QuoteOriginally posted by: SurferSkilled, I guess. But to me the difference between a "good" trader and a "bad" trader is simple. Good traders make bets where they "risk 1 to make 3" and never allow a loss of more than 1--the stated RISK. Bad traders say they "risk 1 to make 3" and then end up losing 5,7,9 or worse. When you set up a trade that's assymetrical (p/l), you have to have an iron-clad risk mgmt system. Sometimes that system breaks-down and they didn't allow for that. Whenever you set-up a trade that is assymetrical (limited profit, unlimited loss) you are short volatility. When you do it front against back (term structure arb) you're short "vvol" or kurtosis. They were short the second derivative of gamma/vega in size. All their bets were short vol, as are all mean-reversion bets (ACT). At Salomon, they had plenty of bank to double-down ad infinitum...not so at LTCM (finite resources). Convergence is a very difficult game when you posess finite resources.So is this just a general critique, not trade per trade? Cause I heard these same ideas put in the same exact words by Nassim Taleb. Amazing coincidence, huh? You then think that if you see cash-and-carry arb on 3 months futures or off-the-run/on-the-run arb it's reasonable to pass on it no matter what the size of the arb, cause it's short vol? Is there a good trade except for buying out-of-the money option? I hoped you'll critique a specific trade where every guy in the pit knows its wrong. I guess not.

Nassim Taleb probably doesn't want us all to refuse to take any position but a long kurtosis bet . Surfer, you're going to put the poor guy out of business! Seriously though, I really admire Taleb (I have read Dynamic Hedging at least 10 times, Fooled By Randomness 3 times, and his research paper about induction approximately 20 times), but the markets cannot function if certain individuals and institutions are not willing to specialize in taking and managing certain risks. This was part of Scholes' lecture and others have said it too. As indicated by Taleb, the market-maker is perpetually short vol. Increasingly, everybody (i.e. every cracker-jack expert) claims that being short vol is a risk that should be avoided, but aren't all forms of insurance really a bet on the volatility of something? (A coworker of mine has been known to quip “short vol is short your job”). Maybe Taleb would be short vol at some level too. Every strategy has its place from my perspective. The way I see it, LTCM was in the business of providing liquidity much the same way a market-maker is supposed to be. The organizational structure of LTCM seems to have been set up simply to remove some of the constraints that prevent the dealer from really being able to provide liquidity when it should be the most profitable. Anyway, from what Taleb is willing to disclose, it sounds like he is taking substantial risks too. Maybe he will be the first publicly known hedge fund operator to entirely bleed to death. I don't think Taleb and Scholes are so different. Who knows, maybe if LTCM had not returned capital they would have weathered the storm. Personally, I think both these guys are extremely intelligent and have something to teach us. Regards,

Obviously, there are times when being short vol makes sense. Just not when you have the biggest position, most of the street is leaning the same way and you are over-leveraged. As long as you're not in the position where your success helps create your ultimate demise--do not create a paradox that you can't resolve.

Surfer, I agree with you. I think that the short equity index vol trades they were apparently carrying seemed out of character for LTCM. They should have stuck to fixed income . Actually, I think that they should have avoided equity entirely (i.e., no pairs or Risk Arb either).

QuoteOriginally posted by: SurferObviously, there are times when being short vol makes sense. Just not when you have the biggest position, most of the street is leaning the same way and you are over-leveraged. As long as you're not in the position where your success helps create your ultimate demise--do not create a paradox that you can't resolve.Ok, so first they just were bad, naive traders, didn't understand "real world dynamics". Then they were too short vol which is against the common sense of everyone in the pit who went to a high school. Then being short vol is bad due to deep philosophical reasons. Now it turns out that it's good to be short vol at the right price. Moreover, it turns out that most of the street thought so too and did often at a worse price than LTCM. So you completely reversed your position. Now it's similar to my original one. Which is it all depends on price, and price seemed right not only to them but to everyone else. Thanks.

-------If people want money with no risk just go look for a buried Treasure or marry a rich woman----------------Zerdna:Athena Onasis has become 18 last week............ I doubt if one can find a richer one.......

