My Tribute: Victor Niederhoffer, the best of the best...........

  

Victor Niederhoffer passed on to the Spirit World last week.

 

Here some entries I found  on my computer and thought I would share them with you.

 

Human happiness is dependent upon being a member of a support group, and having good meals and friends.

 

He'd always tell me not to be too sure of my positions, and that he knew many bums on the Bowery who had more numbers and relations to support their speculations that I had and they died broke.

 

Somebody is going to say, "Vic should have had more humility when he sold all those naked puts in 1997." I agree. It's something I work on every day.

 

I find companies with natural humility do much better than those that have the opposite character. Occasionally you see that in the down-to-earth, self-deprecating sensibility shown when executives for companies like Wal-Mart sleep two in a room on a trip or travel a few hundred miles for their famous Saturday meetings.

 

Forgetting a natural humility is the reason that so many of the financial weekly commentator's forecasts and hopes -- dare I say all of them since 1964? -- have been so erroneous. And it's the major reason so many bearish funds and pessimistic books about the stock market find the limelight at stock market lows, even though a buy-and-hold strategy in almost every market returned some 10,000-fold in the last century.

 

Bessemer Venture Partners instructively lists its misjudgments and all speculators might do well to adopt the practice. For my own part, passing on, or selling out of, early-stage investments in Audiovisual Associates, E*Trade, Indiana Precision, and NavTeq were among the 9- or 10-figure mistakes I have made. In the market, I have allowed myself to be squeezed out of enormous profits for the sake of a token gain so often that it lays me low to think of all of them.

 

Firsts be aware of deception. The market is at least as smart as the caterpillar which has a hundred ways of deceiving its predators. A good understanding of deception in nature, and models that go into first, second and third level deception in various games is a good start.

 

Secondly, be aware of the power of indirection. A frontal attack is often met by the adversaries best defenses. It wastes too many resources. Absolutely essential is to divide and conquer.  

 

Third, develop a good character. All your faults will come out in the market. and if you are a chronic complainer, or liar, or compulsive gambler, or procrastinator, the market will ferret them out and do you in.  

 

Fourth, always be humble. The market is so smart, so changing that to think you ever have the answers for too long, is certain to lead you to be behind the eight ball when things change.  

 

Fifth, develop good fundamentals. I like to use football analogies and to get a good three point stance and to play well without the ball. Maybe go back to coach Wooden and start with washing the hands, and putting on the socks, and keeping your execution costs low.

 

Sixth,  learn how to handle failure. It's bound to happen, and you have to learn from it.  

 

Seventh,  read good books.

 

Eighth, suit your positions to your size so that you don't get in over your head.  

 

Ninth,  have some escape hatches and contingency plans.

 

Tenth, remember the importance of having a higher purpose or mission in life.

 

Eleventh,  find a good mentor but  never take a tip from anyone or a trade for the day, because you won't know if it fits in with your persona as it did with theirs, and you'll never know how strong their convictions are, and when they change them, and you'll be weak.

 

Twelvth,  Be optimistic. Nothing good has ever come to those who hope for the destruction of civilization or the market or who fight the upward drift which must continue up to follow the strands of human progress, which is still grand, even today especially if you consider all the individualism unleashed on the world in India and China.  

 

Thirteenth,  the best meal for a lifetime is to take a vitamin D3 supplement each day, and exercise.  Exercise is always helpful as it prolongs the life, and eases the tensions, and improves the digestive process, and makes you look better, thereby attracting better mates, and mentors, and is in keeping with the fundamental nature of humans, which involves play and sympathy.  

 

Family. The people that you can always count on are your extended family, and the more you use this to support you, the better you'll be. Conversely, be aware that most of your non-extended family, except for your very good friends, can never be trusted to support you when you need it the most and indeed are likely to disappoint you over the long run.

Friends. Friendship based on business is always better than business based on friendship.

 

Every part of the universe, for 15 billion years, changes all the time. The only way to be in FLOW in every way is to embrace that change. Meld with it in every way. This for me, is the key to choosing myself.

 

Victors Trading Points……….

One of the key points is: cycles change. another is: always test.  There is a danger in taking or discarding ideas for granted without turning on every stone first and testing on recent data.

 

What to use:

 Multivariate Statistics
 Connections between stocks, currencies, grains and metals
 Opening patterns
  Anomalies" (systematic departures from randomness)
 Runs or sequences and reversals
 Contrarian play of "public trades"


 What not to use:

 Pairs trading (stocks)
 Chaos Theory
 Nonlinear differential equations
 Stochastic Programming
 Fuzzy logic
 Neural networks
 Catastrophe theory
 Genetic algorithms
 Fourier analysis
 Nearest neighbor
 Clustering
 Machey-Glass equations
 Calculus
 Rotation
 Cycles
 Fibonacci, Gann and T.A.
 Spurious correlations
 Behavioral finance

 

The best way to achieve victory is to master all the rules of disaster, and then concentrate on avoiding them.” 

 

Determination

Father/Son relationship

Family

Profit

Math

Capitalism

Free Thinking

Humbleness

Risk

Loss

Change

Objectiveness

Speculation (Art and Science)

Statistics

Music

Trees

Gambling

Individualism

Education

Willingness

Hubris brings down the best Advisors, the best Managers and the best firms too. With Advisors, sometimes I see some of the best forget the customer service that helped get them to the peak. They no longer call back their client's quickly enough, or they think, after a few winners, that they are smarter than the markets. Hubris retards their growth, because referrals go from a flood to a trickle. They become average without ever realizing why.

The best Branch Managers forget the service orientation that made them stars and focus exclusively on the next big ticket recruit. They make sure that they are managing “up” to their bosses instead of “down” to the people relying on them. Their offices become revolving doors with the best leaving and the good ones coming in wondering what happened to the responsive guy they bought into during the recruiting process.

Worst of all, hubris brings entire companies down. Advisors become numbers instead of names. Firms advertise how their “platform” is superior to their competitors while forgetting that their platform is only as good as the Advisors who are using it to provide solutions to their clients. Advisors want to feel connected to senior management who understand their problems, who have lived what they lived day to day, who provide solutions and not obstacles.

Hubris makes us all forget a basic truth: we all are entitled to nothing and that we must earn what we make each and every day. 

 

• February 25, 2010, 11:02 AM ET

Ten Things I Learned While Trading for Victor Niederhoffer

 

Victor Niederhoffer

I traded for Victor Niederhoffer for about a year starting in 2003. I was up slightly more than 100% for him, primarily trading futures using a quantitative approach. During that period I had one down month: June 2003.

Victor was a top trader for George Soros before starting his own fund in the ’90s and then writing the classic investment text “Education of a Speculator.” He then suffered one of several blowups in his career when his fund crashed to zero while on the wrong side of a couple of bets during the Asian currency crisis in 1997 (most notably, he was short S&P puts when the market crashed that year).

Despite that, Victor has consistently traded his own portfolio quite successfully and is one of the best traders I’ve seen in action.  He still posts his daily comments on trading and the markets at his site dailyspeculations.com.

Here are 10 things I learned during my time trading for Victor:

1.) Test, test, test. Test everything you can. If someone says to me, “There’s inflation coming so you better short stocks,” I know right away the person doesn’t test and will lose money. Data is available for almost anything you can imagine. (In my talks, I always discuss the “blizzard system” based on data of what the stock market does depending on how many inches of snow have fallen in Central Park that day).  Victor and his crew would spend all day testing ideas: What historically happens to the market on a Fed day? What happens on options expiration day if the two prior days were negative? Do stocks that start with the letter “x” outperform? Nothing was beyond testing.

2.) Optimism. There’s plenty of reasons every day to assume the world is going to end. The media is constantly speculating about imminent financial collapse, hyperinflation, peak oil, pandemics, terrorism, etc. One of Victor’s favorite books, which I highly recommend, is “Triumph of the Optimists,” which shows the success of the U.S. markets over the past century over other markets and asset classes. Yes, the markets take a hit. But invariably buying dips (and being careful not to get wiped out) will be a long-term strategy for success.

3.) Fearlessness. I had a big March 2003 trading for Victor. The market was threatening to go to new lows at the advent of the Iraqi war. I went long and strong and had a great month. Then, for the rest of the year, for fear of destroying a great track record, I would go up a few percentage points at the beginning of each month and then coast for the rest of the month, probably leaving another 100% or so on the table as I passed on trading many high probability situations. I always suspected Victor was very disappointed in me for that. When you have a high probability situation, trade it and trade it big.

4.) Everything Is Connected. Whether you are studying baseball, checkers, trees, wars – all contain patterns similar to the patterns we see every day in trading. Sometimes the best way to get perspective on your trading is to study something seemingly unrelated and to then consider the analogies.

5.) Ayn Rand. There’s a lot of retrospectives right now about Rand, one of Victor’s favorite authors. I don’t care much for the so-called Objectivism or Rand’s views on capitalism, but what struck me about her books was the emphasis on competence. Her novels are about competence and the personal gratification one gets by being good at what you do, whether it’s building railroads, designing a building, trading or cleaning a house.

6.) Warren Buffett. Victor is not a fan of Warren Buffett. This forced me to look at Buffett in a whole new way. Is Buffett a value investor? What other tricks of the trade has Buffett used over the years? I ended up reading every biography of Buffett, going through four decades of SEC filings, and pouring over not only his Berkshire letters but his prior letters from his hedge fund days (1957-1969). The result was my book, “Trade Like Warren Buffett.”

7.) The First Day of the Month. It’s probably the most important trading day of the month, as inflows come in from 401(k) plans, 1RAs, etc. and mutual fund have to go out there and put this new money into stocks. Over the past 16 years, buying the close on SPY (the S&P 500 ETF) on the last day of the month and selling one day later would result in a successful trade 63% of the time with an average return of 0.37% (as opposed to 0.03% and a 50%-50% success rate if you buy any random day during this period). Various conditions take place that improve this result significantly. For instance, one time I was visiting Victor’s office on the first day of a month and one of his traders showed me a system and said, “If you show this to anyone we will have to kill you.” Basically, the system was: If the last half of the last day of the month was negative and the first half of the first day of the month was negative, buy at 11 a.m. and hold for the rest of the day. “This is an ATM machine” the trader told me. I leave it to the reader to test this system.

8.) Always Protect the Downside. This is learned by negative example. As Nassim Taleb has pointed out ad nauseum, Black Swans occur. (See the Malcolm Gladwell article on Taleb to see Taleb’s thoughts on Victor.) No matter how much you test, there will be a “this time is different” moment that will force your bank account into oblivion. I trade a strategy based on selling puts and calls at levels where my software thinks its statistically unlikely the market hits those levels before the next options expirations day. But I also use some of the premium I earned from selling those puts and calls to buy slightly further out puts and calls as insurance the market doesn’t run away from me. No matter how confident the software is, always protect.

9.) Keep Life Interesting. Victor surrounds himself by games and the people who enjoy them. When I knew him, he took regular checkers lessons, played tennis every day, and has some of the oddest collections I’ve ever seen. He stands out on a crowded city street and seems to spend part of each day seeking out new and interesting experiences. He often asked me what I’d been reading and if it was trading related he was disappointed. Trading is ultimately a window into the psyche of the world at that moment. Uncovering the nuances of that psyche is ultimately more important than doing the latest test on what happens after a Fed announcement (but, on that point, tests have shown that whatever the market is doing before a 2:15p.m. Fed announcement on Fed days, chances are it will reverse after 2:15).

10.) Be Open to New Ideas. In 2002, I was still reeling from the dot-com collapse. I had sold a company near the height of the insanity in 1998 and also started a VC fund that opened up doors in March, 2000, the absolute peak of the market. I was trying to figure out new things to do. I came up with a list of about 30 people I looked up to and came up with 10 ideas for each person about how they could improve their business. To Victor, I sent a series of trading ideas that I had both backtested and had traded successfully. To Jim Cramer, I sent a list of 10 ideas for articles he should write. Of the 30 people, they were the only two who responded and ultimately I ended up managing a little bit of money for Victor and writing for Jim Cramer’s site, thestreet.com. I’m grateful for the opportunities that both people created for me.

James Altucher is a managing partner of Formula Capital, an alternative asset management firm, and an author on investment strategies

 

One does not think of the Mediterranean Sea as being a place for rogue waves---Hobart, Alaska, North Sea, yes; the Med no.  But that is the nature of perception.

 

"The ship's owner and operator, Louis Cruise Lines, said the vessel was struck Wednesday by three "abnormally high" waves more than 33 feet (10 meters) high that broke glass windshields in the forward section. Two people died and 14 were slightly hurt, the company said.

Large waves are not rare in the Mediterranean, but ones that size occur only once or twice a year, said Marta de Alfonso, an oceanographer with the Spanish government."

 

Victor is a legendary speculator, market philosopher, gamesman, and racquet sport champion. He worked directly with George Soros and was ranked the number one hedge fund manager in the world for several years then disaster struck. In 1997, an overly expansive speculation in the Thai stock market caused spectacular losses in his accounts. Due to extensive leverage, his losses were magnified over and above his 50% loss in Thailand, and spillover effects from that debacle caused his fund to be well over its head in U.S. equities when they closed down limit on Oct. 27,1997.

In short, a combined sequence of events � huge declines in individual Thai stocks,losses in the Thai currency and the closing of the U.S. stock market and extensive up moves in the prices of options the fund was short; all came together in one day, in a short and disastrous coincidence. The loss, over and above profits made and withdrawals from the fund, totaled approximately $50 million. In addition to the losses in the funds, Victor had invested heavily in his own trading. To cover his debts and living expenses, after much soul-searching, he took out a mortgage on his house at an interest rate of 18% a year and sold his liquid assets, including his entire silver collection and his holdings in private and publicly held companies. He started again from the bottom. He scraped together a small trading stake and started plying his trade, slowly building back what was lost, determined never ever to allow the same mistake to happen twice. In a true example of the human spirit and his will to be a champion again, he is back in the game at a top level.

