In an article for the New York Times Business section…
Finally there is an article that speaks to the other side of the risk of trading. When so much press revolves around people like Warren Buffet, and movies like “Pursuit of Happiness” touting the chances of getting rich quick, the uninformed may begin to think that anyone with half a brain should be able to make money. In an article for the New York Times Business section entitled “Ex-Trader Tells Story as a Warning”, Nicholas W. Leeson is put forth as an example that not every informed individual fares well.
Trading is not a zero sum game as some people believe. For every winner there is not necessarily a loser. On the other hand, with millions of people trading, there are bound to be some statistical anomalies; very big winners and very big losers even if all the choices are purely random. No one hears much about the very big losers, and there is normally a smaller limit to how much any one person can lose, but no limit to how much can be won.
By hiding his trading losses…
Mr. Leeson’s story is an interesting study of what can happen when the downside stops are essentially removed. Mr. Leeson traded for Barings Bank in Singapore. By hiding his trading losses (which led to his criminal conviction and prison sentence), Mr. Leeson had access to virtually all of the resources of Barings Bank allowing him to rack up losses of over a billion dollars, bankrupting Barings Bank. Individual traders usually bottom out long before losses of this size, making their demise less than newsworthy leaving the rest of us to read only big success stories. If an individual investor loses everything he has it rarely makes the news.
The unfortunate side effect of the lopsided press is that it brings uninformed individual traders to the table, many of which are trading with their life savings thinking they will be rich, too. The Efficient Market Theory tells us that the only way that these risk taking souls can consistently win is if they have information not available to the rest of the market. If they do, and they use it, they are most likely to be in danger of retribution by a federal judge for insider trading.
…the average individual will fare slightly worse
The market in general has an average positive return. Conventional loans and the use of derivatives can increase leverage, risk, and return, pushing these risk takers to the end of the statistical bell curve. If we assume that most of the professional and institutional traders fare slightly better than the market, then the average individual will fare slightly worse, though still perhaps achieve positive returns. Again the “house” has the advantage, and trading has transaction costs giving the “house” a further edge.
The reference to gambling in the New York Times article is appropriate. Many investors don’t realize what risks they are taking, or the fact that they have only a slightly better chance of making half again as much money as they’ve invested than they do of losing half of their money. The Efficient Market Theory gives some comfort as well, though, because it should be just as difficult to pick a particularly bad deal as it is to pick a particularly good one. Market psychology causes the losses to generally be much faster than the gains, however.
I agree with him on one point
Finally there is an article that speaks to the other side of the risk of trading. When so much press revolves around people like Warren Buffet, and movies like “Pursuit of Happiness” touting the chances of getting rich quick, the uninformed may begin to think that anyone with half a brain should be able to make money. In an article for the New York Times Business section entitled “Ex-Trader Tells Story as a Warning”, Nicholas W. Leeson is put forth as an example that not every informed individual fares well.
Trading is not a zero sum game as some people believe. For every winner there is not necessarily a loser. On the other hand, with millions of people trading, there are bound to be some statistical anomalies; very big winners and very big losers even if all the choices are purely random. No one hears much about the very big losers, and there is normally a smaller limit to how much any one person can lose, but no limit to how much can be won.
By hiding his trading losses…
Mr. Leeson’s story is an interesting study of what can happen when the downside stops are essentially removed. Mr. Leeson traded for Barings Bank in Singapore. By hiding his trading losses (which led to his criminal conviction and prison sentence), Mr. Leeson had access to virtually all of the resources of Barings Bank allowing him to rack up losses of over a billion dollars, bankrupting Barings Bank. Individual traders usually bottom out long before losses of this size, making their demise less than newsworthy leaving the rest of us to read only big success stories. If an individual investor loses everything he has it rarely makes the news.
The unfortunate side effect of the lopsided press is that it brings uninformed individual traders to the table, many of which are trading with their life savings thinking they will be rich, too. The Efficient Market Theory tells us that the only way that these risk taking souls can consistently win is if they have information not available to the rest of the market. If they do, and they use it, they are most likely to be in danger of retribution by a federal judge for insider trading.
…the average individual will fare slightly worse
The market in general has an average positive return. Conventional loans and the use of derivatives can increase leverage, risk, and return, pushing these risk takers to the end of the statistical bell curve. If we assume that most of the professional and institutional traders fare slightly better than the market, then the average individual will fare slightly worse, though still perhaps achieve positive returns. Again the “house” has the advantage, and trading has transaction costs giving the “house” a further edge.
The reference to gambling in the New York Times article is appropriate. Many investors don’t realize what risks they are taking, or the fact that they have only a slightly better chance of making half again as much money as they’ve invested than they do of losing half of their money. The Efficient Market Theory gives some comfort as well, though, because it should be just as difficult to pick a particularly bad deal as it is to pick a particularly good one. Market psychology causes the losses to generally be much faster than the gains, however.
I agree with him on one point
It’s not that I like seeing Mr. Leeson make a fortune on his bad risk taking, but it is nice to see some press showing that trading is not a get rich quick scheme. So that everyone might be more aware of the risks, let him speak. I agree with him on one point. He predicted that the dollar had further to fall against the pound and the euro in mid-November 2006 and I believe that is still the case in early 2007. Strong economies in both geographies and a flagging economy in the US struggling with inflation will continue to push the dollar weaker. I think the more dramatic changes will be against the Chinese Yuan, however (see Chinese Currency)
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