Not price. Situation. Zerdna, you're need to be right is obvious--a bad tendency. After the situation shakes-out, then there's a chance to sell vol and take the other side of the trade. Not until. The price is incidental, it's where you are in the process that matters. Once the variance has blown-out, the situation is new and may offer an opportuntiy to sell variance to those who are squaring the books."

QuoteOriginally posted by: SurferSkilled, I guess. But to me the difference between a "good" trader and a "bad" trader is simple. Good traders make bets where they "risk 1 to make 3" and never allow a loss of more than 1--the stated RISK. Bad traders say they "risk 1 to make 3" and then end up losing 5,7,9 or worse. When you set up a trade that's assymetrical (p/l), you have to have an iron-clad risk mgmt system. Sometimes that system breaks-down and they didn't allow for that. Whenever you set-up a trade that is assymetrical (limited profit, unlimited loss) you are short volatility. When you do it front against back (term structure arb) you're short "vvol" or kurtosis. They were short the second derivative of gamma/vega in size. All their bets were short vol, as are all mean-reversion bets (ACT). At Salomon, they had plenty of bank to double-down ad infinitum...not so at LTCM (finite resources). Convergence is a very difficult game when you posess finite resources.I think we're getting closer to agreement.Yes, part of being a good trader is correctly assessing the possible outcomes of your strategy. If you say your loss is limited to $1, then you should be able to make sure you don't lose more than $1. I think LTCM traders were able to do that but things got out of control. It wasn't that the traders or the risk management system were individually bad, both were among the best in the world. The trouble is that they were too close together. There was no independent risk management function. A firm with tough risk-management policies would have trimmed positions dramatically in June 1997. A trader-run firm would never have gotten so illiquid. Somehow, things went wrong. You call that bad trading, I call it an unfortunate interaction between top traders and top risk people.I think the effective capital at LTCM was actually higher than the arbitrage group enjoyed at Salomon. LTCM turned down equity capital, and was allowed to borrow almost without limit. Salomon would have been out of business as an independent entity long before it lost $4.2 billion in six months trading, even at its peak in the late 1980s; and the arbitrage group would have been shut down long before it imperiled the firm's survival.

QuoteOriginally posted by: SurferNot price. Situation. Zerdna, you're need to be right is obvious--a bad tendency. After the situation shakes-out, then there's a chance to sell vol and take the other side of the trade. Not until. The price is incidental, it's where you are in the process that matters. Once the variance has blown-out, the situation is new and may offer an opportuntiy to sell variance to those who are squaring the books."Surfer, so basically if i sell long-term index vol (that's what LTCM sold) at let's say 2.5 historical implied and when vol goes finally down and trades at historical implied and I square the books you gonna short it to me? If that's your business plan, I suggest you run it by Nassim first before publicizingI think what people underestimate is how much ganging up on the fund was done. When Sally liquidated and Russia started to go under fund started to look around for money. They had to talk of their trades to people. People they talked to started having thoughts. What if i short and somehow force margin call? Then whether I buy the fund or not, i cover lower. So they shorted, they did stupid small trades in the end of the day in illiquid markets to force stupid markings of the fund positions. Then they called "confidentially" like crazy and leaked to financial press, so big investors who ordinarily wanted to get into the fund stay away. I am not saying it's not understandable after the fact, it's just hard to anticipate without experiencing.

QuoteOriginally posted by: zerdna<blockquote>Quote<hr><i>Originally posted by: <b>Surfer</b></i>I think what people underestimate is how much ganging up on the fund was done. When Sally liquidated and Russia started to go under fund started to look around for money. They had to talk of their trades to people. People they talked to started having thoughts. What if i short and somehow force margin call? Then whether I buy the fund or not, i cover lower. So they shorted, they did stupid small trades in the end of the day in illiquid markets to force stupid markings of the fund positions. Then they called "confidentially" like crazy and leaked to financial press, so big investors who ordinarily wanted to get into the fund stay away. I am not saying it's not understandable after the fact, it's just hard to anticipate without experiencing.Don't make me drool on my expensive sweater, Zerdna. Geez, so all I have to do is raise some money, and then play a little Hollywood with some 25-year-old pock-faced dweeb from Princeton? Those little punks will run so quick when the price starts going against them a little bit, how many thousands of those shoestring faggots in their cheap Men's Wearhouse shirts can I line up? You call those little sissies a gang, one phone call I've got another billion in credit, and we're squeezing them back the other way. Because I know where they stand, and they know where I stand, but they're playing against each other... MP