Since inception in February 2002, Vic�s current fund, �Matador, � had a three-year annualized return of 31%, placing it among the top five offshore funds. In 2004, Matador had a 50% return, the best of all offshore funds with more than $45 million in assets, according to the TASS rankings. Here�s a gentlemen who came from materially meager beginnings, rose to the top academically, athletically, and financially---lost it all, and is now back on top. He is truly someone we can all learn valuable market and life lessons from, since he has been and suceeded on the front lines in all capacities and levels .

Most investors and traders don�t realize the extent of the subterfuge, con games and outright deceit that occur daily in the financial markets. Victor and Laurel have extensively studied, researched and tested the commonly held beliefs of market participants. As described in their recent book �Practical Speculation�, they have discovered that many of these beliefs simply do not stand up to rigorous testing and are merely delusions that result in losses. In this interview, we will examine the biggest market con games and how you can profit from these popular delusions.

Dave: Welcome, Victor and Laurel, to Real World Trading.

Victor: Thank you for having us.

Dave: Let�s start off by talking about what first perked your interest in �stock market cons�.

Victor: Laurel and I have been working together on the philosophy of markets over the last 8 years. The ideas I will present are our joint work and some of them are touched on in our book, �Practical Speculation�. Laurel, would you please enlighten Dave as to the genesis of our research into the �Invasion of the Body Snatchers� concept.

Dave: Invasion of the body snatchers!? Isn�t that a sci-fi movie from the 1950�s?

Laurel : Yes, It�s a Jack Finney film from 1954. We believe it�s the perfect allegory for an introduction to the big market con. The film is about invaders from outer space that take over people�s bodies, making them hopeless and listless, ready to accept whatever propaganda they hear. It�s a perfect analogy of how investors are misled by market cons

Dave: I see. You believe that the public has been duped by the market�s propaganda machine, so to speak?

Victor: Part of the backdrop to our research was the concern about financial reporting and the corruption of corporate executives, as well as the normal issues with the economy like interest rates and international affairs. But there is always something wrong with the backdrop of the market, the economy and individual companies. The problem is, the public is generally mistaken in its enthusiasm for determining whether factors are bullish or bearish

Dave: Are you saying that it�s impossible to tell how the market will interpret various factors as positive or negative?

Victor: Yes. Retrospectively, after the market has gone down, it�s generally assumed that we are in a bear market and conditions are terrible. This causes the public to lose hope and refuse to take on risk.

Dave: Do bear markets even exist?

Victor: Bear markets only exist in retrospect. This is one of the greatest fallacies in the market. One of the main philosophical points in our book is that it�s guaranteed to happen.

Dave: What�s guaranteed to happen?

Victor: The public must always believe absolutely, with the strongest conviction, the idea that will make them contribute the most to the market and one of the things the public has to do is sell low and buy high.

Dave: That makes sense. It�s how the market feeds and supports itself .

Victor: I wrote about this extensively in my first book, �Education of a Speculator�. The dead weight costs of the market are tremendous. In terms of ecology, there�s a huge loss of energy in the market. This loss of energy, in market terms, is commissions, communication costs, salaries, fancy offices, etc.. These things need to be paid for the market to continue. The public pays these costs, the same way the sun provides the energy for the earth .

Dave: The public needing to buy the tops and sell the bottoms plays right into your aversion to the �trend following� concept of trading. You actually have it listed as number 3 in your 10 big cons of the market. Why?

Victor: I have an aversion to all fixed systems and purportedly easy ways of making money in the market because the market learns and adapts to allow flexible, sagacious and strong decision makers to profit at the expense of the weak .

Dave: OK, why �trend following� in particular?

Victor: The public needs to be tricked or deceived out of their basic role of buy and hold. If they follow the buy and hold mantra, they are going to achieve the Dimsonesque [editors note: Elroy Dimson, Paul Marsh and Mike Staunton co-authored �Triumph of the Optimists, � a 2002 book that documented for the first time the 100-year returns of the world�s stock markets] returns of 10, 000 fold per century. I am particularly averse to trend following methods because of the following reasons: 1. They are often untested. 2. If tested, their variability is too high to rule out randomness, and 3.If tested relative to uncertainty, they assume past seemingly non-random movements of prices are predictive of what�s going to happen in the future.

Dave: Is this strictly for the stock market or all financial markets?

Victor: When trend following methods are tested on the stock market indexes, they tend to show that the correlation of past returns and future returns is negative, and that the number of runs of price changes in the same direction is less than would be expected by chance. I have never seen an example of a real life movement in prices that would allow trend following to work retrospectively that does not also show positive serial correlations and an observed number of runs in the same direction that is greater than would have been expected by chance.

Dave: Are you able to support this view with actual numbers?

Victor: In my book �Education of a Speculator�, I report that the correlation between weekly stock price changes in the S&P futures during the 1990�s is approximately -0. 08. The correlation between daily changes is approximately -0.04 over almost all relevant periods. The chances of a rise following a series of 2, 3, 4 or more consecutive declines, in stocks, is approximately 10% higher than normal. Therefore, trend followers in the stock market averages would appear to be playing in a game heavily stacked against them.

Dave: What about the other markets? Do the same studies hold true?

Victor: No. I hasten to add that such tests would not show similar biases against trend following in other markets such as fixed income, or foreign exchange.

Dave: Then what is your objection to trend following in these markets?

Victor: In general it�s the philosophical objection that the followers of long term trends don�t take into account one of the fundamental rules of economics, which is that incentives matter.

Dave: Please explain what you mean.

Victor: The supply curve moves outward and to the right when prices rise, and inward to the left when prices decline. Moreover, trend following does not take into account the fundamental tendency of the market to abhor upsetting the apple cart by moving prices to permanent new level, thereby creating threats to its tried and true tendency to make the public lose more than they have any right to by constantly buying too high and selling too low. If the public were all trend followers, and the vast majority of them are, then prices would be constantly moving to permanently higher or lower levels, and this would be bad for the well-heeled upholders of the market infrastructure who must survive for markets to continue.

Dave: This all seems to make sense in theory. However, how do you explain the fantastic track records of the major trend followers reported in books on the subject or the economic argument that speculators on big moves are paid an economic return by hedgers and equilabrators?

Victor: Well, I would look as a criterion at the total profits that all trend followers have made over time for their public clients rather than the personal profits they have made for themselves. I would also compare the past high returns that the publicly cited great exponents have made to the total dollar amount that their clients have made or lost. In addition, I would look at the actual total dollar returns to the public of those who invested in some of the greatest trend following funds who admittedly have had much inferior results, lawsuits, and tragedies in their publicly reported and audited results versus the legendary stories of great past performance. Another thing I would like to point out is the publicly reported results of the famous trend followers in the last two years, when money at their disposal is at the maximum. I dare say that billions upon billions have been lost as a review of the rankings of CTA�s would show. But, of course, that�s guaranteed to happen. Looking at the April TASS Flash report, I�d estimate the average trend fund is down 20-40% over the last 2 years, and some are really getting killed. Please bear in mind that the big CTA�s typically offer 8 or 10 different �programs�, so that they can quietly close down the worst performers, or just stop reporting their result.

Dave: Wow, that�s some indictment of trend following. Is there anything else on this subject?

Victor: Of course, I am just getting started! I normally don�t like to talk about this subject since it foments much hatred against me. Many of the proponents of trend following are attempting to market systems, seminars and funds based upon the concept and I stand as a reasoned voice against their profits and thus must be discredited for their own survival. With that said, my major objection to trend following is that it doesn�t take into account one of the most important regularity of the markets, aside from the laws of incentive, and the immense degree of deception and big cons---i.e. the principle of ever-changing cycles . The public is always behind the form. I would even go so far to compare the concept of trend following to a cult like scientology. It�s impossible to have a rational discussion with some of its proponents since so many people have vested interest in perpetuating the myth.

Dave: We are on a roll on this subject, let me see if I can dig a little deeper into your thoughts on the concept of market trends. Do you believe that trends don�t exist at all or simply that an existing trend is not tradable?

Victor: Any trend that exists can be quantified and its departure from randomness can be measured with the usual statistical procedures, such as confidence intervals and likelihoods. Serial correlation coefficients, regression coefficients of current changes versus past changes, and magnitudes of the impact of past moving averages on the future, distributions of the length of runs, the correllelogram, the expected waiting times between peaks and valleys, survival statistics. All these techniques are very good at discovering any non-random elements.

To join a proper debate, such measures must be quantified for various markets and various times, and the degree of uncertainty and departure from randomness must be ascertained. I have never found a movement in prices that anyone could make money with by a trend following method that didn�t also show a major departure from randomness revealed by the standard statistical measures I mentioned. The tragedy is the mysticism and blind acceptance of trendism, that trend following exponents proclaim, without any evidence as to magnitude and uncertainty. No self-reported results that selected individuals or leaders might have made in the past shed light on the debate.

Dave: Your well known saying, �If it can be tested, it must be tested� comes into play here . Exactly what testing have you done to prove the above idea?

Victor: These tests can readily be performed My group of colleagues performs these tests maybe 2-3 thousand times a year over different markets and time frames. Those of a cognitive bent and those with their feet on the ground are always open to the existence of trends, but they test them with the best statistical methods existing. If you apply these tests to stock market moves, you will find that all such tests show negative serial correlation. In fact, they indicate a tendency for reversal.

Dave: What about the upward bias in stock prices? Why can�t that be interpreted as a trend?

Victor: Well, all proper statistical tests take into account this upward drift. They would look for serial correlations over and above the basic drift of the market. One of the other market cons is the permanent bearishness of some of market pundits, and I am the last person to say that this upward drift, evidenced over the last 200 years, does not exist. This in no way refutes, but it does refine the statistical tests required for the stock market. However, I hasten to add that no such upward drift exists in any other market.

Dave: Very insightful, Victor. Your last sentence opens up the next big market con�commodities are better for the long term than stocks. Can you elaborate on this topic?

Victor: This con is very closely related to the trend following big con. There is no upward drift in commodities.

Dave: That idea really flies in the face of the recent increased interest in commodities as promoted by a certain world traveling commodity fund manager.

Victor: Yes, I believe you interviewed him recently. This type of renewed public interest seems to be indicating a top soon. The fact that money was made in the past buying commodities in no way indicates that this will continue. The Niederhoffer/Kenner camp believes in the principle of ever changing cycles. It�s one of our hallmarks.

Dave: Wait a second, Victor. Ever changing cycles? That sounds like a contradiction to me. If a cycle is ever changing, it�s no longer a cycle. What am I missing?

Victor: That�s an excellent question, Dave. The idea of ever changing cycles comes from a racetrack bettor whose insights and value to the public are far superior to even the greatest stock market experts. His name was Robert Bacon, and he wrote a book called �Secrets of Professional Turf Betting�.

Laurel : Bacon also called the concept the principle of ever-changing trend. His great insight was that even if the public ever managed to overcome the crazy urge to gamble and got wise to a winning idea, the principle of ever-changing trends would quickly and drastically change the results. As he wrote, �The would-be professional player must always understand that the form moves away from the public�s knowledge.�

Victor: Unfortunately, the book is out of print and has become very difficult to buy. We also recommend �Horse Trading� by Ben Green, and that is much easier to obtain.

Laurel : We�ve posted some excerpts from Bacon on our Web site, www . dailyspeculations .com. He explains ever-changing trends this way: Say an owner who had been sending his star racehorse out to do its best at odds of 3-to-1 cooled off as the prices sank below 5-to-2.He tells the jockey to win if he can win easily, but to pull back out of the money in the stretch if he sees that an easy winning was not possible. That way, the bad race will put the public off the horse for next time.

Dave: Horse racing and trading, Victor, Laurel? Isn�t that stretching things a bit?

Victor: Not at all, the concepts are very similar. There are two things that happen�the payoff goes down if the horse wins, and the payoff reduction is such that even if the horse were to win with the same probability the system becomes unprofitable. The horse racing business is very similar to the stock market in this way. Strangely enough, most of the major horse racing systems of the 1930�s have the same philosophical underpinnings as trend following systems . They basically say take the horse that�s winning the most, bet on him, and stay away from the horse that�s losing the most . The horse racing people actually have a much higher standard of analysis than the proponents of the current stock market systems. The horse bettors always demand workouts, unlike many practitioners of the trend following systems .

Dave: Let me see if I understand how the horse betting systems relates to trend following . Everyone bets on the horse that is in a winning trend, thereby reducing the payoff should that horse win again?

Victor: Correct, but, Bacon says that would be true if the percentage of wins were the same and here�s his fantastic insight: the percentage of wins does not stay the same, it goes down because the owners like to bet on their own horses. Therefore, if the odds are 2 to 1 for a win, they don�t bet as much or push the horse as much as they would when the odds are 10 to one . The chances of winning is actually greater the fewer wins a horse has.

Dave: I see how that would relate to trend following systems.

Victor: Those systems are designed to create the same situation on paper. These systems look good in the past, and they look good with small amounts of money�10, 20, 50 million dollars -- thereby luring the public to put billions and billions into it. Then they fail. There are people who must exist for the markets to survive; these are the easy money people. It�s the big players who see the exponents of easy money coming. The people who are flexible, analytical and scientific�like those who read our books and those who read your interviews trying to find the insights -- are the ones who survive and thrive in the market.

