Strategy/method with high percentage of losers

Quote from eusdaiki:

The problem with looking at expectancy with systems such as LTCM's or taleb's... is that expectancy is calculated based on the "average winner & losser" and the probability of each of these 2 outcomes.
When dealing with swan events the average becomes irrelevant...
sure the average winner and avg lossers of LTCM gave them positive expectancy, and all their Phd Nobel laurette geniuses said that it was impossible for them to go bust... but then the unexpected happened... none of their models could've predicted Russia's default and they took such a loss that it made the average winner and loser irrelevant... they got killed by a tail event, not by the average.

Taleb's system is just the opposite... take small lossers and hope to profit from a tail event.

At the end of the day, both LTCM and Taleb's empirica fund ended in the same place (bankrupt) the difference is that LTCM nearly took the entire financial system with them... while Taleb just lost on a predictable and controlled pattern... so which one was the real gambler?
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Great points. Taleb's system is not winning either - the point of this threads' question.

One more point.

LTCM was taken out by other traders who guessed their methodology and pushed them off the cliff as I seem to recall reading.

Arrogance fails. Humility wins. The efficient market will baptize you BIG TIME when they figure out what you are doing. That is why in my previous discussions of an edge, I am quite careful not to reveal factors that I consider hard-won hard-to-learn critical success factors.
 
Quote from Swan Noir:

Just to be clear it is not that I think LTCM's demise was predictable but I think the possibility of disaster there was much easier to see than many pretend.

What is amazing is that the amounts at risk seem quaint today ... lol.
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With respect, I would consider this comment pure hindsight bias. In an alternative reality, we might be praising LTCM as "the smartest guys in the room".

Just my two cents worth.
 
I think your comment is a fair one in terms of my ability to see the probabilities. It is way above my pay grade and beyond my capability. I did not mean to suggest i saw it.

But I do not think it is hindsight bias to say that we have seen those who leave context -- particularly cultural context -- out of their models were predictably playing with fire. And I suspect there were quite a few major league players who contemporaneously saw that event risk in a gangster society needed to be more heavily factored.

In an alternate reality almost every bust out might be praised as the smartest guy in the room. The problem at LTCM was that they invented an alternate reality that perceived that a savage society had become civilized (in investment terms) in a decade. They should have thought in terms of five or ten decades. I'm not criticizing the numbers they crunched; I'm pretty sure i would not understand them. I am suggesting that it takes more than the math to win the game they decided to play.



Quote from StarDust9182:

With respect, I would consider this comment pure hindsight bias. In an alternative reality, we might be praising LTCM as "the smartest guys in the room".

Just my two cents worth.
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Quote from Swan Noir:

I agree with much of what you say about swan events and the statement below is dead on accurate. But the problem with their model is that it was, although constructed by brilliant men, quite naive at its very core. Everyone knows that Russia had been a gangster society for the 70 years of communism but men who run that kind of capital should have also factored in the fact that it was a hard core gangster society for hundreds of years prior to communism. Culture trumps all and they should have known that.

To think you can run financial models that are exclusively mathematical in nature against a backdrop of a gangster culture is beyond naive it is insane. For a guy like Meriwether to let the quants run wild with pure (or nearly pure) math and not temper it all with the fact that there was not (and is not) a reliable rule of law to depend on makes the model one dimensional. A reasonable and balanced model could have factored in that bonds from that type of society need a lot more vol factored in.

Quants have their place but grown ups are supposed to stay in charge. When they don't craziness takes hold.
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You're right about russia, but their models had an even more fundamental flaw. They start with the assumption that people are rational and the market has normal distribution... these assumptions make your life easy when creating a mathematical model since it is very hard to factor human nature (not rational) into a model or wild fractal chaos...
but it is also the model's aquile's heel. :)
 
Quote from StarDust9182:


LTCM was taken out by other traders who guessed their methodology and pushed them off the cliff as I seem to recall reading.

Arrogance fails. Humility wins. The efficient market will baptize you BIG TIME when they figure out what you are doing. That is why in my previous discussions of an edge, I am quite careful not to reveal factors that I consider hard-won hard-to-learn critical success factors.
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Ooh yeah! The Street's vultures made sure to pick LTCM clean when they started losing control... thats one thing the market is good at... helping a distresed participant lose a lot more than he intended...

about the market being efficient... I tend to side with Soros in thinking that it isn't and prices are not in equilibrium most of the time...
 
Quote from Swan Noir:

I think your comment is a fair one in terms of my ability to see the probabilities. It is way above my pay grade and beyond my capability. I did not mean to suggest i saw it.

But I do not think it is hindsight bias to say that we have seen those who leave context -- particularly cultural context -- out of their models were predictably playing with fire. And I suspect there were quite a few major league players who contemporaneously saw that event risk in a gangster society needed to be more heavily factored.

In an alternate reality almost every bust out might be praised as the smartest guy in the room. The problem at LTCM was that they invented an alternate reality that perceived that a savage society had become civilized (in investment terms) in a decade. They should have thought in terms of five or ten decades. I'm not criticizing the numbers they crunched; I'm pretty sure i would not understand them. I am suggesting that it takes more than the math to win the game they decided to play.
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I completely agree with you. (LOL sorry! I know that in fine ET tradition, I am supposed to call you names and argue particularly when I know I am wrong.)

At the risk of sounding arrogant (see a previous post) these are the two lessons that I took from their defeat:

1) Almost all knowledge/science today uses models. The only model of the universe that is completely accurate is that universe itself. Simplification brought their downfall at a higher level. This is a common failing of our education and government systems - simplifying until they lose the point in the simplification. A model is like the market, it is not the market.

2) Being intelligent is a handicap you have to learn to overcome before you can trade well. Never believe totally your own story.

I think that there are other lessons and many corollaries in this story as in all such stories. There but for the grace of God go us all.
 
Quote from StarDust9182:



1) Almost all knowledge/science today uses models. The only model of the universe that is completely accurate is that universe itself. Simplification brought their downfall at a higher level. This is a common failing of our education and government systems - simplifying until they lose the point in the simplification. A model is like the market, it is not the market.
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Very true!
 
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