Bankroll Management - A Lesson from Soros and Druckenmiller
Two things to discuss in this post.
Bankroll Management Lesson from Soros & Druckenmillers 1992 Trade
This is as an important as a post as ever so if you’ve never heard about part two I’d encourage you to really read it and attempt to absorb it.
Your portfolio depends on it.
The Federal Reserve FOMC today at 2:00 pm EST, with market participants widely expecting the U.S. central bank to keep rates on hold Wednesday.
This is important - all of it.
What Central Bankers do have an effect on every asset class and the failure to understand that cause and effect is fatal.
Despite what your local favorite day trader says, this stuff really matters because portfolio managers are going to add/reduce risk and allocate it accordingly.
And a lot of people missed that in late 2021 when the markets silently sold off after Fed Minutes.
Powell's challenge this week is that financial markets are not buying his warnings that additional monetary tightening is still on the table. Investors believe the world’s largest economy is already slowing enough to prevent the need for further rate rises.
But who knows.
One, placing bets on this event is what every failing day-trader does.
It doesn’t make anyone any serious money aside from watching P&L fluctuate rapidly and that’s a gambling addiction, not a sustainable business.
And there’s a difference in running money v. being an absolute degenerate.
We have a few weeks left in the year and this meeting today that may or may not adjust things, but it does matter.
For end of year bankroll management and Q1.
I already called it quits in the fund this year aside from holdings that are there.
One of my PAs is up +80% and with that comes the next part of this post is how taking that into account will affect a few end of year bets for me based around this FOMC decision.
Right now, I have a position on, and might put one on post this meeting, that takes a similar approach to what Soros and Stanley Druckenmiller did in 1992 and to be clear, I’ve always taken this approach - this is not something new I am testing.
In 1992 George Soros & Stanley Druckemiller had a legendary bet that made over $1B.
The entirety of it from thesis to execution to risk assessment for the portfolio is a lesson to take in.
But let me explain the trade, briefly (google the rest).
Soros's bet hinged on the fact that the pound was overvalued, and that the British government would eventually be forced to devalue it. He began buying up German marks and selling pounds, betting that the pound would fall in value. Soros also bought British securities and sold short German securities based on the cash flowing into fixed assets in countries with strong currencies and vice versa. As Soros's bets became larger, the Bank of England was forced to intervene in the market to prop up the pound.
The Bank of England raised interest rates to 15%, but this did little to stop the pound from falling. Throughout the rest of that day interest rates would be moved 3 times, eventually back down to 12%. The British government spent a combined $29 billion that day trying to slow the demise of their currency.
On Black Wednesday, the pound reached a record low against the mark. The Bank of England was forced to abandon the ERM and allow the pound to float freely. This caused the pound to fall even further, and Soros made a profit of an estimated $1 billion. The effect was much larger felt with the businesses that had exposure to the pound, ultimately meaning Soros' bet was nothing more than a small piece of a complex puzzle that turned out very profitable for him.
In More Money Than God (read this book), Sebastian Mallaby recounts how Robert Johnson, a currency trader Soros was in the process of hiring from Bankers Trust, laid out the risk-reward of shorting the pound:
“Well, sterling is liquid, so you can always exit losing positions. The most you could lose is half a percent or so,” Johnson said.
“What could you gain on the trade?” Druckenmiller asked.
“If this thing busts out, you’d probably make fifteen or twenty percent,” Johnson answered.
“How likely is that to happen?” Druckenmiller pressed.
“On a three-month time frame,” Johnson responded, “about ninety percent.”
“How much would you do in your own fund?” Soros asked, referring to a portfolio that Johnson ran for Bankers Trust.
Johnson indicated that he would leverage himself up to take advantage of this trade. He might do three to five times capital.
“Oh my God,” Druckenmiller said quickly.
That conversation there is gold - they found asymmetry.
A topic most retail investors fail to grasp - and you should if you actually want to make any serious money doing this.
This trade worked and Quantum Fund ended the year up +69%.
But what if it lost?
“We realized that we could push the Bank of England against the trading band where they had to buy an unlimited amount of pounds from us. The plan was to trade the fund’s profits and leverage up at the band’s boundary. The fund was up about 12 per cent for the year at the time, so we levered the trade up to the point where if they pushed us back up against the other side of the trading band, we would lose the year’s P&L but not more.” –Inside the House of Money
That’s bankroll management.
If you’re still reading this, read it again.
Then go and research this trade in detail.
Because I know most of you don’t bet in this rationale.
The bets most of you make are binary - you put it all on one idea and hope for the best - or 1-2 trades, back to cash: wash, rinse, repeat: the way of the degenerate day-trader.
That doesn’t work.
Some of you might be able to get away with it but for any of you managing money or trading larger dollar amounts it’s not a sustainable approach.
It requires portfolio and bankroll management.
I am going to dive more into Bankroll Management inside for subscribers and what I’ve personally taken as framework from this 1992 trade and way of thinking.
But like I said, if you just spend an hour reading about what these guys did it will help.
It helped me.