Can you be too clever?

bbmac

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I've just read the book 'When Genius Failed' the account by Roger lowenstein on the Rise and fall of Long Term Capital Management. (LCTM.)

It is of course the account of how the principles of the fund both miscalculated the volatility of their traded instruments in determining risk and therefore leverage, and also how, to some extent, they moved outside their own fields of expertise (bond arbitrage) seeking out fresh markets,in an attempt to hedge further through diversification, not realising that they were in fact placing the same bet over and over again. Undone by the liquidity squeeze that followed the Asian crisis of the mid 90's followed by Russias' debt default, It succumbed to the fatal temptation ...to put it's money somewhere regardless.

As the author puts it;

'...LTCM put supreme trust in diversification-one of the key shiboleths of modern investing, but an overrated one. As keynes noted, one bet soundly considered is preferable to many poorly undertood. The same economist also noted that 'markets can remain irrational longer than you can remain solvent.'

The author goes on to conclude;

'...LTCM fooled itself into thinking it had diversified in substance when in fact it had done so only in form.' and that '..it was inexperienced and highly leveraged...a lethal combination.'

The fund was of course rescued then effectively liquidated by a consortium of 14banks at the instigation of the Fed, (lest it's collapse have wider ramifications on the financial system.) These banks themselves being huge creditors of the fund, and as the author noted '..Though it is seldom realised, a creditor is also beholden to the debtor.'

He goes on; '...They had programmed the market for a cold predictability that it had never had; they had forgotten the predatory acquisitive and overwhelmingly protective instincts that govern real-life traders. They had forgotten that you cannot programme the human factor'

This crisis resonates somewhat in the Northern Rock crisis, both caused by a flight from risk and a liquidity squeeze...... Just because you can measure volatility doesn't mean you can predict it.

This fund was composed of nobel winning economists, and the stars of Wall Street, and some of the brightest sparks in academe, yet it was the most spectacular collapse...and this gives rise to my question

1. Can you be too clever for your own good?
 
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what you certainly can be is overconfident. I also read that book and the guys at LTCM missed one thing that everyone's mother knows: regardless of who you are and your qualifications and experience, you have limitations.

Years later, one of the LTCM guys justified their decisions by essentially saying that Russia's default and everything that followed was unforseeable. One wants to say, 'No **** Sherlock', but pauses when one realises that, while one specific event it unforeesable, it is perfectly forseeable that the unexpected happens from time to time. It must be one of the mystries of human psychology that, regardless of historical evidence, we overestimate our ability to forsee events.

When you think about, the geniuses at LTCM failed because they failed to take into account something you can easily explain to a ten year old: sometimes things that you have no reason to expect do happen.

I think they were too conceited rather than too clever
 
I have not seen adequate evidence that suggests being clever gives a better ability to predict future outcomes. I have seen many (including on these boards), who believed that they were more clever than the rest and were able to predict the future but again this was never proven in scientifically controlled conditions.


Paul
 
bbmac

I personally don't believe you can be to clever for your own good but the LTCM catastrophe is another prime example of how intellect does not guarantee you success when trading financial markets.

Regards

TMM
 
Overconfidence ?

Doesn't really strike me as being clever - if they were that clever they wouldn't have gone bust (& that's happened to other traders also). Sounds more like over-confidence to me - bigger they are the harder they fall !

Having said all that, it is understandable - do you ever get that feeling when everything's going swimmingly well, that you've at last, nearly got this business (trading) cracked ? The market soon sorts out this psychological flaw - but it's always there and has to be fought.

Is that what happens to the big boys?
 
Can you be too clever?

Happens to me all the time :(

No problem with being too clever, I think the problems described above were caused by too much arrogance and too much ignorance. Anyone really "clever" would have recognised the dangers and positioned themselves accordingly.
 
Clever people cut themselves more, a lot

I have not seen adequate evidence that suggests being clever gives a better ability to predict future outcomes. I have seen many (including on these boards), who believed that they were more clever than the rest and were able to predict the future but again this was never proven in scientifically controlled conditions.


Paul

Hi Paul

Good Post,

Ian man of few words, but always good ones. ow that hurt :eek:

I have read that in fact the opposite is true , people, clever or otherwise and clever well thats subjective anyway, to many skill sets to judge clever, bit open ended IMO

Tests carried out prove that people who were most confident regarding predictive tasks in fact made the worst traders, the best or one of the best were people who served in the Army or other jobs that required them to have learnt disipline at a level deeper than most.

The above I read someware on my travels, so can"t refer to link

Stuck in my mind because ~

I NEEDED TO ADDRESS THAT ISSUE AT ONE TIME AND STILL DO FROM TIME TO TIME. :LOL: :LOL:

Andy AKA
 
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Famous difference between wisdom vs cleverness I believe...

Wisdom lets you see the forest with great clarity and a focus on ends.

Cleverness erroneously lets you believe you're adding value through spending 16 hour days on an in-depth analysis of an individual tree with great attention to means.

Unfortunately the latter is rather incompatible with keeping sight of the whole in an objectives driven search for success.

Idiot Savantism springs to mind.
 
Your clever you are

Famous difference between wisdom vs cleverness I believe...

Wisdom lets you see the forest with great clarity and a focus on ends.

Cleverness erroneously lets you believe you're adding value through spending 16 hour days on an in-depth analysis of an individual tree with great attention to means.

