What lessons can traders draw from Amaranth blow-up?

Thanks for all the replies here. Insightful. I think it's a combination of bad luck (bad weather and strong enemy), the usual large leverage, large position, hubris that led to the blow-up.
 
globalarbtrader said:
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
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Again, you can also add Endeavour to the list of the RV blowups...

But yeah, I think RV, as a strategy, has some "short vol" features. Moreover, it's remarkably easy for one of those BSDs to end up with a feeling of overconfidence and omniscience when doing RV. Et voila, the end result is more often than not a pretty spectacular blowup.
 
I have read up on the Amaranth blow-up episode. It was definitely a case of position size getting too large. On certain months, Amaranth natural gas trading took up >50% of the month's open contracts and trading volume. In fact, the positions were so huge that they breached regulatory limits, not to mention risk limits. Futures exist for the hedgers to hedge price for risk management but irresponsible speculators such as Amaranth ran up prices that make lives hard for hedgers. Natural gas prices got so out of whack that even the hedgers were complaining about prices going out of whack with fundamentals.

So what if Amaranth reported big profits on its position? Prices were going up on the weight of Brian Hunter's buying. There's no way to get out without pushing down prices. Just as prices go up on the weight of Hunter's buying, it will go down on the weight of his selling. Futures are not for long-term investments that one can buy and hold like stocks. Futures are for trading. It is quite foolish to get into such large positions that are hard to unwind in the first place. Hunter was essentially betting that change in weather conditions will bail him out. Maybe he did not go to church regularly and God did not bail him out.

Amaranth was a multi-strategy hedge fund. It is irresponsible of the people in charge to let a trader turn it into an energy hedge fund. Investors were right to feel cheated.
 
And if Brian Hunter got lucky and the trade went his way, he would have been lauded as a great trader without being called out for taking a bad risk.
 
What lessons can traders draw from Amaranth blow-up?

The blew up for the same reason that churns so many retail traders - piss poor risk mgmt. - simple as that.
 
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