Excerpt from the book Fooled by randomness by Nassim Nicholas Taleb
(The author tells the stories of three Wall Street traders (Nero Tulip, Carlos and John) whose fates were defined by the 1998 summer crises. A good reading for traders looking at differing trading strategies one being in which you can obtain some very good returns for some time with a certain set of skills, but the same "skills" may blow you up at some rare circumstances. And conversely, the second strategy of traders who obtain above the market returns over a long period of time may however comparatively underperform the star traders, atleast in the shorter timeframe)
Nero Tulip The disciplined, risk averse trader Story 1
Nero Tulip became obsessed with trading after seeing a strange scene in front of Chicago Mercantile Exchange - A red Porsche convertible, abruptly stopped in front of the building entrance. Its driver a visibly demented athletic man, a trader in his thirties, his face flushed red, emerged and ran up the steps as if he were chased by a tiger. He left the car double-parked, its engine running. After a long minute, a bored young man clad in a yellow jacket (yellow was the color reserved for clerks) came down the steps, visibly untroubled by the traffic commotion. He drove the car into the underground parking garage as if it were his daily chore.
That day Nero Tulip was hit with infatuation that strikes like lightning. This is for me! he screamed enthusiasticallyhe could not help comparing the life of a trader to the alternative lives that could present themselves to him.
Nero is a trader who can commit hundreds of millions of dollars in a transaction without a blink or a shadow of a second thought. He holds an undergraduate degree in ancient literature and mathematics from Cambridge University. He enrolled in a Ph.D. program in statistics at the University of Chicago but, after completing the prerequisite coursework, as well as the bulk of his doctoral research, he switched to the philosophy department. He called the switch a moment of temporary sanity, adding to the consternation of his thesis director, who warned him against philosophers and predicted his return back to the fold. He finished writing his thesis on the methodology of statistical inference in its application to the social sciences. In fact, his thesis was indistinguishable from a thesis in mathematical statisticsit was just a bit more thoughtful (and twice as long).
After witnessing the scene of the trader chased by a tiger, Nero found a trainee spot on the Chicago Mercantile Exchange, the large exchange where traders transact by shouting and gesticulating frenetically. There he worked for a prestigious (but eccentric) local, who trained him in the Chicago style, in return for Nero solving his mathematical equations. The energy in the air proved motivating to Nero. He rapidly graduated to the rank of self-employed trader. Then, when he got tired of standing on his feet in the crowd, and straining his vocal cords, he decided to seek employment upstairs, that is, trading from a desk. He moved to the New York area and took a position with an investment house.
Nero specialized in quantitative financial products, in which he had an early moment of glory, became famous and in demand. Many investment houses in New York and London flashed huge guaranteed bonuses at him. Nero spent a couple of years shuttling between the two cities, attending important meetings and wearing expensive suits. But soon Nero went into hiding; he rapidly pulled back to anonymitythe Wall Street stardom track did not quite fit his temperament. To stay a hot trader requires some organizational ambitions and a power hunger that he feels lucky not to possess. He was only in it for the funand his idea of fun does not include administrative and managerial work. He is susceptible to conference room boredom and is incapable of talking to businessmen, particularly the run-of-the-mill variety. Nero is allergic to the vocabulary of business talk, not just on plain aesthetic grounds. Phrases like game plan, bottom line, how to get there from here, we provide our clients with solutions, our mission, and other hackneyed expressions that dominate meetings lack both the precision and the coloration that he prefers to hear. Whether people populate silence with hollow sentences, or if such meetings present any true merit, he does not know; at any rate he did not want to be part of it. Indeed Neros extensive social life includes almost no businesspeople.
So, Nero switched careers to what is called proprietary trading. Traders are set up as independent entities, internal funds with their own allocation of capital. They are left alone to do as they please, provided of course that their results satisfy the executives. The name proprietary comes from the fact that they trade the companys own capital. At the end of the year they receive between 7% and 12% of the profits generated. The proprietary trader has all the benefits of self-employment, and none of the burdens of running the mundane details of his own business. He can work any hours he likes, travel at a whim, and engage in all manner of personal pursuits. It is paradise for an intellectual like Nero who dislikes manual work and values unscheduled meditation. He has been doing that for the past ten years, in the employment of two different trading firms.
