Rogue traders

Quick thought: When rogue traders are found out, they get sacked by their employers, even arrested by the authorities. They have broken the rules, betting the house and losing vast amounts of money. We read about these people every few years. Kerviel is the latest.

But there is more to this story. If markets are broadly random, then for every spectacular blow up, there is a rogue trader who has got lucky and made a fortune for himself, his team, and his employer. Why don’t we read about these traders; they are equally guilty of betting the house and should be punished for their crimes. But no, these ‘bad’ good trades are never made public. I wonder why.

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15 responses to “Rogue traders

  1. Because that attitude is considered standard and we think they’re successes. That’s why everyone fell over themselves to interview LTCM before it went bust and Neiderhoffer before he went bust (again). How much do we really know about the risks that many traders are taking now, we just see whether they’ve made money or not, but clearly that’s not enough.

    Taleb of “Fooled by Randomness” compares the trading that many people do to a game of Russian Roulette. We just see the winners and we fawn all over them, thinking they’re smart because they’re successful, we don’t think about the risks they’ve taken.

    So when you hear people talk about “brilliant” traders where the only sign of their brilliance is that they made lots of money, you’re probably looking at lucky rogues 🙂

  2. ‘we just see whether they’ve made money or not, but clearly that’s not enough’ – this is so true Tyro. Your comments are important to keep in mind…they keep us humble before the markets…that is, we should NEVER think we have got the markets figured out.

    I haven’t read Taleb’s books yet, having been put off somewhat by his spiky, dismissive attitude, but after listening to a couple of his podcast interviews from ‘Bloomberg on the Economy’ I have a great deal of respect for him.

    : )

  3. Yeah, he is certainly not a guy to tolerate fools very well! He devotes a lot of print space to explaining why these people are fools and why we shouldn’t extend them much respect and snark only constitutes a few well-chosen sentences scattered throughout the book so don’t let his snarky exterior throw you off, even if you don’t share his views (yet).

  4. Actually, Niederhoffer IS brilliant. He did lose money — no, he didn’t just lose money, he totally F’d up. But he is brilliant and interesting, besides.

    I think what you said is very true. CEOs and the media let those traders get away with their recklessness because those traders made money. Lots of it. So in effect, the CEOs are passing risk from the traders onto their shareholders much more than most people realize. Some are leveraging entire corporate structures in the process. Or so it seems.

    To the average retail trader’s credit, I have observed a very skeptical mindset on outsized returns. On more than a few occasions, I have read a blog post that wondered about the risk a trader has taken to achieve an enormous gain. The flavor of the month for small-scale traders seems to be managing equity curves, in addition to everything else. Previously, this was the domain of risk managers at banks, investment firms, and prop firms…or so I thought.

    I think Taleb is one of a few people who have really brought the harmful aspects of mainstream risk management and theoretical quantitative modeling into the public eye. I like his snark — but I draw the line just before the part where we should think of such people as fools. I am as critical of quant fetishism as the next guy, even cynical, but I still gotta respect their effort…challenging as that may be at this point.

    I would not classify Niederhoffer as a lucky rogue. Compulsive, maybe. But not a rogue. He never pulled any punches with his clients.

    When you think about it, the rewarding of recklessness when it works out is true in the business world in general. This has been a fundamental aspect of American business for the last fifty years — at least. There is almost a sort of awe when one takes outsized risk, particularly when they announce it to the world and then win.

    Forgive my rambling. I’ve had a few too many bourbon and gingerales tonight.

  5. Jay – I totally agree about outsized returns being a good indicator of a lucky rogue, but I don’t see why you’d think that Niederhoffer wasn’t the same. He missed fundamental aspects of the market and built a business around selling options in such a way that he could earn a good consistent living all the while closing his yes to the risk of ruin, and it caught up to him.

    I agree that in many other areas he was a very bright man. His books are favourites of mine and in many areas he has a keen insight, but I don’t think that absolves him.

    Hmm… Bourbon & gingerale, huh? I could get me some of that…

  6. When I first read about Niederhoffer’s blow up following the Asian crisis. I referred back to his excellent first book ‘The Education of a Speculator’ and can remember thinking that he didn’t follow his own wisdom. In most avenues in life, the gap between knowing the right thing and doing the right thing can be very wide. He’s has had some hairy moments since then, but he has seems to have learned lessons along the way. Most importantly, whereas other fund managers are generally very secretive, VN has been very open with his books and his Daily Speculations site, which reminds me of the debates in the old coffee houses, with great minds coming together from all spheres in life.

    Niederhoffer has said “I don’t know how to make money without taking the kind of risk that would be disastrous for many people to consider”, which tells us another disaster can never be ruled out. The possibility exists. I suppose the difference is that he knows it whereas many others don’t have a clue.

  7. If Vic is brilliant, it’s only in the same sense that an idiot savant is brilliant. Deriving complicated options formulae in one’s head without being able to control one’s trading risk is about on the same level as being able to count all the spilled matches on the floor without being able to wipe one’s own buttocks.

    He’s very open on his Daily Constipations site – try reading some of his material that he wrote while his funds were blowing up in mid-2007! ROFLMAO. Really “open.”

    My first impression about Vic was positive, but mistaken. When I initially read some of his material about applying scientific methods to speculation, I thought it was great to find that kind of attitude!

    Then I read about his “scientific” opinions of methodologies like trend following and value investing, and I thought, jeez, how could anyone take a scientific look at the data and NOT reach the conclusion that those methods worked?

