Paul Tudor Jones and the Obsession With Capital Preservation

Paul Tudor Jones is famous for calling the 1987 crash, when his fund more than doubled while markets collapsed. He would say that is the wrong thing to remember him for. His real skill is defence. He spends his day thinking about how much he can lose, not how much he can make.

Defence first

Jones started as a cotton trader and founded Tudor Investment Corporation in 1980. Early in his career he took an oversized cotton position, got caught, and lost a large share of his clients' money in one trade. He has said that day changed him.

Since then, his first question on any trade is where he gets out. He assumes each position is wrong until the market proves otherwise.

The rules he trades by

• Never average down. Adding to a loser turns a small mistake into a large one.
• Cut size when trading badly. After a run of losses he trades smaller, not bigger.
• Use a time stop. If a trade has not worked within the expected window, he leaves, even without a loss.
• Ask for 5:1. He looks for trades where the potential gain is about five times the risk. At that ratio he can be wrong most of the time and still make money.

The 200-day moving average

Jones uses the 200-day moving average as a simple filter across markets. When price is below it, he gets out or gets defensive. The rule is crude, and he knows it.

Its value is that it prevents catastrophe. No market falls 50% without first crossing its long-term average. A rule that removes the worst outcomes does not need to be clever.

How 1987 actually worked

Jones and his colleague Peter Borish compared the 1980s market with the 1920s and saw a close resemblance. They were positioned short ahead of October 1987. The preparation mattered, but so did the willingness to act on it when the break came.

Note what he did not do. He did not bet the firm on the forecast. He sized the position so that being wrong would have been survivable.

Why preservation compounds

A 50% loss needs a 100% gain to recover. A 10% loss needs 11%. Avoiding deep drawdowns is not caution for its own sake. It is the arithmetic of compounding.

Jones also treats capital as mental capital. A trader in a deep drawdown thinks badly, and bad thinking produces the next loss.

What to take from it

• Decide the exit before the entry.
• Never add to a losing position.
• Trade smaller when you are losing.
• Take only trades where the reward is several times the risk.

Part 5 of 15 in the series Lessons From the Masters. Next: Jesse Livermore: Genius, Leverage and Ruin.

Independent educational commentary, not investment advice. References to people and firms do not imply affiliation or endorsement. The picture is an illustration, not a photograph. Past results say nothing about future ones. Trading leveraged products carries a high risk of loss.