Dave: Thanks for the compliment to my readers! So, you are saying that flexibility is the key to success in the market?

Victor: That�s one key. One needs to have strength, flexibility and a foundation. People should know this intuitively. Most people understand this via playing cards or any sport for that matter. It is a fact that deception is rampant and flexibility wins the game. Those people who play the same game and are predictable are easy prey. This is another reason why even in those markets that test well for trend following, we have an aversion to accept it as a given. This all relates back to the fact that the anecdotal method does not prove anything. This �My dad can beat up your dad� nonsense is a real waste of time. Many CTA�s and hedge fund managers become very wealthy, but this does not prove that they have made money for the public. It means they make a lot on fees.

Dave: Let�s move on to the next big con, the fund of funds. It seems to make sense to me that diversifying a fund into multiple funds would be a good thing. Why is this concept a con?

Victor: I like to say that all funds of funds will converge to a Sharpe ratio of minus 1000.

Dave: What?!

Victor: Well, that is just a figure of speech. Actually, the issue is the fees. They pay fees on about 10 different levels, but that is not the worst of it. Currently, most of these funds tend to be equally weighted on the long and short side. Therefore, since the market is pretty much a random walk with a positive drift of 10% or so a year, they end up with a zero percent return . They make 10% on their longs, lose 10% on their shorts, and often pay multiple fees. It�s a losing proposition for everyone but the manager.

Dave: Moving onto another one of your favorite big market cons, technical analysis. Many traders trade exclusively with TA. Why do you consider it a con?

Victor: Everything is part of the basic philosophical backdrop that we discussed earlier. TA tends to unleash people from the fundamental foundation that they need to be successful.

Dave: It gives most traders false hope? Is that what you are saying?

Victor: That is part of it. It also gets traders to trade too quickly. It makes people fearful and elated, causing too much turnover -- and turn over is very expensive in this game.

Dave: Do you see any value at all to technical analysis?

Victor: Many of my best friends are technical analysts and I am actually a technical analyst myself. However, the kind of technical analysis I perform is scientific. I put forth hypothesis, I test them, I consider the uncertainty, I quantify them, I try to put them in an economic framework . When done in this manner, TA has value. What I don�t believe in is the idea that the visual intuiting of price charts can give much insight into the subsequent distribution of prices. This is the way most people view TA and why TA cons most traders. I do believe that the interplay of markets, and price distributions, are of a highly predictive nature.

Dave: These predictive distributions and market interplay is how you make decisions in the market?

Victor: It�s what I am most renowned for. A large part of the managed account industry in one way or another started out with this basic idea that I pioneered. Monroe Trout, Roy Niederhoffer and Toby Crabel, among many others started at my firm. A number of managers with over a billion dollars under management started with me. This makes it much harder for me since many of my former top people are using and augmenting my methods elsewhere, and of course my ideas become subject to the principle of ever-changing trends.

Dave: Correct me if I am wrong, Victor. But I think your studies have shown some value in the VIX indicator. Is this accurate?

Victor: That�s an example of a fixed system, a shooting star. In general, a good rule of thumb is when the market is looking terrible that�s a very good time to buy and when it�s looking great it�s a good time to reduce your exposure. Not to short it -- I don�t ever believe in selling the stock market short. The VIX is very highly correlated with the recent market move, so it�s very hard to separate the VIX from the current market move. A very good predictor of future VIX is the current VIX.

Dave: Explain what you mean by this, please.

Victor: If the VIX is 14% now the best predictor of where it will be in a year is 14%. There is nothing �too high� or �too low� about it. There are just as many factors that will pull it down as will pull it up. There are many statistical measures to forecast volatility. The book by F.X. Diebold, �The Elements of Forecasting, � is excellent in this regard. Changes in VIX have a much better forecasting ability than the levels themselves.

Dave: You mean the rate of change?

Victor: Yes, if VIX changes in a one-month period by several percentage points, this is the kind of indicator, in conjunction with the market move, that is a proper area for testing .

Dave: Moving back into market cons. One of the heroes of investors is an individual named Benjamin Graham . His �Security Analysis� book is the bible to value investors and required reading in many business programs. What was his actual performance in the market?

Victor: Abysmal! His performance in romance was much superior to his performance in the market. The Rea-Graham fund applied Ben�s ideas over a 15-year period, and it was one of the worst-performing mutual funds of all time. He actually got out of the market when the Dow was 500, believing there was no way it could go very much higher. However, that�s anecdotal evidence. He could have very good insights even if his performance as an investor was poor. The fact is, his book is very shoddy, not scientific. I consider his basic idea of value investing one of the worst big cons.

Dave: Value investing is a con!? Why?

Victor: In general you get paid for taking risk in the market. The basic idea of value investing is to invest in companies that can�t lose money. If you can�t lose money there�s no profit, there�s no return, since there is an unchanging demand structure.The rate of return quickly goes down to the risk-free rate.

Dave: Isn�t the Sage of Omaha the best known value investor?

Victor: Yes, he used to invest in things like farm equipment, candy stores, shoe manufacturing, textile plants with tax losses. These are the kinds of companies where the rate of return is usually less than the risk-free rate. Practically speaking, I happen to know something about valuing companies. I ran the largest merger business involved with selling private companies to public companies. I visited thousands of companies. My people sold over 1500 companies. One can never sell one of these value companies above its liquidating value. If you could there would be tremendous competition to drive it down. That�s the economic argument. The real-world argument is that the kind of companies the Sage boasts about buying in 5 minutes are simply not the stocks you want to buy.

Dave: OK, growth is where the average investor should be, and avoid value stocks?

Victor: Yes. The one study that I consider superior to all others is the Value Line study. They set out to prove that value is where to be, but the study proved that growth has beat value by about 20 to 1. It�s a real-life study unlike many others .

Dave: Wow, that sure is impressive. Is this why you don�t buy stocks with a low P/E?

Victor: Yes. Low P/E stocks tend to be the �value� stocks that have a rate of return close to the risk-free rate. The average IPO is priced by the underwriters to yield 50-60% per year. This is in normal times. When people are so risk-averse, as they have been for the last few years, the underwriters discount the yield to make the IPO more appealing.

Dave: Laurel, I would like to direct this next question to you. In �Practical Speculation� you talk about an indicator that I find fascinating, it seems counter-intuitive like many of the things you and Victor have discovered�you call it the stadium indicator. Tell me a little about what happens to a company after they sign a stadium naming deal?

Laurel : This question needs to put into the general framework of culture. The consequences of the hubris, excess and expansive behavior Hubris was a favorite theme of the ancient Greek historians and storytellers, who used it to show the fate in store for the arrogant and the boastful. The stories are still highly relevant today. The stadium indicator was a number of hubris indicators we invented and tested for �Practical Speculation". We looked at CEOs who said �We�re No . 1, � and at companies that announced they would be building the world�s highest skyscraper as headquarters, and at companies who named stadiums after themselves.

There were plenty of anecdotes that saw their stock prices plunge after they named stadiums after themselves. Enron's pre-bankruptcy $100 million stadium deal comes to mind, and 3Com and CMGI saw their stock prices fall from the clouds. To find whether there was any general truth to the idea, we did a systematic study. We found that stocks performed significantly worse than the S&P 500 after acquiring stadium naming rights, both that year and the subsequent year.

Victor: What we have found is that the companies that tend to be most hubristic tend to be the ones that perform the worst.

Dave: Pride goeth before a fall.

Victor: Exactly. Related to this is our baseball indicator.

Laurel : This one goes back to what we were saying about expansiveness and excess in popular culture. We found that when home run hitting records are being broken right and left, a down market tends to follow. Think Babe Ruth in the 1920s. When the rules of the game change to favor pitchers over hitters, and teams start focusing more on defense -- hitting singles and stealing bases -- that seems to portend an up market.

Victor: These indicators are cultural examples of how excesses cause the public to be betting on the wrong type of horse at the wrong time.

Dave: I can see how all these factors you mentioned tie together. Now let�s get down to the nitty gritty. How do you trade?

Victor: I am happy you see the correlations. What we teach in our book is to try to understand the forces involved the market. Pay attention to rates on fixed income versus the rates of return on the stock market. Pay attention to buybacks as signals, cash earnings versus accrual accounting, negative serial correlations in stock market indexes. But of course our book was a worst-seller. They didn�t even have a copy of it in my local book store. We are happy there are a few eagles out there who gave us a good review . �Active Trader� magazine and the �Journal of Investment Management� are two.

Dave: We are almost out of time. Is there anything you would like to leave our readers with?

Victor: I try to teach a method of thinking. We are dedicated to try to deflate ballyhoo and create a proper framework for proper stock market decision-making.

Dave: Victor, Laurel �Thank you for joining me today. I truly appreciate your time .

Victor: It was our pleasure. Thank you

 

The more secrets you have, the sicker you are. This applies to all aspects of personal and business life. The more secrets you keep about who you really are, what you are doing with your money (the last great taboo of our culture), the sicker you are.

This is nowhere more true than in trading. If you do not get right with yourself and those who believe you and believe in you, you are in sickness and stinking thinking. The most important way to begin falling apart without going to pieces is to tell the truth. If you are hiding your losses from a loved one, step up and tell that person. Don't pretend you are a winner when you are losing. Don't allow your pride to get in the way because pride (especially if built on a false and crumbling foundation) leads to misery, falling apart and, for some, going to pieces.

What happens when you go to pieces? Addictions, acting out behavior, depression, continued lying to self and others, and all manner of mental, physical and spiritual DIS-ease. It is only through telling the truth and being radically honest and taking personal responsibility that you find true freedom. This is exactly what happens every day in life and in the markets. There is so much hype, deception, misinformation and disinformation. You search desperately because you want to find the truth. But most of it is not the truth. The truth is often intolerable to bear. Denial, rationalization and the search for confirmation of your biases are much easier. No one wants to fail, but failure is a part of life. Failure is a part of trading and investing. Losing in the markets and life is often the beginning of winning. It's OK to fall apart without falling to pieces. It's necessary to get stopped out, to preserve capital, to embrace risk and take total personal responsibility for your thoughts and actions. Winners fall apart, but they quickly regroup. They don't crumble and hide in the corner or lie to others about how great they are.

It's freeing to admit that we are human beings, that we are fallible and we make mistakes. It's OK to make mistakes. It's not OK to lie about them and pretend they don't exist. In time, the truth will be revealed but at this moment, hundreds of suffering people have lost trust. Trust is a commodity in very short supply today, yet it is the bedrock of any relationship. People will not trust you if you lie to them. You will never learn to trust yourself if you continue to lie to yourself. It's a vicious cycle of denial and obfuscation that leads to self-destructive behavior and further self-sabotage.

There are many lessons for trading and living in this story. Here are a few ways to keep from going to pieces when it all falls apart:

Always tell the truth to yourself and those you love and who love you.

Trust, but validate and verify everything.

Don't trust anyone but yourself when it comes to your money.

If something seems too good to be true, it probably is.

Don't assume anyone has your back. Take full and total responsibility for your actions and don't sit around waiting for someone to bring you flowers or make money for you

Just because something has worked in the past, don't assume it will keep working. Linear thinking is complacent thinking and leads to a false sense of security and comfort.

Don't get greedy. Remember, bulls and bears make money-pigs get slaughtered.

Don't put all your eggs in one basket. Diversify whenever possible.

Everything you thought and dreamed for your future can be gone in the blink of an eye.

Hope is not a viable strategy for trading or investing in anything.

Stay really strong in body, mind and spirit because you never know when the tsunami is going to hit.

Prepare for the worst and expect the best. Have a backup plan. Have three backup plans.

When it all falls apart, you can and will survive if you don't fall to pieces.

If you once forfeit the confidence of your fellow citizens, you can never regain their respect and esteem. It is true that you may fool all of the people some of the time; you can even fool some of the people all of the time; but you can't fool all of the people all of the time–Abraham Lincoln

• Posted Monday, June 21, 2010 11:09 AM | By Kathryn Schulz

"When you first contacted me about an interview on errors, I made the error of excessive self-esteem. I thought for a second that you thought I was a sagacious personage who had led a not uneventful life that might have something useful to say to your readers. But then when you mentioned [Alan] Dershowitz, it came to me in a flash."

Thus began one of 26 e-mails (not counting those dedicated to the logistics of our interview) that I received from Victor Niederhoffer after inviting him to participate in this series. Niederhoffer is a hedge fund manager, a former partner of George Soros, a five-time U.S. Nationals squash champion, and the best-selling author of The Education of a Speculator and Practical Speculation. Those successes notwithstanding, Niederhoffer is best known for two spectacular financial blow-ups. In 1997, a risky investment in Thai bank stocks combined with a dramatic one-day drop in the Dow Jones to permanently close the doors of Niederhoffer Investments. Ten years later, having recouped his losses, Niederhoffer saw his Matador Fund, buffeted by the 2007 credit crunch, self-destruct.

Niederhoffer's e-mails suggested a man already obsessed with wrongness. In them, he referenced the statistical concept of path dependence; shared a series of proverbs about the game of checkers (of 5,000 such proverbs, he hazarded, about 250 concerned error); meditated on the difference between Type One mistakes (excessive credulity) and Type Two mistakes (excessive skepticism) (he himself is much more prone to Type One, he says: "I'm tremendously gullible"); observed that "one should be careful of multitasking or multiromancing"; sent me the citations for hoodoo in the Oxford English Dictionary (a hoodoo is something or someone that brings bad luck); and noted that the harpooner in Moby Dick would have made a great interview subject for this series. Finally, he pointed out that the word error has no antonym. "In retrospect," he wrote, "I know much too much about errors and much too little about the opposite, whatever it is."

