Fooled by randomness | Nero's methods | Conservative trader

#RiskAversion #predeterminedLoss #NakedOptions #HighMortalityRate #BlowUpInUnison #Fall1994 #FederalReserveBankTightening  #IAmShootingForLongevity

• #RiskAversion 
• #predeterminedLoss 
• #NakedOptions 
• #HighMortalityRate 
• #BlowUpInUnison 
• #Fall1994 
• #FederalReserveBankTightening  
• #IAmShootingForLongevity

 A word on Nero's 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 years - but 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) $2,500,000. On average, he manages to accumulate $500,000 a year in after-tax money (from an average income of about $1,000,000); this goes straight into his savings account. In 1993, he had a flat year 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 doesn't Nero make more money? Because of his trading style - or perhaps his personality. His risk aversion is extreme. Nero's objective is not to maximize his profits, so much as it is to avoid having this entertaining money machine called trading taken away from him.

Blowing up would mean returning to the tedium of the university or the non-trading 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, $1,000,000 - regardless 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, like John whom we will encounter soon.