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Overconfidence destroys a Wall Street trading myth

2024-06-28

Investing is a game of probabilities, where investors need to bet between risk and opportunity. From an investor's perspective, successful investing is actually the monetization of cognition; what kind of investment cognition one has will ultimately lead to what kind of investment outcome. Often, the biggest risk in the market is not the risk itself, but the unwillingness to take risks. However, if investors endlessly take risks, this behavior is called "devil" operation, which is no different from gambling behavior.

The Life of a Devil Trader: Success and Failure

Brian Hunter is one of the most famous "devil traders" in the world today. When it comes to the history of famous loss cases, the bankruptcy of Amaranth Fund is naturally indispensable. The transformation of a star trader into a devil trader, resulting in a huge loss of 6.5 billion US dollars, and the instigator is the American trader Brian Hunter.

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In 2005, Brian Hunter, a trader of the hedge fund Amaranth, discovered the market demand for natural gas and was ready to make a fortune by taking advantage of the fluctuations in natural gas prices. Hunter bought related natural gas financial products at low prices and spent a lot of money to buy options with high exercise prices - he firmly believed in his analysis results and believed that the price of natural gas would soar soon.

Soon, Lady Luck came to Hunter. At the end of August 2005, the super hurricane Katrina swept the United States, causing many places to be hit by heavy rain and tsunamis, and the disaster was severe. The price of natural gas doubled at least in a few days.

With the sudden natural disaster and the amplification effect of option leverage, Hunter's "big bet" on natural gas yielded huge returns, and even with his own strength, he turned the performance of the entire fund from loss to profit. It is said that Hunter's bonus that year reached an astonishing 100 million US dollars. At that time, he was only 32 years old.

At the age of 32, Hunter became the top star trader of the company with this battle, and more funds were entrusted to Hunter like snowflakes, and even the company's boss also took out his own money and let him help manage it. The sudden success and praise made Hunter extremely confident, and this confidence further expanded with the increase of power given to him by the company.

In January 2006, another opportunity to make money came. He once again followed his trading logic "according to the prescription". However, this time the trading strategy was "short air long more", that is, short-term bearish on natural gas, but long-term bullish. At that time, in the New York Mercantile Exchange, Hunter held 70% of the natural gas short positions, and his profit and loss in a day could reach tens of millions of US dollars. This time, Hunter invested heavily and made 2 billion US dollars for the company.

However, the terrifying "black swan event" occurred. Due to the continuous follow-up of new funds to Hunter's short position in natural gas, the impact of climate on natural gas was weakened, and the trend of natural gas futures contracts became short-term rise and long-term decline, which was exactly the opposite of Hunter's trading logic.Afterwards, Hunter's losses grew larger and larger, and the funding gap became increasingly severe. In just two weeks, the entire $9 billion fund had lost $3 billion.

For the vast majority of traders, the most rational approach at this time would be to cut losses in time, as the trend is obviously out of control. However, Hunter at this time was still confident, not only did he not cut his positions to stop the losses, but he even successfully persuaded the company to invest a large sum of money to cover the positions.

The result of such a contrarian operation can be imagined. In just over a month, Hunter's misjudgment led to a huge loss of $6.5 billion, and the Amaranth Fund also announced bankruptcy.

Investment is not endless adventure.

The myth of a star trader collapsed in an instant, from being acclaimed on Wall Street to being labeled as a devilish trader who failed, Brian Hunter's experience is lamentable. However, such a painful story still occurs frequently in the market to this day.

From this story, we can see two important points: First, after accumulating multiple successful transactions, blind confidence, lack of awareness of risk-taking, heavy position operations, and positions that have far exceeded the bearing capacity of individuals and even the entire company. Second, holding on to illusions, when the market is contrary to the initial expectations, he not only did not cut losses rationally but also kept adding positions against the trend, increasing the cost of losses, which has a significant warning significance for all investors.

The core of investment success lies in personal growth. It is essential to have a strategy when trading, and controlling your hands and stabilizing your heart is the key to improving the success rate of investment. Investment is not endless adventure, and all gambling behavior will eventually die in market risks. Although black swans are low-probability events, their destructiveness should not be underestimated. Even if you can be right 100 times, as long as you make a mistake for the 101st time, the consequence of entering the market with a full position has a great possibility of being knocked down by low-probability events, losing the opportunity to make a comeback.

Therefore, under any circumstances, you cannot gamble on a risk probability by luck. It is essential to put risk control first, always prioritize the safety of the principal, and never forget the risk for the sake of making the most money.