QuoteDon't make me drool on my expensive sweater, Zerdna. Geez, so all I have to do is raise some money, and then play a little Hollywood with some 25-year-old pock-faced dweeb from Princeton? Those little punks will run so quick when the price starts going against them a little bit, how many thousands of those shoestring faggots in their cheap Men's Wearhouse shirts can I line up? You call those little sissies a gang, one phone call I've got another billion in credit, and we're squeezing them back the other way. Because I know where they stand, and they know where I stand, but they're playing against each other... MPMob, that actually does sound like a business plan. Go get them tiger

To all of you LTCM haters:The guys at LTCM were the best ever, they knew so much and were pure geniuses. They just lost because of some small simple mistakes (maybe), actually I don't even think it was their fault, because they were so superior to everybody. That's actually why their failure is no big deal, not like B.Citron, N. Leeson, V. Niederhoffer or J. Koonmen who lost because they were stupid arrogants and didn't understand PDE's. Not like these moronic noise traders that trade on non-information (hahahaha they are so stupid they cannot even tell noise from real info!!!), and end-up losing their $50,000 savings in 8 months with an Ameritrade account. No! LTCM guys were smart and skillful and it wasn't their fault. Small mecreants like me can just be in awe in front of such greatness. And so should you.Plus honestly, who gives a flying f@$k that the Fed had to come up with a rescue package in order to avoid a global market collapse? They were geniuses ok? Actually, would the Fed come and rescue non-geniuses? Of course not. So why argue more. They were geniuses. And it wasn't their fault.My LTCM fan-club site will open soon. Free membership for Britney Spears fans. First 200 memebers get a free copy of the tale of Icarus. Hope to see you soon!!!

QuoteOriginally posted by: Aaron<blockquote>QuoteYes, part of being a good trader is correctly assessing the possible outcomes of your strategy. If you say your loss is limited to $1, then you should be able to make sure you don't lose more than $1. I think LTCM traders were able to do that but things got out of control. It wasn't that the traders or the risk management system were individually bad, both were among the best in the world. The trouble is that they were too close together. There was no independent risk management function. A firm with tough risk-management policies would have trimmed positions dramatically in June 1997. A trader-run firm would never have gotten so illiquid. Somehow, things went wrong. You call that bad trading, I call it an unfortunate interaction between top traders and top risk people.I also think there are other more fundamental issues involved in the failure of LTCM. Issues easily explained by behavioral finance kind-of-stuff but also more fundamental issues such as: 1) arbitrage not always happen even if it should (gross substitution is needed) and 2) the failure of historical time series to predict the future. Finally, the old-fashioned difference between risk and uncertainty made by F. Knight should not be forgotten.Galileo´s dictum is maybe correct and the "Book of Nature is written in mathematical characters"... but the Book of Financial Markets so full of human nature? I doubt it. A tought but interesting discussion would be mathematical finance and its true ability to explain human behavior. Economists are already going through that debate as they are those that said that mathematicals economics has decreasing returns already.Aaron, I am really interested in your view on this hard subject. Not a quick brilliant answer but rather a long thread and maybe some reading recommendations.

---------First 200 memebers get a free copy of the tale of Icarus----------HibumalinTha tale of Icarus is a tale of a person who tried to cross his limits. Is not a tale of arrogance or stupidity.Icarus is the emblem of the Greek Air force and i guess of many Air Forces around the world.

*****Mob, that actually does sound like a business plan. Go get them*****Zerdna, I actually pay a lot for these sweaters, you should look into it. If you are seeking a business plan that is more realistic given your means, you might find the sweater business is to your liking MP