What lessons can traders draw from Amaranth blow-up?

[learner88]

Amaranth was the biggest hedge fund blow up in history. Strangely, it did not seem to cause much of a panic compared to LTCM. Anyway, being the biggest, what lessons do elitetraders here learn from their blow-up experience?

Is it the usual over-leverage, over-large position size stuff? Did I miss anything else?

 

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http://www.investopedia.com/articles/07/amaranth.asp


A strategy that Hunter implemented involved playing the spread between the March and April 2007 contracts. Hunter bet the spread would widen between the two contracts, when in fact it narrowed greatly in early September. As mentioned before, Hunter further compounded his losses by using a strategy referred to as doubling down. By borrowing money to initiate new positions, the fund became more leveraged. Eventually, the amount of leverage that Hunter used peaked at an 8:1 ratio. Amaranth had borrowed $8 for every $1 they originally possessed.

 

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The problem that can be seen is Mr. Hunter was betting on the weather and more so because he had made serious dough in 2005 from it. That is no different to betting on a ball game based on few macro factors.

To worsen this nonsense "dart game" approach, he piled up insanely on the leverage only to add more once the trade went against.

 

[Maverick74]

Amaranth was the biggest hedge fund blow up in history. Strangely, it did not seem to cause much of a panic compared to LTCM. Anyway, being the biggest, what lessons do elitetraders here learn from their blow-up experience?

Is it the usual over-leverage, over-large position size stuff? Did I miss anything else?

Read this book:

Hedge Hogs: The Cowboy Traders Behind Wall Street's Largest Hedge Fund Disaster Hardcover – May 21, 2013
by Barbara T. Dreyfuss (Author)

It goes over the blowup in detail. Basically John Arnold took Brian Hunter down. This blowup was entirely in the natural gas market. So there was no spillover to other risk assets. And as much money as Hunter lost, Arnold made. Net net it was a wash.

 

[tomorton]

Nice thread. I'd never heard of Amaranth before though LCTM is always the text-book case.

Sounds like they made every critical mistake they possibly could -
over-leveraging
following a big star trader
buying into a trendless market
no stop-loss
doubling down on a loser
trusting in rational markets and price reversion to the mean
failure to bank gains and get out
........and then they started cheating

Great lessons for traders no matter their scale.

 

[Maverick74]

Nice thread. I'd never heard of Amaranth before though LCTM is always the text-book case.

Sounds like they made every critical mistake they possibly could -
over-leveraging
following a big star trader
buying into a trendless market
no stop-loss
doubling down on a loser
trusting in rational markets and price reversion to the mean
failure to bank gains and get out
........and then they started cheating

Great lessons for traders no matter their scale.

Actually none of those are the reasons why they failed. You really need to read the book. There were very specific reasons that are unique to natural gas that caused the downfall. You really can't use standard retail trader reasons for their downfall.

 

[globalarbtrader]

It's interesting to note that of the 5 biggest trading losses of all time, that weren't outright fraud (Kerviel), all were spread / RV trades: Howie Hubler, Amaranth, LTCM, London Whale.

High correlation -> Low estimated risk -> High leverage... leaves you very vulnerable to a breakdown in correlations and/or changes in relative volatility.

GAT

 

[Maverick74]

It's interesting to note that of the 5 biggest trading losses of all time, that weren't outright fraud (Kerviel), all were spread / RV trades: Howie Hubler, Amaranth, LTCM, London Whale.

High correlation -> Low estimated risk -> High leverage... leaves you very vulnerable to a breakdown in correlations and/or changes in relative volatility.

GAT

You can add liquidity to that list. In the case of Amaranth, the devil was the infamous widowmaker spread (march/april natural gas). This spread for the most part is liquid for guys like you and me, but the size that Arnold and Hunter were throwing around was epic. They basically encapsulated the entire market. They both needed each other to get out. The book I mentioned above is a great read and the blowup reads like an action packed movie.

 

[777]

Actually none of those are the reasons why they failed. You really need to read the book. There were very specific reasons that are unique to natural gas that caused the downfall. You really can't use standard retail trader reasons for their downfall.

Not entirely true as they took on more risk than was wise, a prevaisive theme across the board with blowing up.

Not effectively weighing iquidity issues if hasty exits were needed was one factor they had in common with LTC, as well as over-leveraging.

But yes there were, as you say, unique reasons in play.

 

[Maverick74]

Not entirely true aa they took on more risk than was wise, an prevaisive theme across the board with blowing up.

But yes there were, as you say, unique reasons in play.

But so did Arnold and he made billions. We only criticize the losers. With John Arnold, we say he is the most successful hedge fund manager that ever lived. The youngest self made billionaire in US History.