Unfortunately the latter is rather incompatible with keeping sight of the whole in an objectives driven search for success.

Idiot Savantism springs to mind.

You again :!:

Your to clever for your own good, I got my eye on you :eek:

good link and POST again

Andy AKA
 
Hmmm - interesting point, and not sure it's one I am comfortable with. Discpline is good, but you need to be able to constantly question your own assumptions imho as a trader, particularly when you are in a position. Does the thing that made me want to get into this position in the first place still hold true?

Just not sure a military background, with the focus on obediance that that implies, quite equips you for that kind of thinking.

My $0.02 as always

GJ

Hi , good point

Not sure , just remember reading it and taking note, think the assumption was that they would or do follow the plan better than others to the letter which removes or reduces the emotion attached etc Less likely to deviate from intended action in certain situations

arrrrrrrrrrrrrrrrrrrrrrrrrrr just looked at chart and not RUN MY PROFITs on the Ftse

Iv deviated not so clever today :eek: :eek:

Going out to be sick, no just joking to pick the Mrs up and go to work, catch y later :p


Andy AKA
 
Have a nice one Andy, glad you liked the link :)

sport-smiley-023.gif


Better luck running your profits next time :)
 
Hmmm - interesting point, and not sure it's one I am comfortable with. Discpline is good, but you need to be able to constantly question your own assumptions imho as a trader, particularly when you are in a position. Does the thing that made me want to get into this position in the first place still hold true?

Just not sure a military background, with the focus on obediance that that implies, quite equips you for that kind of thinking.

My $0.02 as always

GJ

How much of trading success is ascribable to one's ability to analyse markets? I beleive it is all a matter of odds and probablity. If the odds are good enough and you have enough capital, I can see how one can make lots of money trading just because they are disciplined. Is it really the case that your analysis of 'the reason you entered the trade' contributes to your suceess over time? I allow for situation where you use that analysis to control the odds rather than to understand the markets, of course.
 
I'm talking about the big shop, macro type trading, where no-one would seriously consider trading purely on, say technical analysis, without any consideration for fundamentals, context etc.

Sure if you need an emotionless person to pull the trigger on a black box model thenm maybe I concede that a military background could have some use. They're not the only people with discpline though.

An entire room full of prop trading trappist monks anyone? ;)

GJ

Hi GJ,

You see, I don't believe that anyone actually knows much about why prices move and what causes the moves before they happen. I have serious problems with the idea, big shop or not,that anyone really knows what is going on in (at least the fx) markets. What I can buy is if someone says they trade based on what is already known but make their money by getting the numbers right. I think trading is a numbers game, and by and large, I don't think anybody really knows what is going on.

I was watching Greenspan about a week ago when he said 'markets are random' and predicting what is going to happen in fx is pointless. I agree although I think his implication that you can't make money from randomness is wrong. In trading, you can control a lot of the elements that can make you money over time. If I could be bothered, I can, I am sure, give you live examples every day of how to make money trading. A lot of these examples will be wrong, but the trick is to make the losses small and the winners large enough to offset the losers and give you a profit. There are lots of reasons why everyone is not making a killing just taking these trades. That is what I am talking about.

In my opinion, people who think they know more because they work for a big bank are just nonesensical. Who in God's name would make money last summer because they knew what was happening? Of course one could have made a killing just buying the yen once the move actually started, which has nothing to do with knowing anything other than the thing was going up.

I mean no disrespect you. I actually admire your posts a lot, but I really do not think anyone knows much because they work in a 'big shop'. Of course some people are better analysts than others, but that is a separate point.

After all, wasn't LTCM staffed by some of the cleverest people in economics and Wall Street? I would guess they didn't fail because of lack of knowledge, and I am sure those guys 'knew' more about the markets than 'the big shop macro traders' under discussion here. Their ego and lack of risk management is what screwed them up. Think about it: if it was really about knowledge of the markets, those LTCM geniuses would never have resorted to playing with probabilistic outcomes in a way they thought would ensure their huge profits. They would just trade 'big macro' pictures and make money. They were obviously smart enough to realise directional trading is hard.
 
Bbmac,

A theoretical basis from a Ph D has more depth than one derived from an A level.

Regardless of failures to account for the unknown, specifically quantifying that which can’t be quantified (how do you do that?), they used standard risk–exposure measures.

They identified tiny imperfections in the market and sought to exploit (profit) from these via arbitrage. But there were two problems – the returns were so small they had to gear-up by a factor of 30 plus. Also, arbitrage is only possible if the opposite/complimentary elements behave rationally to restore imbalances. As you point out, irrationalism is a very powerful antidote to rationalism.

I agree with Fxscalper – one can be over-confident but sometimes, as above, this can only be known with hindsight.

GJ,

I find that quite funny, actually – “fkuc you and your models”. I didn’t know they were upping the ante on redemptions - that is questionable but the reason has got be management realised less funds, less management fees so to compensate, they had to gear up to take more on the performance side. I mean, how many Bentleys does one person really need?

A military background may not necessarily be conducive to predicting markets but an AK47 can influence possibilities.

Paul,

You’ve never seen Gypsy Rosie Lee trade.

Andy,

Markus is not too clever; he’s a product, and an example, of German thoroughness.

Grant.
 
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