Modus Operandi
A word on Neros methods. He is as conservative a trader as one can be in such a business. In the past he has had good years and less than good yearsbut virtually no truly bad years. Over these years he has slowly built for himself a stable nest egg, thanks to an income ranging between $300,000 and (at the peak) $2.5 million. On average, he manages to accumulate $500,000 a year in after-tax money (from an average income of about $1 million); this goes straight into his savings account. In 1993, he had a year of underperformance and was made to feel uncomfortable in his company. Other traders made out much better, so the capital at his disposal was severely reduced, and he was made to feel undesirable at the institution. He then went to get an identical job, down to an identically designed workspace, but in a different firm that was friendlier. In the fall of 1994 the traders who had been competing for the great performance award blew up in unison during the worldwide bond market crash that resulted from the random tightening by the Federal Reserve Bank of the United States. They are all currently out of the market, performing a variety of tasks. This business has a high mortality rate.
Why isnt Nero more affluent? Because of his trading styleor perhaps his personality. His risk aversion is extreme. Neros objective is not to maximize his profits, so much as it is to avoid having this entertaining machine called trading taken away from him. Blowing up would mean returning to the tedium of the university or the nontrading life. Every time his risks increase, he conjures up the image of the quiet hallway at the university, the long mornings at his desk spent in revising a paper, kept awake by bad coffee. No, he does not want to have to face the solemn university library where he was bored to tears. I am shooting for longevity, he is wont to say.
Nero has seen many traders blow up, and does not want to get into that situation. Blow up in the lingo has a precise meaning; it does not just mean to lose money; it means to lose more money than one ever expected, to the point of being thrown out of the business (the equivalent of a doctor losing his license to practice or a lawyer being disbarred). Nero rapidly exits trades after a predetermined loss. He never sells naked options (a strategy that would leave him exposed to large possible losses). He never puts himself in a situation where he can lose more than, say, $1 millionregardless of the probability of such an event. That amount has always been variable; it depends on his accumulated profits for the year. This risk aversion prevented him from making as much money as the other traders on Wall Street who are often called Masters of the Universe. The firms he has worked for generally allocate more money to traders with a different style from Nero, like John, whom we will encounter soon.
When people ask him why he does not hold on to losers, he invariably answers that he was trained by the most chicken of them all, the Chicago trader Stevo who taught him the business. Neros temperament is such that he does not mind losing small change. I love taking small losses, he says. I just need my winners to be large. In no circumstances does he want to be exposed to those rare events, like panics and sudden crashes, that wipe a trader out in a flash. To the contrary, he wants to benefit from them.
Nero's trading records shows a disciplined approach which underperfoms high performers but is solid in terms of consistent returns. However on a longer time basis, while the traders who outperform in the short term with their aggresive approach, may themselves blow out of the market.
Next story of Carlos to follow in part 2
(The author tells the stories of three Wall Street traders (Nero Tulip, Carlos and John) whose fates were defined by the 1998 summer crises. A good reading for traders looking at differing trading strategies one being in which you can obtain some very good returns for some time with a certain set of skills, but the same "skills" may blow you up at some rare circumstances. And conversely, the second strategy of traders who obtain above the market returns over a long period of time may however comparatively underperform the star traders, atleast in the shorter timeframe)
Nero Tulip The disciplined, risk averse trader Story 1
Nero Tulip became obsessed with trading after seeing a strange scene in front of Chicago Mercantile Exchange - A red Porsche convertible, abruptly stopped in front of the building entrance. Its driver a visibly demented athletic man, a trader in his thirties, his face flushed red, emerged and ran up the steps as if he were chased by a tiger. He left the car double-parked, its engine running. After a long minute, a bored young man clad in a yellow jacket (yellow was the color reserved for clerks) came down the steps, visibly untroubled by the traffic commotion. He drove the car into the underground parking garage as if it were his daily chore.
That day Nero Tulip was hit with infatuation that strikes like lightning. This is for me! he screamed enthusiasticallyhe could not help comparing the life of a trader to the alternative lives that could present themselves to him.
Nero is a trader who can commit hundreds of millions of dollars in a transaction without a blink or a shadow of a second thought. He holds an undergraduate degree in ancient literature and mathematics from Cambridge University. He enrolled in a Ph.D. program in statistics at the University of Chicago but, after completing the prerequisite coursework, as well as the bulk of his doctoral research, he switched to the philosophy department. He called the switch a moment of temporary sanity, adding to the consternation of his thesis director, who warned him against philosophers and predicted his return back to the fold. He finished writing his thesis on the methodology of statistical inference in its application to the social sciences. In fact, his thesis was indistinguishable from a thesis in mathematical statisticsit was just a bit more thoughtful (and twice as long).
After witnessing the scene of the trader chased by a tiger, Nero found a trainee spot on the Chicago Mercantile Exchange, the large exchange where traders transact by shouting and gesticulating frenetically. There he worked for a prestigious (but eccentric) local, who trained him in the Chicago style, in return for Nero solving his mathematical equations. The energy in the air proved motivating to Nero. He rapidly graduated to the rank of self-employed trader. Then, when he got tired of standing on his feet in the crowd, and straining his vocal cords, he decided to seek employment upstairs, that is, trading from a desk. He moved to the New York area and took a position with an investment house.