    Then I looked at his record, and how he trades, and compared it to his printed words about applying rational scientific examination to the markets, and I thought, goshdarnit, this guy is about as full of shirt as they come.

    The majority of the material other writers provide is just as thoughtless as Vic’s, filled with straw man arguments and non sequiters, flowery language without useful content. There are maybe two or three that post there that are worth reading on a regular basis.

    Re: recklessness, it’s a cultural thing. Successful recklessness is rewarded, no doubt about it. It’s a statistical outgrowth from the law of large numbers, that if you had 2,000,000 or so HPTs over the decades, the average return on them may be very low, but there will be one or two Neiderhoffers in the group – and they will be praised. If they make a long winning streak before they go negative equity, they’ll get another chance to go negative equity again, with other people’s money. If they go negative equity once or twice while they’re still trading their own 5-figue account, well, they’ll probably move on to indexing.

  8. Caravaggio – I really like that quote of his since it so perfectly sums up so much of Vic. It hints at a great deal of analysis and testing, shows that he’s regularly risking ruin all the time and knows it, but also shows that he’s delusional/frail/human/disassociative enough to think that the risks won’t touch him.

    Bill – I just finished “The (Mis)Measure of the Markets” by Mandelbrot whose work underpins much of Taleb’s work. Mandelbrot eloquently trashes much of conventional wisdom about the markets, and yet he too dismisses trend following as an illusion and a myth. It’s strange how little actual science and data there really is on the markets. On the plus side, Mandelbrot is aware of his own limitations and has never tried to trade other people’s money 🙂

  9. Tyro, the funny thing is, it’s *trivial* to show that trend-following on an index can produce risk-adjusted returns better than buy+hold with a variety of moving average techniques.

  10. Daily affirmation for Bill —

    My focus is not on deriding anybody — not even the “idiots”. My focus is on critiquing their empirical methdologies and models, but being careful not to confuse and conflate this with what might be called “science”. I willingly submit to learning from crackhead hos, ruffians and retards and even from my gay mullet-haired neighbor. My focus is on learning from their successes and failures, not on making attributions.

    Om.

  11. Tyro:

    “I totally agree about outsized returns being a good indicator of a lucky rogue, but I don’t see why you’d think that Niederhoffer wasn’t the same.”

    I have been thinking about why I don’t see VN as a rogue — I dunno why. It doesn’t benefit me in any measurable way to think about this. The definition of a rogue, as used in this context, is vague. If we want to talk about dishonesty, VN is definitely NOT a rogue. If we want to talk about someone who shirks or misbehaves, then with some effort at qualification, he is nothing but.

    But I have learned from him. Perhaps to some, that makes me stupid. I could counter by saying that my equity curve proves otherwise. They could counter my counter by saying that I’m it’s only a matter of time before I blow my account. Perhaps it is my sympathy for VN’s life story and personal accomplishments that is the underlying reason for my unwillingness to make derisive attributions. But instead of coming clean with the emotional reasons for my position, I’ll try to find some other argument as to why I don’t think VN is a rogue and present that instead.

    This is not an attempt at cynicism — although it could easily be construed that way. This is me telling you that perhaps my reasons for not condemning him are more emotional.

    This is the kind of thought process that traders wrestle with all the time.

    ….my daily constipation of the day…

  12. It’s not “Om,” it’s “Moo.” Here’s an edit for you.

    Vic’s a smart guy, but I’m afraid he’s missing some very basic and important points regarding risk control.

    I dispute that his is “very open” on his blog, based on the fact he posted about the market movements being “beautiful” during the very time he was closing his funds due to losses.

    I appreciate and enjoy the fact that Vic writes about using and applying scientific methods to speculation. I wonder, however, how he could have missed what I believe to be significant evidence that certain methods, such as “value” and “trend following,” provide superior risk-adjusted returns. It also seems to be a contradiction that his actual results as a manager, and his documented discretionary methodology, are nowhere near as scientifically based as his writing is.

    I do enjoy the writing of some of the co-authors on the blog, but I find an alarming amount of straw man argumentation, eloquent language without practical content, and ill-developed positions being posted. This distracts from my enjoyment.

    Successful recklessness is rewarded in our culture, as well as in many others. One could speculate that if a great many reckless traders over many decades started out in the index futures markets, there would doubtless be a few who put together long winning streaks before blowing up. If these winning streaks involved a great deal of money, then in the culture that rewards successful recklessness, no doubt these persons would become, and remain, well-regarded money managers. I believe this may be the case with Vic.

  13. LOL…I saw that comment about beautiful moves as well, after I read your post above.

    Moo.

  14. Lots to mull over here; the random creation of trading heroes, self-preservation in adversity, what comprises ‘good’ content, the possibility to get destroyed by ‘beautiful moves’, and on and on. At the end of the day I am still long Vic and the DailySpeculations site!

    I don’t have a problem with people taking a stance far out on the risk-reward frontier, where the possibility of ruin is high (hell, I live out there myself), so long as they are as aware of their position as is humanly possible.

    As an aside, here is the timeline (to 2004) for Bo Keely, the hobo who lived under Vic N’s stairs. Now that’s an interesting life:

    http://www.dailyspeculations.com/keeley/keeley_timeline.htm

  15. I read Bo Keely’s retrospective over at the DailySpeculations site the other day — I would absolutely love to meet this guy, remembering how he was portrayed in the New Yorker article on Niederhoffer. Rather one-dimensional portrayal. He’s more interesting to me than any “Schwagerian supertrader” could ever be.

    If you’re interested in reading more about him, he’s listed in the authors column.

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