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The Big Short: Jamie Mai's Tips

Jamie Mai

Mai is the founder of Cornwall Capital, they followed a bottom up fundamental approach to the markets. They focus on profiting from esoteric market inefficiencies. One major characteristic that Cornwall’s strategies incorporate is that they are structured and implemented as highly asymmetric positive skew trades. Therefore, trades in the upside potential far exceeds the downside risk.

One of these trades included a short bet on the subprime mortgages known from the book “The big short”. Cornwall Capital had an average annual compounded net return of 40% and 52% gross with a Sharpe ratio of 1.12.

One of the interesting aspects he mentions about trading psychology is the risk on and risk off mentality which started to represent itself after the 2008 financial crisis. In the interview he mentioned “In the aftermath of the 2008 financial crisis, a clear risk-on/risk-off paradigm emerged in the markets, and particularly the foreign exchange (FX) markets. If it was a risk-on environment, everybody piled into currencies with exposure to emerging markets and commodities, such as the Australian dollar. When it was a risk-off environment, everyone fled currencies like the Australian dollar and piled into safe-haven currencies,such as the Swiss franc.

Before the 2008 financial crisis, the correlation between the Australian dollar and Swiss franc had ranged between modestly positive to modestly negative for many years—in other words, there was no strong relationship between the two. After the financial crisis, however, the Australian dollar and Swiss franc exhibited extreme inverse correlation because of the risk-on/risk-off psychology that dominated the markets. It got to the point where, if the Swiss franc was up sharply, you could be relatively sure that the Australian dollar would be down sharply and vice versa.”

Not many retail traders will take this into account as they do not consider related markets such as the bonds, equities and commodities market. Identifying the risk on and off cycles can help you as a trader confirm a bias on which direction the market is likely to move.

There were also 4 key points that Mai uses when investing:

1. Mai will find mispricing in a theoretically priced world: identify trade opportunities that arise from prices which are based on one of several standard pricing assumptions that may be entirely inappropriate based on the specific circumstances applicable to the given market.

2. They select trades in which the probabilities appear to be significantly skewed to a positive outcome: At Cornwall they apply this rule by making sure the trade has an estimated gain of the success multiplied by the probability of the positive outcome to be twice as large as the estimated loss if it fails multiplied by the negative outcome probability.

3. Implement trades asymmetrically: this involves structuring trades so that the downside is limited while the upside is open ended. A common way of achieving this type of return risk is being a buyer of options when there has been a mispricing identified.

4. Wait for high conviction trades: stay on the sidelines and do nothing until there is an opportunity that meets this guideline. Having the patience to wait for high expected value trades greatly enhance the return risk of individual trades.

Mai is also a followed of being flexible in his trade opportunities and ideas. He will routinely change his view based on the research conducted. An example would be his trade in dry bulk shippers where he started off that these companies were a buy but ended up with the exact opposite exposure when his research indicated that his initial hypothesis had been entirely erroneous. This supports the fact that the good traders will get out of a position when they realize they have made a mistake. The great traders will take the opposite position when they realize their original view was wrong.

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