
What I Learned from Losing $200M (2015) - samspenc
http://nautil.us/issue/31/Stress/what-i-learned-from-losing-200-million
======
blackholesRhot
I was working in the crude oil / nat gas options pit at the NYMEX during the
summer of 2008 when these trades went down (where much of Mexico's hedge was
traded but not necessarily the author's portion.) A highly ironic part of this
story is that the traders in the pit selling to Mexico thought they were
getting an incredible deal. Both because the price of crude was so high at the
time but also because they were able to "fade" the market. When you're in a
pit like this, there are only ~100 "seats". At the time this meant 100 people
who had firms with enough cash to front ~$1.5M so that you could stand for 6.5
straight hours in a tiny space at the NYMEX and shout back and forth.
Basically what happens is someone will yell out to the other 100 people
"what's the market on DEC'9 crude?" The point is they aren't supposed to say
whether they want to buy or sell. Other people will yell out the prices they'd
be willing to buy or sell at and the quantity. Say someone is willing to sell
200k options at $100/option, and someone else likes that price, they can yell
"sold, 50 DEC'9 crude at 100." meaning they just bought 50k options expiring
in December 2009. For this particular trade, there were three brokers that
were known for representing mexico's hedge in previous years. Traders were
expecting them to come back around this time. When one of these brokers came
into the pit and yelled out "what's the market on DEC '9 crude" traders
guessed he was hedging for mexico and quoted a price a full dollar above where
the market was at. A bunch of people piled on willing to sell at even higher
prices. The brokers had no choice but to accept this higher price. I was just
a 22 year-old DRW intern on loan from a Stanford PhD program and in my head I
was thinking "what the hell is going on.. that's not the fair price. I need to
be selling!" I didn't actually sell anything because I didn't have the
confidence or authority (it was my first month). But a senior trader explained
this to me on our walk back to 7 world trade center after.

~~~
throwaway613834
Thank you for sharing this! One outsider/laymen question:

> When one of these brokers came into the pit and yelled out "what's the
> market on DEC '9 crude" traders guessed he was hedging for mexico and quoted
> a price a full dollar above where the market was at

> The brokers had no choice but to accept this higher price.

I don't understand this. They didn't say they want to buy or sell anything.
Why were they obligated to do either?

~~~
stevenj
I think they meant it's because traders knew that these brokers wanted to buy
(to hedge), so the price was only going to go up further.

------
lordnacho
As a derivs trader myself, I find much wrong with this account.

First of all, he came away net positive, so the title is a bit of a
humblebrag.

Aside from that though, he should have known beforehand how models work. David
Hume mentioned it hundreds of years ago; you only have the past, and the past
might not contain all the dynamics of the future. Lest you think this only
happens to social science models, there have been plenty of engineering
accidents that our models did not predict.

If you have a huge position, the market again does not behave like when you're
just observing. Your moves push things around, often the wrong way. That's
another thing he and his bank should have known.

Finally, there's a big attribution issue. He got paid well, but is it trading
skill that won the day? I'd say it's the salesmanship of getting the Mexican
government to let them out of the trade, apparently at a price that was better
than mid. Normally when you're screwed, you don't get mid.

~~~
yellowstuff
Agreed. This part seemed like an exaggeration to me:

> Hitting a market’s ceiling like this was something that none of my
> methodologies accounted for.

I worked at a bank in 2008. The biggest blowup in recent memory then was LTCM
in 1997 (seems quaint now), which blew up partly because they had positions
too large for the markets they were in. It is simply not credible that someone
would put on a huge position in 2008 and not give any thought to the impact
their own trading would have on prices.

~~~
TuringNYC
>> It is simply not credible that someone would put on a huge position in 2008
and not give any thought to the impact their own trading would have on prices.

And yet it keeps happenning, see "London Whale":
[https://en.wikipedia.org/wiki/2012_JPMorgan_Chase_trading_lo...](https://en.wikipedia.org/wiki/2012_JPMorgan_Chase_trading_loss)

~~~
yellowstuff
Good point, it is surprising this keeps happening. There was difference,
though. The London Whale got too big for his market, but I don't recall him
ever suggesting that he hadn't even considered the effect his own trading
would have on prices.

------
anonu
As a junior trader navigating the markets during that time I noticed that
nobody has a clue about anything. Pundits, researchers, analysts, Junior guys,
Senior guys... They all pretend to know. I'm not suggesting the markets are
truly random. Systematic profits are feasible year over year... But only to
the select few who are in the right product or looking at the market in the
right way. I suppose it's those guys that keep attracting fresh blood to a
zero sum game where there are mostly losers.

