emulated, his trading disciplines can. Insofar as Cohen’s behavior demonstrates some of the key attributes of the successful trader, the accounts of his trading experiences contain important information even for the beginning trader. For example, Cohen provides an excellent model of the expert trader’s approach to risk control.
As good as he is, Cohen makes mistakes too—sometimes big ones. Consider the trade in which he shorted IBM before an earnings report. He was dead wrong on his expectations, and the stock gapped up $18 against him in the first trades after the report’s release. Since his reason for placing the trade had been violated, Cohen covered his position immediately. He didn’t try to rationalize the situation; he didn’t give the market a little more time. Although he took a sizable loss, had he waited just until the next morning, the stock would have gone another $10 against him. All traders make mistakes; the great traders, however, limit the damage.
For Cohen, cutting losses is almost a reflex action. Although developing such loss control skills usually takes many years of experience, Cohen offers one piece of related advice that should be as useful to the novice as to the professional: “If you think you’re wrong, or if the market is moving against you and you don’t know why, take in half. You can always put it on again.”
Another important lesson provided by Cohen is that it is critical that your style of trading match your personality. There is no single right way to trade the markets. Know who you are. For example, don’t try to be both an investor and a day trader. Choose an approach that is comfortable for you.
Cohen also advises that it is important to make sure you have a good reason for putting on a trade. Buying a stock because it is “too low” or selling it because it is “too high” is not a good reason. If that is the extent of your analysis, there is no reason why you should expect to win in the markets.
Being a great trader is a process. It’s a race with no finish line. The markets are not static. No single style or approach can provide superior results over long periods of time. To continue to outperform, the great traders continue to learn and adapt. Cohen constantly tries to learn more about the markets—to expand his expertise to encompass additional stocks, sectors, and styles of trading. As Cohen explains, trading for him is an evolutionary process.
Update on Steve Cohen
Steve Cohen declined to do a follow-up interview. He has continued his phenomenal performance. If the massive bear market that began in April 2000 has made trading difficult, someone obviously forgot to tell Cohen. Since the start of the bear market through August 2002, Cohen was up over 100 percent—and that’s in net terms; his gross returns were presumably at least double that level! Even more remarkable, he has not had a single down month during the entire bear market to date. In fact, he has not had a negative return month in four years (since August 1998). Perhaps somewhere there is a trader with better return/risk numbers than Steve Cohen; it’s just that I don’t know who it is.