***

I've enjoyed getting your e-mails. It sounds like you've thought a lot about being wrong.

Well, the reason you contacted me, to call a spade a spade, is that I'm sort of infamous for having made a big, notorious, terrible error not once but twice in my market career.

Let's talk about those errors. The first was your investment in the Thai baht, which pretty much wiped you out when the Thai stock market crashed in 1997.

I made so many errors there it's pathetic. I made one of my favorite errors: "The mouse with one hole is quickly cornered." That is key. There are certain decisions you make in life that are irreversible, that lead you into a path you can't get out of, and unless you have more than one escape clause, the adversary can gang up on you and destroy you. What else? I didn't have a proper foundation. I was not sufficiently private in my activities. I was playing poker with men named Doc. I must've made a hundred errors on that one, but those are five or six that come to mind.

And then there's the greatest error of all, which is that I had delusions of grandeur. Unfortunately I was so successful for so many years in that particular field that I began to believe in my own success. I thought that because my method worked in markets that I knew about and had quantified, I could apply the same methods to something I didn't know about. And I had as an example [George] Soros, who would always say, "I made the most money in things I don't know about."

Did you have a sense that the crisis was coming—a period of dread before the shoe dropped—or did it hit you out of nowhere?

You know sometimes people describe a situation where they see the grim reaper behind them, reaching out with his scythe? I was ice skating the weekend before this horrible crash and all of sudden I started shivering, knowing that if all the forces were aligned against me for one more day, it could lead to an avalanche. I wasn't in that terrible of shape in the previous weeks and days, but I knew I was vulnerable. I knew that if my enemy came in with one terrible final swoop, he could cause me disaster.

Who do you see as your enemy in this situation?

The brokers who had the opposite side of the trades and the people on the floor who had the opposite side of my position in the related markets. They all knew that if I was hurting in one market, I'd have to liquidate in the other markets. Whenever someone's in trouble, it circulates around Wall Street; you'd be amazed how just one small fish is enough to stop the wheels of commerce for long enough to relieve that person of his funds. And then the market goes back to doing exactly what it was going to do beforehand. I still think that the crash of Oct. 27, 1997, was basically due to brokers running my position against me, knowing that I was on the ropes. The market had its greatest drop in the previous 10 years that day. And then the next day, once they were able to force me out, it went up more than it dropped.

I've heard that Soros, among others, cautioned you against the Thai investment. Why didn't you listen to the naysayers?

Well, Soros would be the first to tell you that his predictions are completely random. He never says anything that doesn't jibe with his current position or his hoped-for outcome. And he's chronically bearish. He's chronically thinking that the world needs a central planner to put it to rights and that the market itself is too prone to disaster.

I think a much better view is that the stock market never rises unless there's a wall of fear it has to climb. When the public is most frightened, only the strong are left, and that's when the market is in the best possible hands. I call it taking out the canes. Whenever disaster strikes, the very sagacious wealthy people take their canes, and they hobble down from their stately mansions on Fifth Avenue, and they buy stocks to the extent of their bank balances, and then a week or two later, the market rises, they deposit the overplus in their accounts, invest it in blue-chip real estate, and retire back to their stately mansions. That's probably the best way of making money, to be a specialist in panics. Whenever there's panic hanging in the air, that's a great time to invest.

But I assume that's what you were thinking when you ignored the risk in Thailand, and that didn't work out so well.

There's no magic bullet that will make you money all the time, but what I said can be quantified and has been quantified and certainly works for the U.S. market. My basic methodology, which I developed 30 or 40 years ago and which has been widely copied and stolen and which about the half the industry uses—i.e., that the interrelations between markets are predictive and can be quantified—I happen to believe that this methodology is quite valid and I still use it today. And every now and then I can keep my head above water.

How did it feel to be so wrong in such a high-stakes situation?

It was my first real taste of total disaster. I had pretty much lived a charmed life until that time. I had won some awards as the best-performing fund the previous year, and I had never had a customer lose money with me. I had an unprecedented, too-good-to-be-true kind of record.

When it happened, I went through all the stages of grief: anger, denial, sadness, everything. My sister happens to be a practicing psychiatrist, and she said that of the 11 symptoms of suicide, I had 10 of them. I was destroyed. I had lost money for my customers and that was very terrible. And I had lost my feeling of competence in my chosen field. And I had I lost all my own money, a lot of people were depending on me who would now have to fend for themselves, so it caused a great spillover of grief, too.

That suggests that your mistake affected your social relations, too.

Oh, absolutely. A lot of people were rightfully distressed and displeased, and my social position was definitely much reduced. I lost almost all my friends, and instead of being the head of the family, I became the subject of skepticism. And of course my customers were very upset with me—"How could I have been so stupid?" Fortunately, in most of my disasters, I'm the one who's been the biggest loser. I made what some people would consider the idiotic mistake of believing in my own ideas and putting all my money in the same funds I ran for my customers. So not only did I lose my business, but I lost my personal fortune also. I was once quite a wealthy man and I'm not quite so wealthy anymore, as is appropriate.

On the other hand, I have a number of people who have stood by me through thick and thin. But anyway, the main problem isn't other people. The main problem is when you yourself begin to doubt whether you have what it takes, whether your raison d'être is valid, whether you have a rightful place in the firmament.

Ten years after that first crisis, you were disastrously wrong again, when your Matador Fund folded after losing more than 75 percent of its worth. What happened? Did you make the same mistakes or new ones?

In both cases I was in over my head. I didn't have the capital to be strong enough to provide a backup in the case of unforeseen events. I didn't have a proper foundation. I was playing with adversaries who were stronger than me and who actually made the rules. My base of operations was not diversified enough, and I was vulnerable to forces I couldn't withstand. I was too vainglorious. In my opinion, those are recurring errors behind most disasters.

But also, most people have, in one way or another, a stop loss. If they go to Vegas with $10,000, they say I'm not going to spend more than $5,000. But they never say, "Hey, when I win a certain amount, that's when I'm going to quit." I'd had this incredible string of successes where I made 50, 100 percent, year after year. And in 2006 I'd won the award again as the best-performing fund—you can imagine how reluctant they were to give me the award a second time after my first disaster—but I didn't take account of this. I didn't have a stop-gain, if you will.

Is it reasonable to assume that you're going to make one of these massive mistakes a third time?

Well, fortunately I'm not in Thailand anymore, and I'm not in options anymore. And I'm at an age—especially with my seven kids and my 4-year-old son—where it would be extraordinarily reprehensible to have one more excursion into the River Styx. I'm much more prudent now. I'm more aware of my own liability to err. I've always been a humble person, but I wasn't humble enough. I'm not the great exemplar of unrivaled success that I used to be, and my wife always reminds me of my liability to err in case I'm not beating up on it enough myself.

What do you feel like you've learned?

It's crucial to have good models, to learn from people who are successful and productive and honorable and happy. I was fortunate, I've had some fantastic mentors. My father was my greatest and most continuing example. I always wish I could be as little prone to error as he was. He was the happiest man alive, and he never had to resort to duplicity because everything that came out of him was exactly from his inner self; there was no difference between the input and the output for him. But regrettably, duplicity is very, very important in life. The direct approach always creates tremendous obstruction and friction from the adversary, so often the indirect approach is necessary.

I agree that it's lovely to have good mentors, but can't successful, productive, honorable, happy people get things wrong sometimes as well?

Let's turn it on its head for a second with one of my favorite topics, the hoodoo. There are certain people you meet in life who are like the locomotives that always used to blow up—people who, wherever they go, disaster always ensues. One of my main pieces of advice is: Stay away from hoodoos. Sometimes hoodoos are very affectionate and they like to hug you, and I always burn my shirt right after being touched by a hoodoo.

How do you know a hoodoo when you see one?

First of all, a lot of them frequent areas that are rather ephemeral. Many waterfront communities are peopled with hoodoos. And they generally have a string of failures behind them, they generally are in need of capital, they generally talk a much better game than they play. And they often flatter you and pretend to be your very amiable friend before they really know you. Hoodoos are very good at what they do. A lot of times they command the center of attention and they try to dazzle you with the trappings of success—which when you look into it you find is a will o' the wisp.

Speaking of those who are around when disaster ensues, do you think the people at our major financial institutions are at all chastened by getting it so wrong?

I don't know what the financial institutions feel because they don't talk to me. I'm not in their firmament anymore. They can't get any business out of me, so they don't have any reason to devolve their inner feelings on me. But I know that it's very helpful to have a wealthy fairy godmother who can bail you out when you're in trouble, as certain banks and brokerage houses do. And I imagine that after being bailed out by their former—by their fairy godmother (we won't mention the word "cronies"), they feel that they've been given the breath of life again. And now they have to genuflect before the fairy godmother and be spanked in public and humiliated and their reputations are hopefully ruined, as they should be. But on the other hand, they don't have to face the actual disaster of financial ruination. They don't have to bite the bullet and pay for their own mistakes like me and 99.99 percent of other people who have had great failures.

I'm interested in something you said in one of your e-mails, that it was a mistake to play a flawless squash game.

As a squash player, I was gifted. I had all the right things going for me. I practiced. I was very good with the racket, and I had tremendous anticipation. But I tended to play an errorless game by hitting a slice on my backhand, which took a lot of power off the ball. That wasn't a disaster, but it was definitely a weakness in my game. My opponents always used to say that on a good day they could beat me, because they could hit more spectacular shots than me. But they never did. I went for about 10 years without losing a game, except to [the great Pakistani squash player] Sharif Kahn. He made about six, seven errors a game—but he also made eight or nine winners. I would make about zero errors per game but only one or two winners. He had the edge on me about 10-4, and I regret that I was never willing to accept the risky shots and confrontations, never willing to play a more error-full game.

It sounds like you wish you'd taken more risks as a squash player.

In my market career, I took too many risks. In my squash career, I didn't take enough.

I'm surprised. I would have expected risk to be an-across-the-board characteristic—that an aggressive, risk-taking investor would be an aggressive, risk-taking squash player.

I wish I had applied my squash methods to my speculating. I'd be a very wealthy man if I had.

One last thing from your e-mails: I love this checkers saying, "The popular player loses without an alibi." I think most people are pretty bad at that. It's like, "Well, if it hadn't been for X, I would've won."

I hope you don't feel like I've alibi-ed too much. But a person likes to have a certain amount of self-respect even after disasters. Still, it's terrible to be a bad loser. I like Soros's proverb that you should never marry a woman you wouldn't want to divorce.

Having been down there in the pit of terrible wrongness twice, do you have any advice for people who are struggling with their own catastrophic mistakes?

I think there are causes that led to their disaster and that rather than thinking about the actual minutiae of the downfall, and rather than creating alibis, they should think about the principles that led to their mistakes. And then I think they should let bygones be bygones. Once you've experienced disasters, there's no sense wallowing in misery. You gotta get back in the qualifying tournaments again.

Would you say that anything good came out of those difficult times for you?

Out of these great disasters came my 4-year-old son, who is the joy of my life. What happened was that I got a call one day from the head of Bloomberg, who wanted to give me a job as a writer. I explained that I really don't know how to write and that it's very hard for me, but I was so grateful to him that I said, "You know, you have the worst stock market column in history, it misses the key aspects, and you write it with a formula. I'd like to at least help you in return for your kind efforts to bail me out of trouble." Through that, I met one of their ace reporters, Laurel Kenner, and together we had a son. He's downstairs doing experiments with explosions right now.

If you could hear anyone else being interviewed about being wrong, who would it be?

I'd like to go back and sit at the knee of Charles Darwin or Francis Galton. And I'd sit with Jack Barnaby, who was the greatest squash coach and had something like 200 victories in a row but also a lot of losses.

And I'd sit with my father. Whenever I was in error, my father was like the fairy godmother that I spoke about, but instead of taking trillions from the common man, he would take his $400, which was his entire net worth, and he'd say, "Here, Vicky, this is the last $400 I have, take it and pay off your debts." He'd say "Don't worry, you'll regroup, it's only money. You'll rise again, I know you can do it."

the main reason the economy is in the doldrums is because of reduced incentives and the decline in human capital caused by all the crowding out, and confiscation of productive energy

t is good to take out the canes and hobble down to wall street at the close of days when there is a panic.     

 

George Soros, the billionaire best known for breaking the Bank of England, is returning money to outside investors in his $25.5 billion firm, ending a career as hedge-fund manager that spanned more than four decades.

Soros, who turns 81 next month, will hand back the money, less than $1 billion, by the end of the year, according to two people briefed on the matter. His firm will focus on managing assets solely for Soros and his family, according to a letter to investors. Keith Anderson, 51, chief investment officer since February 2008, is leaving, said the letter, signed by Soros’s sons Jonathan and Robert, who are co-deputy chairmen.

“We wish to express our gratitude to those who chose to invest their capital with Soros Fund Management LLC over the last nearly 40 years,” they said in the letter. “We trust that you have felt well rewarded for your decision over time.”

The move completes Soros’s transformation from a speculator, who in 1992 made $1 billion betting that the Bank of England would be forced to devalue the pound, to philanthropist statesman, a role he first imagined for himself as a Hungarian émigré studying at the London School of Economics after World War II, according to Soros’s writings. In the last 30 years, he’s given away more than $8 billion to promote democracy, foster free speech, improve education and fight poverty around the world, he said in a recent essay.