~~~
ryandrake
> Systematic profits are feasible year over year... But only to the select few
> who are in the right product or looking at the market in the right way.

You seem to be falling for the same myth: That "certain wizards" can get +EV.
Every casino on Earth makes money from this myth. I believe that there are no
wizards in the stock market (or in business in general), and everyone's gains
and losses vs the total market are for the most part random chance.

I'm reminded of the coin flip exercise one of my statistics professors did.
Everyone in the class stand up and get a coin. Flip the coin, if it's tails,
sit down, and the rest of the class repeats the exercise until only one person
remains standing. Then interview that student and ask them how they became
such a good heads-flipper, and what great strategy he/she used to flip so many
heads in a row. This illustrates the survivorship bias we fall victim to when
we look at someone successful and try to determine what wizardry they used to
become that way.

~~~
Danihan
Your comment seems so ignorant to me. Maybe that's true if you are day
trading, or picking dozens of short-term holds each year instead of long-term
buys.

My stock picks have been:

* Google in 2003, because I worked in a call center and saw EVERYONE using it all the sudden to find answers on tech support calls.

* Chipotle at their IPO because I saw the huge lines at every location in my city.

* Amazon in 2008 after the big stock market crash, simply because it just seemed super undervalued considering everyone was still using it / loved it.

* Broadcom in 2014 because it was obvious the cellular industry was going to keep growing and they were well-positioned / undervalued at the time.

None of that thinking required me being a wizard. Nor was it luck. More just
seeing obvious momentum and being willing to act.

~~~
brianpgordon
That kind of stock picking is dangerous.

First, it's easy to look around your little bubble and see that people are
lining up at your local Chipotle or that people use Google for solving tech
support problems, and conclude that Chipotle and Google are taking off. They
may be not be doing as well in other locales/sectors.

And second, how do you know that these signs of promise aren't already priced
in? If you can see signs that Chipotle is doing well, so can everyone else.
And they have deeper pockets and better information-gathering capabilities
than you do. Nowadays satellite imaging and computer vision are used to count
the number of cars in parking lots of retailers to predict earnings!

Lastly, there are innumerable complicating factors that the average retail
investor has no idea how to account for. Maybe the stock price is low because
their EBITDA is barely staying ahead of debt service payments. Did you read
the SEC filings? Maybe they're having difficulties scaling their supply chain
because they lost a big contract with a major supplier. Do you know enough
about the domain to account for how much that should affect the stock price?
Who knows, maybe there's even a seasonality factor to the number of people who
go to eat spicy food, and your guesstimates will fall apart in 6 months.

I wouldn't even bother with this kind of investing. It's just gambling. If you
seem to be winning over time it's either because you're lucky or because the
markets are going up in general. So just invest in index funds- you'll have
lower volatility and you won't be betting against people who have nothing to
do but sit around all day thinking about how to beat you.

~~~
Danihan
I'm sure you're correct, all stock picking is dangerous though. I'd assert
that my style is the least dangerous.

> look around your little bubble

I didn't (and don't) have a bubble. In fact, I frankly despise the Bay Area
and SV because it constantly tries to put you in a liberal / wealthy bubble.

>If you can see signs that Chipotle is doing well, so can everyone else.

Apparently not, though. They doubled on IPO but most people were still VERY
skeptical of them. I could see that they had 100% solved the problem of "fast
casual" service.

>Nowadays satellite imaging and computer vision are used to count the number
of cars in parking lots of retailers to predict earnings!

That should make you want to invest in the #1 company that manufactures
satellite components.

~~~
brianpgordon
> I didn't (and don't) have a bubble. In fact, I frankly despise the Bay Area
> and SV because it constantly tries to put you in a liberal / wealthy bubble.

