Tuesday, December 21, 2010

Taleb's Code

I got this off Against Value at Risk excerpt (which deserves a later analysis), from Taleb's Fooled by Randomness. These concepts could apply to not just financial trading, but all little risk/reward scenarios we go through in everyday life.


Trader Risk Management Lore : Major Rules of Thumb

Rule 1 - Do not venture in markets and products you do not understand. You will be a sitting duck.

Rule 2 - The large hit you will take next will not resemble the one you took last. Do not listen to the consensus as to where the risks are (i.e. risks shown by VAR). What will hurt you is what you expect the least.

Rule 3 - Believe half of what you read, none of what you hear. Never study a theory before doing your own prior observation and thinking. Read every piece of theoretical research you can - but stay a trader. An unguarded study of lower quantitative methods will rob you of your insight.

Rule 4 - Beware of the trader who makes a steady income. Those tend to blow up. Traders with very frequent losses might hurt you, but they are not likely to blow you up. Long volatility traders lose money most days of the week.

Rule 5 - The markets will follow the path to hurt the highest number of hedgers. The best hedges are those you are the only one to put on.

Rule 6 - Never let a day go by without studying the changes in the prices of all available trading instruments. You will build an instinctive inference that is more powerful than conventional statistics.

Rule 7 - The greatest inferential mistake: this event never happens in my market. Most of what never happened before in one market has happened in another. The fact that someone never died before does not make him immortal. (Learned name: Hume's problem of induction).

Rule 8 - Never cross a river because it is on average 4 feet deep.

Rule 9 - Read every book by traders to study where they lost money. You will learn nothing relevant from their profits (the markets adjust). You will learn from their losses.


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