Family Assets

Soros’s sons said they took the decision because new financial regulations would have made it necessary for the firm to register with the Securities and Exchange Commission by March 2012 if it continued to manage money for outsiders. Because the firm has overseen mostly family assets since 2000, when outside money accounted for about $4 billion, they decided it made more sense to run it as a family office, according to the letter.

The rule calls for hedge funds with more than $150 million in assets to report information about their investors and employees, the assets they manage, potential conflicts of interest and their activities outside of fund advising. Registered funds will also be subject to periodic inspections by the SEC.

“We have relied until now on other exemptions from registration which allowed outside shareholders whose interests aligned with those of the family investors to remain invested in Quantum,” the executives said in the letter, referring to its flagship Quantum Endowment Fund. “As those other exemptions are no longer available under the new regulations, Soros Fund Management will now complete the transition to a family office that it began eleven years ago.”

Druckenmiller’s Move

Soros, who controls more than $24.5 billion for himself, his family and his foundations, declined to comment on the letter. Last year, Stanley Druckenmiller, Soros’s chief strategist from late 1988 until 2000, closed his money- management firm, Duquesne Capital Management LLC, and created his own family office.

While Quantum has returned about 20 percent a year, on average, since 1969, when its predecessor was started, according to a person familiar with the firm, the fund’s performance has suffered in the last 18 months. In the first half of this year, Quantum lost about 6 percent, the person said, following a gain of 2.5 percent in 2010. Other macro funds have returned 5.6 percent in the last year-and-a-half, according to Chicago-based Hedge Fund Research Inc.

Soros was born in Budapest in 1930, as Dzjchdzhe Shorash, according Robert Slater's book ``Soros: The World's Most Influential Investor.'' When the Nazis invaded the city in 1944, Soros’s father arranged for false papers for his family and friends that identified them as non-Jews. Most of the people his father helped survived the war, Soros said in the essay published in the New York Review of Books in late June.

‘Evil Force’

“Instead of submitting to our fate we resisted an evil force that was much stronger than we were -- yet we prevailed. Not only did we survive, but we managed to help others,” he wrote, adding the experience gave him an appetite for taking risk. “This left a lasting mark on me, turning a disaster of unthinkable proportions into an exhilarating adventure.”

After London, Soros came to New York at the age of 26 and became a trader, initially buying and selling stocks for Wall Street brokerage F.M. Mayer. He planned to work for five years, enough time, he reckoned, to save $500,000 and return to England where he would pursue his philosophical studies, according to an interview he gave to Michael Kaufman, author of “Soros: The Life and Times of a Messianic Billionaire.”

Instead, he stayed in the world of finance, eventually moved to Arnhold and S. Bleichroeder Advisors LLC, where he set up the predecessor to the Quantum fund in 1969. He started his own firm in 1973.

Conflicting Goals

Over the years, Soros had to deal with conflicting goals of making good and doing good. While Soros’s fund made about $750 million betting on a decline in the Thai baht in 1997, the wager increased economic woes in Thailand as the government spent billions unsuccessfully defending its currency. In the wake of the devaluation, Thailand was forced to cut public spending in exchange for a $17.2 billion rescue package from the International Monetary Fund.

In 1997, his philanthropic tendencies drove him to buy Russian assets. He took a $1 billion stake in RAO Svyazinvest, Russia’s state-owned telecommunications company, and went on to buy Russian stocks and bonds. He didn’t sell his positions even after publishing a piece in the Financial Times advising the government to devalue the ruble by 15 percent to 25 percent. Four days later, Russia followed his advice.

“He felt that if he was a beacon of investment in Russia, others would follow and the capital inflows would transform the society and integrate them into the G7,” Robert Johnson, a former Soros managing director, told author Sebastian Mallaby in his book ‘More Money than God.’ “There’s a philanthropic side of George that started to interfere with the speculative one.”

‘Public Interest’

In his recent essay, Soros echoed the remarks of his former colleague.

“I have made it a principle to pursue my self-interest in my business, subject to legal and ethical limitations, and to be guided by the public interest as a public intellectual and philanthropist,” he wrote. “If the two are in conflict, the public interest ought to prevail,” he said.

Soros opened his first foundation, the Open Society Fund, in 1979, when his fund had reached about $100 million and his personal wealth had climbed to about $25 million. His initial focus was on promoting democracy and a market economy in Eastern Europe. Soros now funds a network of foundations that operate in 70 countries around the globe, everywhere from the U.S. to Montenegro to South Africa and Haiti.

In late 1988, he hired Druckenmiller to be his chief strategist to take over the day-to-day trading of the firm’s assets so he could concentrate on his charitable pursuits.

Breaking the BoE

While Druckenmiller was the architect of the $10 billion British pound trade, which forced the currency out of the European exchange-rate mechanism, Soros served as a coach to the younger man, encouraging him to increase his bet.

Druckenmiller left in 2000, together with another star manager, Nick Roditi, after losses when the technology bubble burst. Just two years before, the firm had been the biggest hedge fund in the world with $22 billion in assets, and Soros said it was too much money to manage in such concentrated positions.

After the departures, Soros decided to farm out more money to portfolio managers both inside and outside Soros Fund Management. He said he would settle for a 15 percent annualized return, about half of what the fund had posted since its start.

Stepping In

In 2007, as the subprime mortgage crisis was gaining speed, Soros again stepped in. Quantum returned 32 percent that year and posted an 8 percent gain in 2008, when funds on average dropped about 19 percent. Overall, Quantum Endowment grew from about $11 billion in June 2000 to today’s level.

The firm went through several chief investment officers, including Soros’s son Robert, before hiring Anderson, who was a co-founder at BlackRock Inc. and its global fixed-income chief.

The uncertainty about markets and Quantum’s 6 percent dive caused Anderson to sell positions in mid-June and the firm is now holding about 75 percent cash. It hasn’t been decided whether Jonathan and Robert will hire a new CIO, or whether they will add to their stable of external managers.

In the meantime, Soros continues to focus on his philanthropy and on voicing his views on macroeconomic events, such as the sovereign debt crisis in Europe.

“My success in the financial markets has given me a greater degree of independence than most other people,” Soros wrote in his recent essay. “This obliges me to take stands on controversial issues when others cannot, and taking such positions has itself been a source of satisfaction. In short, my philanthropy has made me happy.”

 

 

Our brain is hardwired for hope. The brain evolved over the ages to look positively into the future. Even in bad outcomes our brain tends to find some positive conclusions. There is a neural mechanism that generates optimism:

"...these precise regions - the amygdala and the rACC - show abnormal activity in depressed individuals. While healthy people expect the future to be slightly better than it ends up being, people with severe depression tend to be pessimistically biased: they expect things to be worse than they end up being. People with mild depression are relatively accurate when predicting future events. They see the world as it is. In other words, in the absence of a neural mechanism that generates unrealistic optimism, it is possible all humans would be mildly depressed".

I try to draw some parallels with trading. Most traders tend to look positively to news and expect positive outcomes to challenges. This could explain why buying a dip is more successful than selling an expansion of price to the upside. It explains also why crashes catch by surprise the optimistic herd, that continues to look positively into the future although all the elements are there to understand that things are very bad.

Only a few "mildly depressed" investors manage to sail macro and micro events maintaining a good understanding of what is going on. (I am not sure whether this is good or bad news because it is not very exciting to be "mildly depressed" in order to make money...).

"How do expectations change reality? ..... To induce expectations of success, she primed college students with words such as smart, intelligent and clever just before asking them to perform a test. To induce expectations of failure, she primed them with words like stupid and ignorant. The students performed better after being primed with an affirmative message".

“Expectations become self-fulfilling by altering our performance and actions, which ultimately affects what happens in the future. Often, however, expectations simply transform the way we perceive the world without altering reality itself.”

The majority of the people displays optimism (which is generally considered as a winning attitude), but they are surprised by negative events that happen more often than not. They take risks because they see a bright future and are self-confident. They make more mistakes (and win less frequently) than pessimists although being positive can improve their results and their performance. When few of them win, they win big.

At the same time it is hard for pessimists (which are are seen as "losers") to be surprised. They analyze all the various scenarios, especially the negative, and are ready to cope with them. They see the world as it is. They make less mistakes. They tend not to take risks because things could easily turn bad. They have more winners, but have a lower average winning trade. Their results are less volatile. When they are caught by surprise, it is very, very painful.

Our brain is hardwired for hope. The brain evolved over the ages to look positively into the future. Even in bad outcomes our brain tends to find some positive conclusions. There is a neural mechanism that generates optimism:

"...these precise regions - the amygdala and the rACC - show abnormal activity in depressed individuals. While healthy people expect the future to be slightly better than it ends up being, people with severe depression tend to be pessimistically biased: they expect things to be worse than they end up being. People with mild depression are relatively accurate when predicting future events. They see the world as it is. In other words, in the absence of a neural mechanism that generates unrealistic optimism, it is possible all humans would be mildly depressed".

I try to draw some parallels with trading. Most traders tend to look positively to news and expect positive outcomes to challenges. This could explain why buying a dip is more successful than selling an expansion of price to the upside. It explains also why crashes catch by surprise the optimistic herd, that continues to look positively into the future although all the elements are there to understand that things are very bad.

Only a few "mildly depressed" investors manage to sail macro and micro events maintaining a good understanding of what is going on. (I am not sure whether this is good or bad news because it is not very exciting to be "mildly depressed" in order to make money...).

"How do expectations change reality? ..... To induce expectations of success, she primed college students with words such as smart, intelligent and clever just before asking them to perform a test. To induce expectations of failure, she primed them with words like stupid and ignorant. The students performed better after being primed with an affirmative message".

“Expectations become self-fulfilling by altering our performance and actions, which ultimately affects what happens in the future. Often, however, expectations simply transform the way we perceive the world without altering reality itself.”

The majority of the people displays optimism (which is generally considered as a winning attitude), but they are surprised by negative events that happen more often than not. They take risks because they see a bright future and are self-confident. They make more mistakes (and win less frequently) than pessimists although being positive can improve their results and their performance. When few of them win, they win big.

At the same time it is hard for pessimists (which are are seen as "losers") to be surprised. They analyze all the various scenarios, especially the negative, and are ready to cope with them. They see the world as it is. They make less mistakes. They tend not to take risks because things could easily turn bad. They have more winners, but have a lower average winning trade. Their results are less volatile. When they are caught by surprise, it is very, very painful.

 

 

Number 1 is never to get in over your head. Not having staying power will
prevent you from reaping the benefits that occur on those small number of
businesses you own that need just a little bit more before striking the gusher.
Number 2 is nver under any circumstances accept an offer out of the clear blue
sky for your share of the business that seemingly is good, but where the party
offering you the buyout knows much more than you do. I have lost millions on
many occasions by accepting a quick profit in a deal where it turned out if I
waited a year or two or three, I would have realizedd a tremendous windfall.
Number 3 is not to mix romance with business. Romance should come out of
business not business out of romance. The romantic aspect will cause a strain
and make you look foolish too all your colleagues
Number 4 is not to have 3 person partnerships as too many coalitions can form,
and you will be invovled in diplomacy rather thanbusiness
Number 5 is to keep your business consistent with the ida that has the world
in its grip. Give your customers what they want, and give returns and the
customer is always rite.
NUMBER 6 is to be sure that you are aligned with the forces in Washington that
control so much of life these days, and have so much in perks and profits to
give to their cronies.
Number 7 is to associate yourself with good partners, and good friends, and good
employees whose loyalty goes beyond the dollar or the clock. An ounce of loyalty
and integrity is worth more than a pound of immediate profits. When the going
gets tough, and it always does in business, you need to have the loyal
ones.Certain groups and certain belief systems are aphoristic and proverbial
for their disloyalty and tendency to deceit and they should be avoided
Number 8 is to always remember that when dealing with a family business, the
loyalty of the family members is to themselves but not to you. The worst short
term frauds and cons, and some of the worst long term cons, I have been
victimized in had a father and son working in concert to deceive you int giving
them your chips.
Number 9 is to associate yourself with people that have a record of success
in their family, previous career, or athletics. Those who tend to fail in one
thing will bring you down in the other.
Number 10 is to work hard and keep good records so that you will learn
from your mistakes and be able to jump in with full force on the good
opportunities when they occur. Keep a reserve for such.
I know there are many more. And some of mine aren't sharp enough. Vic

 

 

11. Be aware of the competition, learn from them and have a strategy to compete.
Perhaps the reason athletes do well is because they are aware of the competition
and develop a niche or strategy to beat or compete with them. Likewise for
successful family: there are few things more powerful and motivational than
common goals and team-work within a clear framework for utilizing each
individuals diverse unique talents and self interest. A successful family
man has shown that he is capable of uniting such a competitive group.

 

 

That many people mistakenly come to me to ask for advice on trading. At the junta which I turned over the moderation to gene epstein he likes to refer to me as a philanthropist. So at the end of each junta, about 20 people crowd around me asking me for philanthropy to them . Another 20 request a meeting with me to get my advice. But I don't have good advice. And I don't have a minute in the week where I'm not trading or parenting with my 7 kids. If one had a minute, it would be nice to say hello to the significant other, especialy when one doesn't have a losing position. However, that's so rare that it's not worth talking about. Many mistakenly see that on occasion I luckily beat the odds and make a small profit and come to me for a little guidance as to how to take out a little profit from the market. It seems so easy and the hourly wage is so great relative to what they make. I note that m y average swing from day to day is often greater than my father's total earnings in his life time. That's a terrible lure to many people. But you can't make a profit nor have I ever seen one who could unless you buy and hold, unless you have tremendous quantified and updated date taking account of all sorts of statistics and randomness and ever changing cycles. Then you have to be there 24/7 to implement it because the swings that are good only last for seconds and if you have job or like to have lunch or dinner, that's incompatible. of course other than buy and hold you can always invest with a hedge fund.but... but... but... . By the time, a operator pays his sales force, and his administration, he has to charge 20- and 2 . Okay suppose he can overcome 1-% a year vig, and make 2 % more than the market 10%. That gives you 12 % before fees, and 10% before vig . What's left for you the investor. I reiterate, one feels like telling those who wish to join the fray, come to me to Rockaway or the Hamptons to the ocean. And I"ll hold up my hands like King canute and say " I am as incapable of helping you, and you are as incapable of making a profit other than buy and hold as I am to stop the waves ". vic

 

 

 

 

 

THE BLOW-UP ARTIST

Can Victor Niederhoffer survive another market crisis?

by John CassidyOCTOBER 15, 2007

Niederhoffer’s approach is eclectic. His funds, a friend says, appeal “to people like him: self-made people who have a maverick streak.”

