Daily Speculations

The Web Site of  Victor Niederhoffer & Laurel Kenner

Dedicated to the scientific method, free markets, deflating ballyhoo, creating value, and laughter;  a forum for us to use our meager abilities to make the world of specinvestments a better place.



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Department of Strategy


A letter to Victor Niederhoffer from an EdSpec reader inspires an exchange on losses:

4/6/2004 I just wanted to let you know that your book is the first  book on investing
I've read. I've read the financial papers and all that, for  information to
observe, but The Education of a Speculator is a spell-binding read. I'm from
a background of losing. Never graduated high school, never went to college
(I'm 24 now) but for the last year I've been obsessed with markets. I used
to calculate VISA/AMEX transactions, or credit/cash transactions in the
restaurant where I work as a lowly servant, and try to predict how many cash
transactions I was going to get based on historical data. I  used to predict
how long I could speed based on how many cops I saw in a certain time
period. I would also use weather and size of local events, and factor that
in to the current business trend of the restaurant over the previous year
for that day and make a prediction for my shift. There are "patterns" to be
noticed, but none to profit from. I refused to read any investing book
because I believed that technique disseminates when known by
a few.

Your book grabbed me and has kept me reading over and over. The philosophy of
biological perspective you have laid has become rudimentary to my thinking. (I
also use bizarre homemade ratios that I keep secret until I can use them)
I'm writing of myself here because I want you to know that I'm not just
saying "good job" or "cute book." You are the most underrated trader/investor
that I know of. I hope that doesn't offend you. Da Vinci was always marveled
after but never really got credit for the things he was doing because he was
just too good at everything. People felt threatened that he could go from
one discipline to the next creating and dashing old and new ideas. He made
the initial impact, and left the huge amounts broken ground for the
followers to dig. You are like Da Vinci in this sense. You are a "jack of
all trades, still a master of many."

I see these people (Long-Term Capital in '90s) taking credit for arbitrage  investing.

Yet, it seems you've been there all along, quantifying
out the truths. When you're gone people will look back on you with

One last note. I won't bore you with my all my transactions, but I
thought I had created some new technique. I ran 3,000 into
1.4 million in six hours of demo trading and around 100 trades that lasted
an average of 60 seconds, and were nearly 80% winning. I don't think it's
possible to run it to this extent because the volume that I'd throw around would
destroy the low volatility situations that make this possible. I haven't
yet been able to duplicate this, though I've made consistent "profits" with the same
concept. (I only "paper" trade) I just went over a part in your book
about how you hit the "off note" in markets after a really big move.....I
guess I'll never do anything new. That system I though I found was just a
really exaggerated sequence of what you were writing. You're
the man Vic.
Best Regards,
Orson Terrill

4/15/2004 Victor Niederhoffer responds: As one with direct experience of a wipeout, recall October 1997 -- and perhaps, according to many as well as a certain derivatives expert, as one who is a time bomb still waiting to explode -- my observations might be relevant.

1. It is so much easier to wipe out than to profit big.

2. Improper money management is a key. Not taking account of the worst move that your margin, counterparts, family and employees can stand within the day is a cause.

3. Lack of liquidity exacerbates the wipeout risk, since to get out of a position you can set a chain in motion that will lead via the butterfly effect (first noted by Wallace) or consilience to bellyupness.

4. No contribution you make to the upkeep of market, even of small seven figures, is too small for the market to stop in its tracks in order to force you out and take what you have.  Same thing with Leeson and every other market.

5. Allowing others to know of your position can change the numbers in your empirical distribution as they gun for you, either directly or indirectly.

6. There is a tendency to succumb to the final blow rather than fighting desperately, as Aubrey always did. One must prepare in advance to fight and have loyal and trained partners to help fight on all fronts in such a situation.

7. Many secretly desire to go belly up because of psychological maladies like Oedipus complexes or unrequited unholy love of another kind.

8. If all else fails, and you do go under, you learn who your friends are.


A floor trader comments:


As a  creature of the floor, I have a "worm's eye view" of the predations and parasitism of the public. It is what it is. One must learn to survive or else perish. The members of the floor are just fulfilling their role as per Chapter 15, Ed Spec. I have learned that the same predations and antics happen on a macro scale, but with a twist: The macro players are not only predators but cannibals who will devour their own if not their young. Banks, brokers and even law firms use their privy information to squeeze the positions of their "clients."

During my first year "87" of trading I had a particularly bad day. After the close, I was sitting in the pit tallying up my losses and trying to figure out how many I was long, when an "old-timer" came over and asked me what was wrong. I told him I lost X amount and was long and was glad it was over. He said, "The stock market is down 500, and it's far from over." I was speechless. He said, "Kid, this is the hurt business and tomorrow you'll find out what you're made of and, more important, who your friends are." The next day, I found out the answer to both. I still have the blank signed check he gave me that morning.

