Monday, May 12, 2008

About Victor Niederhoffer's Experiences

In 1979, Victor Niederhoffer turned $50K into $20Million within 18 months, and became one of the first traders known for quantitative perception. Like any other business, his performance has had ups and downs throughout the decades, and perhaps we could all learn something from the experiences.

I came across this article a few days ago, and it really begs the question of practicality concerning quantitative finance developments today. Mr. Niederhoffer had assumed that stock markets generally moved upwards, a fundamental concept behind current theories in mathematical finance, and this belief had hurt his performance.

Stock prices drift downwards, too

The assumption that stock fundamental values generally stay static while risk-free interest rate serves as an upward drift parameter, i.e. value added via inflation, simply does not apply for actual, realistic market behavior. Companies fail, and more often than not speculative bubbles become mistaken for genuine added value.

Ignoring “unlikely” risks, weaknesses of applied mathematical models, generally makes blowing up a statistical eventuality (Mr. Niederhoffer had blown several hedge funds, but had always managed to get back up and fight another day). No matter how infrequently storms occur, boats are built to withstand the heaviest of them. So should your trading strategy.

Change of paradigm

Fundamentally and statistically, it does not take much for businesses to fail, and yet it requires everything for a moment or two of success. Business and liquidity cycles all point to very dissimilar perspectives than that of Mr. Niederhoffer, or the typical public investor.

It does not matter if your convictions are right or wrong, your objective remains to come out profitable. Pride plays no part in the markets. With that, maybe it is time to take a deeper look into your risk management, so that you WILL survive the worst of times.

0 Reflections: