Blowing Up

May 11, 2007

I was turned on to an article in the New York titled "Blowing Up" by Rob Booker's blog. According to him, it's the best article he's read in a long time and I have to absolutely agree with him.
The article is about a money manager named Nassim Taleb who created an investment strategy "predicated entirely on the existence of black swans; on the possibility of some random, unexpected event sweeping the markets." Most traders dismiss this black swan as an unlikely event like Victor Niederhoffer who was one of the most successful money managers in the country at one time. Niederhoffer blew up his entire account by selling a large number of options, betting that the market would be quiet. The odds were totally in his favor he thought because the chances of the market going down so heavily were miniscule. Unfortunately for him, the market plummeted 8% in October, 1997 due to the economic crisis in Asia. Niederhoffer made the same mistake again and lost after two planes crashed into the World Trade Center. The black swan reared its head again.
Taleb takes an opposite approach and bets that the black swan will inevitable rear its head and when it does, he will have his payday. In the meantime, he compares the waiting as bleeding a slow death and most days as other money managers are making large sums of money, he's losing small amounts of money.
So as long as you have a definable risk which only threatens a small amount of your capital, you have a chance of riding a wave of profitability that outweighs these smaller losses. I don't want to oversimplify this because it's not easy but it is possible. Weigh your time and be patient. That unexpected event that could wipe out a traders account is right around the corner