Nero specialized in quantitative financial products, in which he had an early moment of glory, became famous and in demand. Many investment houses in New York and London flashed huge guaranteed bonuses at him. Nero spent a couple of years shuttling between the two cities, attending important meetings and wearing expensive suits. But soon Nero went into hiding; he rapidly pulled back to anonymitythe Wall Street stardom track did not quite fit his temperament. To stay a hot trader requires some organizational ambitions and a power hunger that he feels lucky not to possess. He was only in it for the funand his idea of fun does not include administrative and managerial work. He is susceptible to conference room boredom and is incapable of talking to businessmen, particularly the run-of-the-mill variety. Nero is allergic to the vocabulary of business talk, not just on plain aesthetic grounds. Phrases like game plan, bottom line, how to get there from here, we provide our clients with solutions, our mission, and other hackneyed expressions that dominate meetings lack both the precision and the coloration that he prefers to hear. Whether people populate silence with hollow sentences, or if such meetings present any true merit, he does not know; at any rate he did not want to be part of it. Indeed Neros extensive social life includes almost no businesspeople.
So, Nero switched careers to what is called proprietary trading. Traders are set up as independent entities, internal funds with their own allocation of capital. They are left alone to do as they please, provided of course that their results satisfy the executives. The name proprietary comes from the fact that they trade the companys own capital. At the end of the year they receive between 7% and 12% of the profits generated. The proprietary trader has all the benefits of self-employment, and none of the burdens of running the mundane details of his own business. He can work any hours he likes, travel at a whim, and engage in all manner of personal pursuits. It is paradise for an intellectual like Nero who dislikes manual work and values unscheduled meditation. He has been doing that for the past ten years, in the employment of two different trading firms.
Modus Operandi
A word on Neros methods. He is as conservative a trader as one can be in such a business. In the past he has had good years and less than good yearsbut virtually no truly bad years. Over these years he has slowly built for himself a stable nest egg, thanks to an income ranging between $300,000 and (at the peak) $2.5 million. On average, he manages to accumulate $500,000 a year in after-tax money (from an average income of about $1 million); this goes straight into his savings account. In 1993, he had a year of underperformance and was made to feel uncomfortable in his company. Other traders made out much better, so the capital at his disposal was severely reduced, and he was made to feel undesirable at the institution. He then went to get an identical job, down to an identically designed workspace, but in a different firm that was friendlier. In the fall of 1994 the traders who had been competing for the great performance award blew up in unison during the worldwide bond market crash that resulted from the random tightening by the Federal Reserve Bank of the United States. They are all currently out of the market, performing a variety of tasks. This business has a high mortality rate.
Why isnt Nero more affluent? Because of his trading styleor perhaps his personality. His risk aversion is extreme. Neros objective is not to maximize his profits, so much as it is to avoid having this entertaining machine called trading taken away from him. Blowing up would mean returning to the tedium of the university or the nontrading life. Every time his risks increase, he conjures up the image of the quiet hallway at the university, the long mornings at his desk spent in revising a paper, kept awake by bad coffee. No, he does not want to have to face the solemn university library where he was bored to tears. I am shooting for longevity, he is wont to say.
Nero has seen many traders blow up, and does not want to get into that situation. Blow up in the lingo has a precise meaning; it does not just mean to lose money; it means to lose more money than one ever expected, to the point of being thrown out of the business (the equivalent of a doctor losing his license to practice or a lawyer being disbarred). Nero rapidly exits trades after a predetermined loss. He never sells naked options (a strategy that would leave him exposed to large possible losses). He never puts himself in a situation where he can lose more than, say, $1 millionregardless of the probability of such an event. That amount has always been variable; it depends on his accumulated profits for the year. This risk aversion prevented him from making as much money as the other traders on Wall Street who are often called Masters of the Universe. The firms he has worked for generally allocate more money to traders with a different style from Nero, like John, whom we will encounter soon.
When people ask him why he does not hold on to losers, he invariably answers that he was trained by the most chicken of them all, the Chicago trader Stevo who taught him the business. Neros temperament is such that he does not mind losing small change. I love taking small losses, he says. I just need my winners to be large. In no circumstances does he want to be exposed to those rare events, like panics and sudden crashes, that wipe a trader out in a flash. To the contrary, he wants to benefit from them.
Nero's trading records shows a disciplined approach which underperfoms high performers but is solid in terms of consistent returns. However on a longer time basis, while the traders who outperform in the short term with their aggresive approach, may themselves blow out of the market.
Next story of Carlos to follow in part 2