On a wall opposite Victor Niederhoffer’s desk is a large painting of the Essex, a Nantucket whaling ship that sank in the South Pacific in 1820, after being attacked by a giant sperm whale, and that later served as the inspiration for “Moby-Dick.” The Essex’s captain, George Pollard, Jr., survived, and persuaded his financial backers to give him another ship, but he sailed it for little more than a year before it foundered on a coral reef. Pollard was ruined, and he ended his days as a night watchman. The painting, which Niederhoffer, a sixty-three-year-old hedge-fund manager, acquired after losing all his clients’ money—and a good deal of his own—in the Thai stock market crash of 1997, serves as an admonition against the incaution to which he, a notorious risktaker, is prone, and as a reminder of the precariousness of his success.

Niederhoffer has been a professional investor for nearly three decades, during which he has made and lost several fortunes—typically by relying on methods that other traders consider reckless or unorthodox or both. In the nineteen-seventies, he wrote one of the first software programs to identify profitable trades. In the early eighties, he went into business with George Soros, then arguably the world’s most successful investor. A few years later, when prominent money managers were based almost exclusively in Manhattan, Niederhoffer moved his home and his trading room to Connecticut, to a twenty-thousand-square-foot neo-Tudor mansion crammed with books, manuscripts, silver jewelry, art work, and a collection of seashells. The walls of his vast living room, which has a ceiling about thirty feet high, are covered with more than two dozen paintings, many depicting industrial landscapes or Western shoot-’em-ups, and the floor is occupied by, among other objects, a large painted pony, a black-spotted wooden hound carrying three quail on its back, a seated pig, and two miniature black bears. Niederhoffer’s home is also frequently occupied by various of his children. (He has six daughters and an infant son, from two marriages and an extramarital relationship.)

After the 1997 Asian financial crisis, Niederhoffer was forced out of business for several years. Then, in his late fifties, he made a dramatic recovery. He founded three new hedge funds and launched a Web site, DailySpeculations.com, where he posts his idiosyncratic insights into the stock market—“What can we learn from shelled species about the markets?” he wrote in May—as well as opinions about sports, politics, and culture (“ ‘The Fantasticks,’ currently running as a revival on Broadway, is the perfect musical”). He has mentored dozens of successful traders, many of whom regard him as a guru. “Before I joined Victor, I used to trade for a Wall Street firm,” James Lackey, a self-employed Florida investor who placed trades for Niederhoffer from 2002 to 2006, told me. “But I quickly realized that I didn’t know very much. What he taught me was how to approach the market as a whole, and how to analyze it scientifically. He was just amazing at seeing what was happening and showing us how to make money.”

Niederhoffer, a former national squash champion who is considered one of the most talented Americans to have played the game, relishes the acclaim, but he knows that in his field circumstances can change quickly. By the end of August, his funds were in trouble, and on Wall Street rumors circulated that he would soon be out of business again. Niederhoffer had been worried all summer, but he tried to project a wry, self-deprecating humor. “If an event like 1997 occurred again, my dependents would be up the creek, and I would be a night watchman somewhere, just like Captain Pollard,” he said to me when I visited him at his home one morning in June. “In America, they give you a second chance but not a third.”

Tall and trim (he still looks like an athlete), with closely cropped white hair, olive skin, and a long, expressive face, Niederhoffer speaks softly, with a strong Brooklyn accent. He was wearing a yellow shirt, pink trousers, and white socks, but no shoes—he maintains a “no shoes” rule in the office, to reduce noise—and was sitting behind his desk, which is dominated by two Bloomberg screens, in a large room over the garage which he shares with his partner, Steve Wisdom, and several members of his company, Manchester Trading. (The trading operation fits into two rooms; the other one is over the kitchen.) In one hand, he was holding a telephone receiver, and his light-blue eyes were fixed on the computer screens. “The market’s way down today,” he said by way of greeting. Turning back to the telephone and addressing his broker at the Chicago Mercantile Exchange, he asked, “Can you repeat those quotes, please?” After a few seconds, he said, “I’ll sell two hundred red March at five hundred and ten. I’ll sell two hundred blue March at eleven ten.”

The Chicago Merc is a futures market, where people trade contracts that give them the right to purchase a particular commodity at a specified date in the future. Originally, the items traded on the exchange were physical commodities, such as eggs, butter, and pigs, and its main customers were farmers and food companies. In recent decades, futures trading has become more abstract; professional speculators now use the exchange to place bets on the prices of financial securities, such as stocks, bonds, and currencies—a development that Niederhoffer, a former math prodigy who has a Ph.D. in economics, has exploited. He likes to be at his desk well before the Chicago market opens, especially on days when he has big positions riding overnight. He is mainly a short-term operator—he bets on how prices will move in the subsequent few minutes, hours, or days—and most of his knowledge of current events comes from Bloomberg. (He doesn’t read newspapers or watch television.) When he arrives at his office, he turns on his computer and reads about developments in the Asian and European markets, which often foreshadow the day’s action in the United States.

At the end of the previous week, the yield on ten-year Treasury bonds had surged to almost five per cent, prompting Niederhoffer to turn uncharacteristically bearish on stocks. Once the bond yield reached five per cent, he had reasoned, some investors would move their money from stocks to bonds, which would depress stock prices. Accordingly, he had sold short more than a billion dollars’ worth of stock futures. (Selling short, a common tactic among speculators, involves selling something you don’t own with the intention of buying it back later, at a cheaper price. If the price of the security falls while you are “short,” you make a profit; if the price rises, you lose money.)

Even by Niederhoffer’s generous standards, going short a billion dollars of stock futures was a large bet, but it worked out well. Not long after the markets reopened on Monday, the bond yield climbed to five per cent, and stocks and stock futures tumbled. On Wednesday, the morning of my visit, shortly after the opening bell sounded on Wall Street, Niederhoffer repurchased the futures he had sold, making more than five million dollars.

He didn’t look pleased, though. During the morning, stocks had continued to fall, and he knew that if he had waited he could have made an even bigger profit. He says that in twenty-eight years as a professional investor he hasn’t had a single truly satisfactory trading day. At eleven o’clock, the Dow Jones Industrial Average had slipped about a hundred points and the S. & P. 500 Index was down about thirteen points. Niederhoffer stared morosely at his Bloomberg screens. “The score doesn’t look good,” he muttered. The screens were tracking the movements of various stock-market indices in Europe and Latin America, but I noticed that they weren’t displaying any American prices. Niederhoffer used to invest heavily overseas, but since his 1997 misadventure in Thai stocks he has confined his trading to the United States. He explained that when the U.S. market was falling he preferred to track the DAX, a German stock index that generally moves in synch with the American market. “You can see how much you are losing, but it doesn’t hurt as much as watching the S. & P.,” he said.

Before long, Niederhoffer cheered up a bit. “There have been three big down opens in a row, which is unusual,” he said. “The market doesn’t like to do the same things repeatedly.” He turned to Alex Castaldo, a thin, bespectacled fifty-three-year-old Italian who has a degree in electrical engineering from M.I.T. and a Ph.D. in finance from CUNY, and asked him to compile some data. “Doc,” he said to Castaldo, “what does the market do when it opens down a lot three days in a row?” A few minutes later, Castaldo handed Niederhoffer a computer printout, which showed that since the start of 2003 there had been just ten occasions on which, for three consecutive days, the S. & P. 500 had fallen sharply in the first hour and a half of trading. On eight of those occasions, stocks had bounced back, with the average market rise by the end of the following trading day amounting to three tenths of one per cent. For a trader like Niederhoffer, who uses leverage—borrowed money—to scale up his bets, the ability to predict even relatively small changes in the market can pay off handsomely.

The software that Niederhoffer uses to identify stock-price patterns is a version of the code that he wrote thirty years ago. Many hedge funds and Wall Street banks now rely on such programs to spot potentially lucrative market fluctuations and place orders automatically—a practice known as “black box” investing—but Niederhoffer is scornful of this method. Although markets sometimes move in predictable ways, he says, the patterns change constantly, and reliance on mathematical algorithms can be disastrous. At Manchester Trading, Niederhoffer or Wisdom reviews each trade before it is placed.

In this instance, Niederhoffer expected the market to rebound, but he decided to hold off on buying. Morgan Stanley had just issued a notice advising its clients to reduce their stock holdings. “Plus, the Fed has been making bearish noises,” Niederhoffer said. A few minutes earlier, the Dow had dropped below thirteen thousand five hundred. Castaldo went over to Niederhoffer’s Bloomberg and called up some U.S. stock charts. Niederhoffer, looking at the falling lines, announced, “It’s gone down two per cent—that’s enough.” Then he turned to Owen Wilson, a young Englishman who has worked for him for a couple of years. Holding a phone to his ear, Wilson shouted out quotes from the Chicago Merc. “Buy a hundred and fifty at eighteen seventy-five,” Niederhoffer said. Wilson placed the trades and called out more numbers. Again, Niederhoffer told him to buy. Within a few minutes, Wilson had purchased tens of millions of dollars’ worth of stock futures.

Niederhoffer received his first lessons in finance as a child growing up in Brighton Beach. He learned to bet on stoopball, paddleball, and checkers, which he played with other local kids, and with adults who went by nicknames such as Bitter Irving, Bookie, and Nervous Phil. His father, Artie, a New York City cop who spent twenty years on the force before becoming a professor of sociology at John Jay College of Criminal Justice, tried unsuccessfully to dissuade him from gambling. “Everything was a money game,” Niederhoffer told me. “My father hated it, but I loved to win a nickel or a dime.” With the encouragement of his uncle Howie, who was in high school, he also placed wagers on professional sports. In October, 1951, on Yom Kippur, Howie and Victor, who was eight, sneaked out of synagogue and bet eight hundred dollars on the Brooklyn Dodgers, who were playing the New York Giants in a pennant-decider. When Bobby Thomson hit his famous home run, defeating the Dodgers, Howie and Victor were devastated. (The knowledge that only two of the lost dollars were Niederhoffer’s did little to console him.)

Niederhoffer says that as far back as the Middle Ages his ancestors were money changers. At the end of the nineteenth century, his paternal great-grandparents moved from Austria to the Lower East Side, where several of their seven sons sold fruit from a horse and cart. Niederhoffer’s grandfather Martie, who had a good head for figures, became an accountant. In the boom years of the nineteen-twenties, Martie borrowed money and invested it in real estate and stocks, assembling a portfolio that made him nearly a millionaire. The stock-market crash of October, 1929, destroyed most of his wealth; two years later, the market dived again, wiping out what he had left.

Martie, who spoke Yiddish and pidgin Spanish, got a job as a translator in a Brooklyn courthouse. But he retained an interest in the stock market, and in 1954 he financed Victor’s first equity investment: a hundred shares of the Benguet Mining Company, which was trading at fifty cents. For several years, the stock hardly moved. Then, in just a few months, it doubled in value. On Martie’s advice, Victor sold his shares, and made a profit of fifty dollars. During the next thirty-six months, the stock’s value increased to thirty dollars a share. “I have repeated the mistake of grabbing at small profits and selling at a targeted round number over and over in my speculative career,” he wrote in “The Education of a Speculator,” a memoir that he published in 1997. “I believe many others make this same error.”

At the age of six, Niederhoffer says, he was such an accomplished paddle-tennis player that he had to spot his opponents fifteen points a game. At thirteen, he defeated a seventeen-year-old to win the New York City junior singles tennis championship. (In school, his competitiveness elicited mixed reactions. At the end of his last year at P.S. 225, his sixth-grade teacher wrote, “Although a little trying at times, you were the spark the class needed this year. You have a keen mind; learn to curb your inclinations to demonstrate superiority.”) At Abraham Lincoln High School on Ocean Parkway, Niederhoffer was the president of his class, the captain of the tennis team, the star of the math team, a pianist in the orchestra, a clarinettist in the band, the sports editor of the newspaper, and a frequent contributor to Vanguard, the school magazine. In an article that appeared in the June, 1958, issue, Niederhoffer warned that automation “will require a complete reorientation” in the attitudes of trade unions. Five months later, displaying a view of government intervention that he would later renounce, he argued that “federal aid to education is imperative if equality of educational opportunity in our democracy is to have real meaning.”

Niederhoffer’s father, whom he idolized, encouraged his athletic and intellectual pursuits, and his mother, Elaine, who was descended from a long line of rabbis, pressed him and his younger brother and sister—now, respectively, a commodity-fund adviser and a psychiatric social worker—to succeed. “My mother was never content,” Niederhoffer told me. “She pushed us to be No. 1.” In January, 1960, at his mother’s urging, he applied to Harvard. In a letter of recommendation, his academic adviser and tennis coach, Milton Hecht, wrote, “Victor ranks among the first in intellectual achievement and promise in comparison with the thousands of students I have taught in the last thirty years.” Harvard awarded him a partial scholarship, as did Columbia and the University of Pennsylvania. Niederhoffer chose Harvard, where he majored in economics.