Tom Ryan on Resilience


In my experience conditioning with small shocks to improve resilience has had both positive and negative effects. Positive in the sense that it can provide a real live-fire experience of what "cost" can mean in the "cost-benefit" analysis, which is helpful for understanding one's risk acceptance. I recall one particular meeting back in the 1980s with the upper management of a large mining concern where at the end of my presentation I was asked by the CEO, "Just to clarify, you say your best estimate is a 10% chance of this happening?" Yes..  "Well hell, forget about all of those cost benefit numbers. I'm bettin' on the 90%". I mumble something about Princeton, prospect theory. And after the CEO leaves the hired help turns to me and says, "Don't worry about him -- he's just the CEO." (A few years later when the 10% did come into play, there was a new CEO, but that is another story for another post.)

In any case conditioning does help build confidence to deal with routine losses, but I have also found that it has the negative consequence of building up unrealistic expectations, in the sense that we have often seen that too many 0.5 std deviation events in a row lend people to be unprepared, psychologically, and financially, for the 1.5 std deviation event. Which recalls an experience last fall with a client who told me upon my arrival, "We expected a slide of rock, but not THAT BIG of a slide of rock".

As Mr E has said many times, show him a low volatility 30% return on equity and he'll show you a chaos put in the making. In physics, resilience is defined as a value that characterizes a material's resistance to shock. Subsequently it was adopted by ecologists, initially in the same sense as in physics to express the idea of a system's stability around a point of equilibrium. Thus, applied to ecosystems, resilience defines the capacity to resist a large unexpected perturbation and the ability to return to an equilibrium after having been subjected to a shock.

In 1973, Holling proposed a new significance for the term. Holling's new definition was no longer based on the traditional homeostatic systems approach (emphasis added by me) "Resilience is the capacity of a system to absorb and utilize or EVEN BENEFIT from perturbations and changes that attain it, and so to persist without a qualitative change in the system's structure." To me the key here is not simply survival, but to benefit from the shock or event. I like his definition because Holling distinguishes very clearly between stability and resilience; the first indicating a system's capacity to return to equilibrium, and the second the fact that the system does not lose its internal structure in a period of perturbation. A system can be highly resilient and yet fluctuate widely, i.e., have high resilience but low stability (trading systems come to mind). A resilient system is able to incorporate changes in its way of functioning without changing qualitatively.

Another essential distinction between this perspective and the homeostatic systems approach concerns the way in which uncertainties and risks are taken into account in a system. Traditionally, human societies have searched for means to reduce uncertainties and risks by increasing their control over their physical environment. For example, we generally choose to protect ourselves from natural environmental hazards (for example by constructing dikes against flooding), and we justify large expenditures of this nature with reference to medium-term risks defined by the historical data. Meanwhile we prefer to consider the occurrence of long-term events (events with return periods longer than our lifespans) as uncertainties which are too difficult to take into account.

Risk management professionals have preferred to ignore such long-term uncertainties, because they are in-precise, and to turn their attention instead to the risks that occur frequently and that can be readily calculated (VAR). In regard to resilience, the types of risk we are concerned with all tend to have a low probability of occurrence, placing them into the realm of low-probability but high-consequence risks. We know from experience that low-probability-high-consequence risks are very, very difficult to manage. Thus there are two closely related aspects of resilience which must be considered. The first concerns the behavior of a system, due to the structure of its attributes and the interactions between them, the other aspect concerns how one formulates models of unexpected or even unforeseeable future events. One must have not only a mechanical resilience, but a mental one as well. The four conventional risk management strategies in finance are:                  

1. Diversification. 2. Insurance. 3. Pre-loss dynamic hedging 4. Post-loss reinvestment with reserves.

All of these strategies can be used to promote resilience but the effectiveness of each strategy is highly dependent upon the nature of what is being protected and the type of system disturbance. Coming back full circle, mentally, it would seem to me that there are similar personal strategies that we can employ to improve our personal resilience beyond conditioning. I can diversify my personal interests a bit, so in the hypothetical case of losing my business, I would still have plenty to live for, my trading, my family, my non-profit work, my friends, the spec list etc. I can also insure myself by building close relationships with friends who would be there to help me psychologically in case I get knocked down by a catastrophe of some sort. I can also hedge my financial life with my spiritual pursuits of my personal god, and thru constant education and knowledge building I can make sure that I have a reserve of intellectual capital and mental strength to fall back upon in case my life burns down - I can build up a new one because "I know how."