Almost everyone lives in a bubble. Unless you're a nomad traveling constantly,
you mostly just see what's in the vicinity of your house or apartment. Your
local area with the successful Chipotle is a bubble. Tech support is just one
tiny slice of the uses for a search engine- a bubble.

> Apparently not, though. They doubled on IPO but most people were still VERY
> skeptical of them. I could see that they had 100% solved the problem of
> "fast casual" service.

Usually when people say this, there was some element that they didn't identify
which made the investment riskier than they realized. It seems in retrospect
that it was inevitable that the stock would go up, but if you could go back in
time and get inside the minds of other investors you might be appalled to
learn of the complicating factors that you didn't even take into account.

Just think about it for a moment. Think about how much human effort and
capital is poured into price discovery in the markets. Billions of dollars.
Teeming trading floors, millions of lines of code, people all around the world
running models and analyzing filings and biting their fingernails watching the
ticker. Do you think you know better than they do what the price of Chipotle
stock should be?

The answer to that question may well be "yes" if you have expertise in the
domain and you're experienced with investing and financial modeling. But it's
probably not.

> That should make you want to invest in the #1 company that manufactures
> satellite components.

Which is what everyone else is thinking too. The trick is determining whether
the price that the market has agreed on is too high or too low.

~~~
oreo81
You're just assuming that no one can see trends more effectively than you. The
reality is that you have no idea how other people see the world, people could
be way ahead of you and you'll never know it.

~~~
yellowstuff
For big companies thousands and possibly tens of thousands of professionals
around the world are putting in long hours thinking about what the correct
stock price is. They are meeting with management, buying proprietary research,
and hiring PhDs to analyze quantitative data. Despite all that the market
makes mistakes a lot, and sometimes a perceptive amateur might even be able to
pick up on those mistakes. Still, I really doubt that many people are good
enough at spotting trends to generate market-beating returns. If they could do
it reliably they'd be billionaires.

~~~
dcow
What a waste, isn't it? Or maybe better put, how presumptuous to think that
years of statistical modeling and formal economic theory somehow endow someone
with effectively better intuition than the next person. Maybe if those years
of training actually lead to better investments there would be something to
consider, but you can't argue that professional gamblers are better than
casual intuitive ones if the pros don't actually yield better results.

~~~
yellowstuff
They do. The median active investment fund underperforms the market, but the
median active retail investor _way_ underperforms the market.

~~~
brianpgordon
And the median active investment fund underperforms the market for a reason.
If a fund plowed 100% of its investment into the S&P 500 they'd be exposing
themselves to laughably high volatility.

------
CalChris
I crewed on a sailboat in YRA races leading up to and during the 2008-9 crash.
It was mostly people from Lehman and Barclays. I was the only SV guy on the
boat.

No one partied harder than those guys but then they really only partied with
themselves. It was kinda like _Boiler Room._ The Dot Com boom is the stuff of
legends but these guys left nothing on the table.

Barclays had a riff and ordered a string of cabs to take people home. One of
them stepped into the cab and said _Vegas_.

For all that they were wrong about everything. Highly paid, quite sure of
themselves but wrong. Basically they were poker players (and they played a lot
of poker) but they weren’t very good. It was just other people’s money so who
cared.

They didn’t learn anything.

~~~
dba7dba
Someone from Korea (S. Korea of course) told me this story that he read in a
South Korean newspaper.

When Lehman was trying desperately to sell themselves in order to get more
funding in 2008, one place they tried it was in S Korea. Lehman's ex head of
Korean office was in a high place in Korean banking industry at the time.

Supposedly some local press was painting it like it was going to be a great
chance for a Korean bank to own the famous Lehman. Probably due to well placed
phone calls.

So Lehman's ceo and his management team came to S. Korea to work the deal.
Like 10 guys.

Guess what, the CEO and his entourage had NOT 1 piece of paper to show during
the negotiation. For a deal that was to involve billions of dollars, the
seller had not prepare even 1 piece of paper to show to the potential
buyer/funder about anything.

To me this suggests

1\. Lehman management was really full of it and thought they could swindle S.
Korean to throw money into a black hole, despite not having done any prep work
on their part.

2\. Lehman management was just going through the motions, while fully knowing
they were doomed.