Niederhoffer spent less time in the classroom than he did on the squash court. Until he moved to Cambridge, he had never played squash—or squash racquets, as it was then called—but the physical demands of the game appealed to him. He borrowed every book on squash at the Widener Library, and took some with him to the practice court, where he opened them on the floor and repeatedly copied the moves they described. In 1962, as an eighteen-year-old sophomore, Niederhoffer won the junior championship of the National Intercollegiate Squash Racquets Association. A year later, he won the Harry Cowles tournament, a prestigious competition for amateurs. “He has good size, quickness, and a skillful touch,” his Harvard coach, Jack Barnaby, told the News and Views of Harvard Sports, a campus publication, in January, 1963. “But a lot of players have those attributes. What he has beyond that is one of the most competitive characters I’ve ever seen. He makes you feel like you are watching a person of Ty Cobb’s cut in action again.”

In the 1963-64 season, Niederhoffer, now a senior, was captain of the Harvard squash team, which went undefeated. He also won the individual national collegiate title, and his aggressive playing style attracted the attention of a reporter at Sports Illustrated, who wrote, “Niederhoffer thinks he is unbeatable and clamors loudly for justice when his shots go awry. Consequently, on those rare occasions when he loses a tournament, squash lovers are delighted.” The reporter quoted Niederhoffer’s freshman coach, Corey Wynn, who recalled his former student’s penchant for “handballing it”—physically blocking his opponents from reaching the ball, a tactic that was frowned upon in New England. Niederhoffer’s mother read the article and consulted a Fifth Avenue law firm, Cohn & Glickstein, about suing Sports Illustrated for libel. (On the firm’s advice, she decided not to file a suit.)

In February, 1966, Niederhoffer won the U.S. national amateur championship, the culmination of a series of important victories. Sports Illustrated and Time sent reporters to these events, and Niederhoffer wasn’t pleased with the coverage. First, he wrote to Time, denying its claim that during the national championship he had offered odds of two-to-one against himself. An editor replied, defending the magazine’s reporting as having been based on “reliable sources.” Unsatisfied, Niederhoffer wrote another letter, to a senior executive at Time-Life, the parent company of both Time and Sports Illustrated, complaining that the articles had “created the impression that I was a poor boy from Brooklyn who had adjusted badly to the rigors of a social sport.”

An aura of class and ethnic prejudice pervaded press accounts of Niederhoffer’s achievements; he was widely viewed as an ill-mannered upstart from the wrong side of the East River. The Times Magazine noted that he was “built wrong for a squash player: not lithe and wiry, or even tall and gracefully powerful. He is shaped rather like a block—fairly broad in the shoulders, no waist, thick shapeless legs—and his color is sallow, the deep oyster sallow of a New York street creature.” In Chicago, where Niederhoffer moved in 1964, to attend graduate school, he couldn’t find a squash club that would admit him. He was so offended that for several years he gave up the game.

After he returned to the court, in 1972, he won the national amateur championship four years running, an unprecedented feat. In January, 1975, in Mexico City, he won the North American Open, a major professional tournament, defeating the legendary Pakistani player Sharif Khan in four games. Afterward, Niederhoffer wasn’t very gracious. “Khan had a fatal plan—a lack of real toughness,” he told Sports Illustrated. “He’s been winning so long he doesn’t know anymore what it is to play a battle to the death.”

Shortly after noon, a housekeeper’s voice announced over an intercom, “Victor’s lunch is ready. Does he want it?” “No,” Niederhoffer replied. “I can’t eat lunch with the market like this.” He looked at his screens. “Europe got killed,” he said to nobody in particular. He was still irked by Morgan Stanley’s bearish notice to clients. “If the big brokerage houses are going to make money from commissions, they have to get people selling as well as buying,” he said dismissively. Unlike most Wall Street firms, Manchester Trading doesn’t have a television in its trading room, partly because Niederhoffer doesn’t want to be distracted but also because he can’t abide doom-mongering market commentators, like Alan Abelson, a columnist for Barron’s, the financial weekly, and Robert Prechter, Jr., the publisher of the Elliot Wave Theorist. “These people have been bearish since Dow 700,” Niederhoffer said angrily. “When the market is going up, they can’t get a hearing. But when the market falls they get invited back on. They say it’s like 1997, or 1987, or 2002. How about 1907? That was a bad year. Interest rates went up; the market went down by nearly fifty per cent.”

Just after one o’clock, the market hit a new low for the day, with the Dow down about a hundred and twenty-five points, and the S. & P. 500 down about fourteen points. It is a strange feature of financial markets that time occasionally seems to speed up. On quiet days, when prices aren’t moving much, traders monitor their positions, read the papers, and chat with each other, and it can seem as though an eternity passes before the closing bell sounds. But when the market becomes volatile every move brings with it a fresh opportunity for profit or loss, and each minute can fly by. The mathematician Benoît Mandelbrot, who pioneered the application of chaos theory to financial markets, refers to this phenomenon as the “multifractal nature of trading time.”

Niederhoffer turned to Castaldo. “This day is far from over,” he said. “Doc, what happens when the market is down twelve points at one o’clock and it has been down significantly the previous two days?” A few minutes later, Castaldo handed him another computer printout. “Most of the time, these computer analyses don’t work, but it gives you an anchor,” Niederhoffer said as he scanned the sheet. “My checkers teacher said even a bad system is better than no system at all.” The data showed that the last time trading seemed to follow the current pattern was between November, 2000, and September, 2002, when there had been eight such three-day periods. In most of these instances, the market had rebounded strongly during the subsequent seventy-two hours. Niederhoffer looked at Owen Wilson. “I’ll buy another fifty at eleven-fifty,” he said.

Niederhoffer’s investment philosophy is based on a belief that over the long term the market goes up, but over the short term it constantly reverses itself. In his books—his second, “Practical Speculation,” was published in 2003—he compares the behavior of investors to that of herds of rampaging elephants that retrace their steps over and over. He refers to this pattern as a “LoBagola,” after Bata LoBagola, the author of “LoBagola: An African Savage’s Own Story,” a book published in 1930 describing the customs and wildlife of West Africa. After the book appeared, LoBagola was revealed to be an African-American vaudeville entertainer from Baltimore, the son of a former slave. In a 2004 post on DailySpeculations.com, Niederhoffer wrote, “Regrettably LoBagola was an American con man. . . . Nevertheless, I claim that despite his imposture, the moves back and forth in big markets often follow a LoBagola, and even though, nay especially because, LoBagola was an impostor his name should be given to major moves which would seem to follow a symmetry up and down.”

Niederhoffer doesn’t claim to be able to say what the Dow or the S. & P. 500 will do next week or next month, but he believes that over shorter periods—hours or days—there are sometimes predictable patterns that can be exploited. In “The Education of a Speculator,” he devotes an entire chapter to this notion, comparing the market’s movements to some of his favorite pieces of classical music, and juxtaposing pages of sheet music with stock charts. “When the markets are moving in my favor in a nice, gentle way—never below my initial price—I often think of the ‘Trout Quintet,’ ” he writes. “Another frequent work I hear in the market is Haydn’s Symphony No. 94. . . . Right after lunch, or before a holiday, the markets have a tendency to meander up and down in a five-point range above and below the opening. The pattern is similar to the twinkling C-major fifths of Haydn’s symphony.”

In the early eighties, when he was making a presentation to potential clients, Niederhoffer sometimes took along Robert Schrade, a friend who was a classical pianist. After Niederhoffer talked about his methods, Schrade would demonstrate the rhythms of the market on the piano. This double act didn’t always impress investors. “CalPERS”—the California Public Employees’ Retirement System—“is not going to be interested in investing with Victor, nor is the Harvard endowment,” Paul DeRosa, a partner at the hedge fund Mt. Lucas who has known Niederhoffer since the late seventies, said to me. “Your basic, buttoned-down endowment, advised by professional consultants, wouldn’t touch him with a ten-foot pole. His is a fund that is going to appeal to people like him: self-made people who have a maverick streak.”

A few months ago, after visiting a Redwood forest in Northern California, Niederhoffer became fascinated by the ecology of trees. He bought several books on the subject and posted an article on his Web site applying what he had learned about trees to the stock market:
Lesson Two: The forest thrives and benefits after many seemingly disastrous events. Fires clear the underbrush. Dead trees still standing provide cover for much flora and fauna. Trees contain so much water that there is still much biomass left when they die, and they contain the nutrients and moisture that other plants or fungi need for survival. This situation is called a biological legacy by the scientists, but is just known as a gift by the laymen.
The number of, the amount of time in between, and the extent of watershed declines that the market has witnessed in the last year, as well as the resilience of the market to these declines, is a good measure of the health of a system. It is often good for future growth, to see decimated parts of the market landscape, such as the U.S. real-estate sector, which has currently taken it on the chin, or the Saudi Arabian market, which is down 75%.

After he wrote the article, Niederhoffer gave the books he had read to one of his employees, Charles Pennington, a former professor of physics, and asked him to develop precise numerical analogies between the life cycles of forests and those of corporations, in the hope that the exercise might suggest some profitable investments. Niederhoffer’s employees are used to such requests. “Things sometimes work that you wouldn’t believe, and things don’t work that you would expect to work,” Steve Wisdom said to me after we had left Niederhoffer at his desk and gone downstairs to eat lunch in his formal dining room. (The dining room is next to the library, where Niederhoffer keeps his collection of rare books and manuscripts, including a first edition of Adam Smith’s “Wealth of Nations” and a copy of David Ricardo’s “Principles of Political Economy and Taxation” which has margin notes by Thomas Malthus.)

Wisdom, a clean-cut man of forty-six, met Niederhoffer twenty-five years ago, in New York City, when Wisdom was a philosophy major at Harvard and the chairman of the university’s Libertarian Club. “We hit it off, and that was that,” Wisdom recalled. After graduating, in 1983, Wisdom worked for Niederhoffer for fourteen years, until Niederhoffer’s business collapsed, in 1997. He returned in 2003, largely, he told me, because of Niederhoffer’s willingness to try new ideas. “Everyone has computers; everyone has Ukrainian math Ph.D.s,” Wisdom said. “There are people chopping at the data every which way. Making money is not easy, and it requires a lot of creativity. Victor always says, ‘Suppose I didn’t know anything. Suppose I’d never traded this instrument before. What would I think?’ ”

Manchester Trading’s three hedge funds are relatively small by current standards. At the end of June, the funds’ collective value was about three hundred and fifty million dollars, of which about half belonged to Niederhoffer and Wisdom. In 2003 and 2004, the funds increased in value by more than forty per cent each year, and in 2005 the value of the largest fund, Matador, rose fifty-six per cent—a performance that earned Niederhoffer an industry award. Last year, his funds were flat. But in the first six months of 2007 they were up again, by between thirty and forty per cent.

Niederhoffer acknowledges that his aggressive investing style and his reliance on borrowed money increase the volatility of his returns and the likelihood that he will suffer a calamity. In May, 2006, Matador lost about thirty per cent of its value, and in February of this year it suffered another big fall. Many hedge funds claim that they can generate high returns with little risk. Niederhoffer tells friends who want to invest money with him that it is too risky. (Most of his clients are multimillionaires and financial institutions.) “The idea that you can make a lot of wealth in a steady, unspectacular fashion, with no great gyrations, is a canard,” he said to me. “If you are going to try and make forty or fifty per cent a year, tremendous variations are inevitable.”

At three o’clock, when Wisdom and I went back upstairs, Niederhoffer was outside playing tennis with one of his traders, Duncan Coker. Soon, however, he returned, sitting down at his desk in a T-shirt, tennis shorts, and sneakers, ignoring the no-shoes rule. “The market’s supposed to go up from three until the close,” he said. “Let’s see if it does.” While Wisdom and I were having lunch, the Dow had stabilized and Niederhoffer had sold some of the stock futures he had purchased earlier in the day. “The worst mistake in this business is to be in over your head,” he said. “I was long about seventy-five million dollars. In addition to that, I had my regular option position. So I took the opportunity to reduce my exposure.”

In addition to speculating on short-term market movements, Niederhoffer frequently sells financial contracts, called “put options,” which, in the event of a steep fall in the market, would oblige him to pay out large sums of money. The buyers of these options are usually other investors seeking to hedge their positions, and in a sense Niederhoffer acts like an insurance company: in return for a premium—the price of the option—he agrees to bear the risk of a market crash. Often, this is a good business; but whenever the market enters a volatile period he is in peril. (“He is his own worst enemy,” Nassim Taleb, the author and derivatives trader, says of Niederhoffer. “One of the most brilliant men I have ever met, and he wastes his time selling options—something nobody can have any skill in—and it leaves him vulnerable to blowing up.”)

As 4 P.M.—the close of trading—approached, the Dow was again down, by about a hundred and twenty points. Niederhoffer didn’t seem particularly discouraged, though. He thought that he discerned a LoBagola pattern. “It’s going to be very bullish for tomorrow,” he said. “It will be the first one-hundred-point drop in sixteen hundred points. I’m going to buy some more futures.”

Niederhoffer’s theories about market behavior date to his college years. In 1964, when he was a senior at Harvard, he wrote a thesis on stock-market patterns. At the time, the so-called “efficient market hypothesis,” which states that stock prices move randomly and therefore can’t be predicted, was coming into vogue. Niederhoffer, citing data on trading volumes and subsequent price movements, claimed to have found evidence that contradicted the random model. His argument didn’t fully convince his adviser, the economist Robert Dorfman, but it helped earn him admission to the University of Chicago Graduate School of Business, where he enrolled in September, 1964.