3\. All of the above.

~~~
chki
I mean if you know that your company is worthless, that is probably not a good
thing to print out in the first place. But it is quite absurd nonetheless.

------
Goopplesoft
This reads like a case study in one of Nassim Taleb's books.

> stress, competition, and choice involved in trading financial instruments
> naturally give rise to illusions of control

> I’d never really experienced the extreme tail of a probability distribution
> firsthand. And that experience disabused me of more than one illusion.

> But what’s the alternative to estimating probabilities?

The implied inevitability of another crisis over the new-ish stress tests is
very saddening. I wonder what can be done.

> The danger is that the financial system and its regulators are moving to a
> narrow risk-model gene pool that is highly vulnerable to the next financial
> virus,” he wrote. “By discouraging innovation in risk models, we risk sowing
> the seeds of our next systemic crisis.

------
xstartup
The same thing happened to me. I had lost 2M in bad deals. "The illusion of
control, overestimate your risk" and failure to understand "probability", the
tail risk was responsible for my ruin.

~~~
tryingagainbro
2 mil was all you had, more or less? Must've been devastating.

You could live like a king in a lot of places with $2mil...almost for life.
Not in NYC but the world has a lot of countries

~~~
nathan_f77
You can retire comfortably almost anywhere with $2M. 3% is an extremely safe
"withdrawal rate" if you invest the money in index funds, and that gives you
an annual income of $60k. That's a solid middle-class income anywhere in the
US, and luxury in South-East Asia.

~~~
ChuckMcM
Apropos of nothing, health care before age 65 in the US (prior to the ACA, and
possibly again) peaked at about $36K/year (age 64). That leaves you with $24K
of your $60K to live on. Not saying it isn't doable, but it isn't as much as
it once was.

All I'm saying is that retirement planning is a bit weird because if you do it
when you're 20 you might miss some expenses that older people have that you
are not yet aware of :-)

~~~
tryingagainbro
_peaked at about $36K /year_

So leave USA for a while or forever, if you need to pay $3000 a MONTH for
insurance. WTF?

Unless you have a very, very specific disease everything will be solved in
many other countries, at a lot less. By paying cash if needed.

~~~
noonespecial
Having to pay $3k per month for health reasons sounds like the very disaster
buying health insurance was supposed to guard against.

If that $3k were paying a mortgage debt, it would be servicing more than
$600,000!

~~~
tryingagainbro
_If that $3k were paying a mortgage debt, it would be servicing more than
$600,000!_

Sadly, $600K is nothing in healthcare costs, at least retail price. A snake
bite can cost $153K [https://www.cnbc.com/2015/07/21/hospital-appears-to-
charge-1...](https://www.cnbc.com/2015/07/21/hospital-appears-to-
charge-153000-to-treat-snakebite.html)
[https://www.cbsnews.com/news/rattlesnake-selfie-results-
in-a...](https://www.cbsnews.com/news/rattlesnake-selfie-results-
in-a-153k-medical-bill/)

------
trophycase
I can relate to this. Getting liquidated early on in my career taught me a lot
about risk management and a lot about myself. I kept throwing good money after
bad, sure that I was correct and that it was only a matter of time. It
wasn't... and I wasn't as smart or clever as I thought I was.

Nowadays I put much less confidence in any one position. Leaving room for
being wrong is the most important thing.

------
nicholas73
Interesting that for all of his clever derivatives idea/sale and post-crash
fortitude/rebound, he overlooked the size of the market he was playing. That
was a pretty newb mistake.

------
imron
What I Learned from Losing $200M - of other people's money.

------
beiller
I am on a roll. This article plays this out like poor investor lost his money
in a market downturn. My view is this; they are trading derivatives. This is
known to be very risky. It just goes to show how a shiny education was hired,
when in reality nothing was known / gained here other than a market bump. Sad
waste of an education IMO.

------
purplepotato
I was working in the crude oil / nat gas options pit at the NYMEX during the
summer of 2010 when these trades went down (where much of Mexico's hedge was
traded but not necessarily the author's portion.)

~~~
Bromskloss
Please tell us stories, if you have some.

------
samatao
"What I learned from losing someone else's $200M" would be a better title :)

~~~
supermdguy
Yeah, that's what I was thinking