At Chicago, Niederhoffer wrote several research papers arguing that it was possible to detect predictable movements in the stock market. He uncovered evidence, for example, that the market tended to do worse on Mondays than on Fridays. Several members of the faculty had helped to develop the efficient market hypothesis, and Niederhoffer’s relationships with his professors were often contentious. At one seminar, he later recalled, “I criticized all those who had concluded that markets were random, including most of the professors in the room, as being too heavy-handed in their testing methods to uncover the structure of price variations. Further, I cautioned them that their failure to disprove a hypothesis that no structure existed was methodologically inadequate to support a conclusion that prices were random. When I put it in the vernacular, ‘You can’t prove a negative,’ pandemonium broke loose.”

Niederhoffer was an early proponent of what is now called behavioral economics, and his unorthodox theories made him something of an academic celebrity. In 1969, he was hired at Berkeley as an assistant professor, and several hundred students signed up for his course on finance. Three years later, enrollment had dropped precipitately. “I wasn’t too good at it, frankly,” he told me. “I was not a very good teacher, and I had my own ideas about things. I was earning nine thousand dollars a year. I was playing squash, doing research, dabbling in business. It was all too much.”

Niederhoffer had also married—Gail Herman, a graduate of Bryn Mawr whom he met at the wedding of a Harvard friend, the economist Richard Zeckhauser. In the early seventies, Gail and Niederhoffer, who had decided to leave academe, moved to New York, where he started an investment-banking firm that sought out small, family-owned companies and helped sell them to bigger, public companies. The venture proved so successful that before long Niederhoffer and a partner, Dan Grossman, started buying and operating businesses themselves. Among the firms they acquired were American Almond, a Brooklyn company that provided almond paste to bakeries, and Tech Com Inc., a Florida defense contractor that built navigation equipment for planes and ships. “I would run the companies. Victor would visit them every two years or so, and cause havoc,” Grossman, a lawyer by training, recalled recently. “He’d say something like ‘What this company needs is sales. No more research, no more secretarial duties—I want you all out there selling things.’ Then he’d leave, and I’d say, ‘Don’t take any notice of what he said. That’s just Victor being Victor.’ ”

By the late seventies, Niederhoffer and Gail had two daughters: Galt, who was named after Francis Galton, the Victorian polymath who helped to develop regression analysis and coined the term “eugenics”; and Katie. In 1981, Niederhoffer and Gail separated, and he began dating his assistant, Susan Cole, whom he married in 1991. They have four daughters: Rand, Victoria, Artemis, and Kira. The mother of Niederhoffer’s son, Aubrey, who is one and a half, is Laurel Kenner, a former editor at Bloomberg whom he met in 1999. “My personal life is more complicated than Rupert Murdoch’s,” Niederhoffer joked to me. (Murdoch has six children from three marriages.)

Niederhoffer began investing seriously in the stock market when Galt and Katie were young. In 1979, using money he had saved, he started trading more or less full time and opened an office in midtown. “I got lucky,” he told me. “In eighteen months, I ran fifty thousand dollars up to twenty million dollars. I had an idea that there was going to be inflation, so I kept selling Treasury bonds and buying gold and silver. For a long time, it worked very well. Then one day I was playing racquetball in Staten Island with a guy who subsequently became the U.S. champion. After the first game, I called the office to see where the market was. The price of gold had fallen from eight hundred and fifty dollars to six hundred dollars in an hour. My net worth had gone down to ten million dollars.

“That was where my Brighton Beach training came in,” Niederhoffer went on. “I’d seen a lot of gamblers die broke. My father used to say I’d end up on the Bowery, like the other gamblers. I’d say, ‘Dad, I’ve got a system.’ He’d say, ‘Baloney. Those guys on the Bowery had more statistics and systems than you’ve got.’ I took what he said seriously. I told my assistant, who later became my second wife, ‘If I ever lose more than half my stake, close out all my positions. Don’t let me trade anymore.’ I went back to my match. During the second game, she sold everything. By then, my ten million dollars had dwindled to five million, but at least I got out with that much.”

Wall Street in the late seventies was much less technologically sophisticated than it is today. “If you could solve two equations in two unknowns, you were a high-tech person,” Paul DeRosa recalled. “Someone with Victor’s quantitative skills was a rare bird. In the early years, that gave him a big advantage.” In 1981, George Soros, who was by then a wealthy investor but who was having a bad year, heard about Niederhoffer’s reputed ability to predict short-term market movements and arranged to meet him at his office. Soros left the meeting impressed, and gave Niederhoffer some money to manage. The men shared an intellectual fascination with markets, and they became close, talking on the phone nearly every day, and playing tennis or chess several times a week. “My father had just passed away,” Niederhoffer recalled. “George was struggling. He needed a ledge to give him some purchase. I provided that.”

By the mid-eighties, Niederhoffer was managing many of Soros’s investments in bonds and commodities, which were worth hundreds of millions of dollars. On Tuesday, October 20, 1987, a day after the Dow dropped five hundred and eight points, Niederhoffer and Soros played tennis, as usual. Both men had lost a lot of money in the crash, and Niederhoffer had trouble concentrating; Soros, however, was calm. Don’t worry, he told Niederhoffer, the market will reopen tomorrow, and there will be plenty of opportunities to make back our losses.

Over the next several years, Niederhoffer’s funds yielded an annual average return of about thirty per cent, which put them near the top of the industry. In 1994, Business Week named him the best commodities-fund manager in the country. A year later, he started two new hedge funds: Niederhoffer Investments and Niederhoffer International Markets. For a while, he hardly slept. During the day, he traded stocks and currencies in Europe and the United States, and at night he bought and sold Japanese yen. He also invested in emerging markets, making successful plays in Turkish bonds and Mexican stocks.

Toward the end of 1996, another profitable year for him, Niederhoffer decided that he wanted to invest in Southeast Asia, which was widely seen as a growing market. He dispatched an old friend, Steven (Bo) Keeley, to the region. Keeley, a veterinarian who spent six months of the year living in the California desert without a telephone or electric power, had trekked in dozens of countries. On one trip, while paddling down the Amazon, he had contracted malaria, briefly gone blind, and been comatose for a week. Keeley believed that assessing a developing country’s economic prospects involved not only meeting with the C.E.O.s of leading companies but studying the lengths of discarded cigarettes—the theory being that the wealthier people are, the longer their butts—and the state of the brothels. After a couple of months in Asia, he reported to Niederhoffer that the brothels in Bangkok had recently become much cleaner and safer, and that Thailand was an excellent place to invest. During the previous decade, the Thai economy had grown at an annual rate of almost ten per cent; its interest rates were among the lowest of any country in the region; and its stocks were cheap because they had fallen sharply earlier in the year. In the spring of 1997, Niederhoffer invested several hundred million dollars in Thailand. Instead of buying stocks in some of the country’s biggest companies, he entered into complicated deals with Wall Street firms to buy futures contracts that were tied to the value of Thai stocks. The margin requirements for futures purchases are much lower than those for stock purchases, so he was able to put up a relatively modest amount of cash, while using borrowed money to accumulate substantial holdings.

His timing was atrocious. In May and June, a wave of selling swept through the Asian financial markets, and Thailand was especially hard hit. Many overseas investors tried to repatriate their money, and the Thai government started to run out of foreign-exchange reserves. On July 2nd, it was forced to abandon what amounted to a fixed exchange rate between the baht and the dollar, which had been in place for more than a decade. The Thai currency collapsed, and so did the stock market. The value of many of Niederhoffer’s Thai holdings dropped by more than ninety per cent. His lenders demanded that he put up more collateral. In order to meet their demands, he was forced to sell many of his profitable investments, which left his funds severely depleted. “We were like someone who is immune-deficient,” Steve Wisdom recalled. “We had lost so much money that we had no resistance left to other maladies.”

Apart from his Thai holdings, Niederhoffer’s most substantial investments were in the American futures markets. At first, the U.S. market weathered the Asian crisis pretty well, but in the fall of 1997 it became more volatile. On October 27, 1997, the Dow fell by more than five hundred points, and, for the first time in recent history, the market closed early. Amid widespread panic, Niederhoffer fielded calls from lenders. Some, including Refco, a large commodities broker, demanded that he give them more money to support his options positions. Niederhoffer was unable to come up with the cash, and the next morning Refco liquidated his portfolio.

“It was a very poor decision on my part to invest in Thailand,” Niederhoffer told me. “I had no scientific basis for investing there. In the U.S. market, there is evidence that it is a good time to invest after a big fall. In Thailand, there was no such statistical evidence. It was purely a qualitative idea. I’d seen Soros do that a lot of times and make a lot of money, but it didn’t work for me. Previously, I had had two or three qualitative ideas that made money—Turkish bonds, Mexican stocks—and it lured me into a false sense of security.”

We were sitting on a bench outside a building in the East Fifties, where Laurel Kenner lives and Niederhoffer stays when he visits. He was drinking a bottle of organic lemonade. I asked him whether hubris had contributed to his downfall. “Yeah, I’d say,” he replied. “In those days, we always wanted to be No. 1 in the ratings. There was a Canadian firm, Friedberg—they were having a good year, and we wanted to keep up with them. It was always nip and tuck between us and them.” Niederhoffer was silent for a moment. Then he spoke quickly: “You asked for reasons—I could name another ten. We had no stops. We picked the wrong country to invest in. We were too illiquid. We had too big a percentage of the market, and we didn’t have the ability to get out of our positions. We were too financially vulnerable to the brokers. I didn’t take account of the fact that I could be squeezed and that customers could withdraw their money. But mainly I didn’t have a proper foundation for my investment there. I had no knowledge of the country. I’d never even visited the country. All I had done was finance a trip by Bo Keeley to the brothels there.’’

After his funds folded, Niederhoffer fell into a deep depression. His eldest daughter, Galt, a film producer and novelist who is thirty-one and lives in Manhattan, recalls coaxing him to Long Island for a walk on a beach, where he knelt on the sand like a zombie. “It wasn’t just depression,” she said. “It was self-hatred and hopelessness. He felt like he had let people down. It was so shameful. This was a guy who grew up in a modest house, the son of a cop. Imagine what it would be like to create all of those things for your family and then to lose them.”

Niederhoffer had managed to retain some of his assets. He mortgaged his house in Connecticut and sold a collection of trophy and presentation silver and some of his rare books, which enabled him to pay off his creditors. He used this period of enforced inactivity to reconsider his approach to investing and to retool his pattern-recognition software. After about six months, using several hundred thousand dollars of his own money, he started trading again. “I had no brokerage account—no broker would do business with me under ordinary terms,” he said. “No customers would open a new account with me.” In 1999 and 2000 he did well, and in 2002 he started Matador, an offshore hedge fund. Its biggest investor was Octane, a hedge fund based in Switzerland, whose chief investment officer, Mustafa Zaidi, is an old friend of Niederhoffer’s.

At the beginning, Matador had less than ten million dollars to invest. In its second year, the fund had a return of forty-one per cent, and Niederhoffer’s renewed success helped him attract more money, including some from former clients who had lost their investments in 1997. (For these investors, he waived the hefty fees that hedge funds normally charge.) Eventually, he had enough cash to open two more funds. In February, 2003, Niederhoffer published “Practical Speculation,” a manual for serious investors, which he co-wrote with Laurel Kenner, whom he had been dating for several years. That year, he separated from his wife, Susan, and in 2004 he and Kenner launched DailySpeculations.com, which they dedicated to “the scientific method, free markets, deflating ballyhoo, creating value, and laughter.”

The Web site has since evolved into an informal social-networking site for speculators and aspiring speculators. “I met a lot of my friends through the site,” James Lackey, the trader who once worked with Niederhoffer and who posts regularly on the site, said. “Victor is like the hub where the wheels of speculation turn. He’s the center of so many of our relationships—we call him the Chairman. He’s the guy who keeps everyone in line.”

In April, 2006, Niederhoffer attended a dinner at the St. Regis Hotel, where MARHedge, a company that published a newsletter for the hedge-fund industry, presented him with an award as the top manager in the commodity-fund category. “What I’m proudest of is that we’ve made several hundred million dollars after fees,” Niederhoffer said to me in July.” “We’ve returned a lot more money to our investors than they have invested.”

As Niederhoffer and his funds prospered, it appeared to many of his old friends and colleagues that he had finally become a master speculator. “It is impossible to go through what Victor went through without it altering what you do,” Paul DeRosa told me in July. “It made him more conscious of risk, more attuned to it. It was an expensive education, but the important thing is that it wasn’t wasted.” Irving Redel, a former gold and silver trader and chairman of the New York Commodities Exchange, who was a mentor to Niederhoffer in his Wall Street days, said, “To be a great trader you need discipline. You have to have certain strategies that you follow, but you also have to have the flexibility to know when it is going wrong. And you have to know to never go beyond what you can afford to lose.” I asked Redel whether Niederhoffer has these qualities. He replied, “He does now.”

On the first Thursday of every month, Niederhoffer hosts a meeting of libertarians at the General Society of Mechanics and Tradesmen, on West Forty-fourth Street. One Thursday evening in early June, about seventy people were gathered in the society’s library, listening to an elderly woman in a white hat, who stood at a lectern talking enthusiastically about Christopher Hitchens’s book “God Is Not Great.” A middle-aged man with a beard spoke next, urging the others to accompany him on a walking tour he hosted called Ayn Rand’s New York, in which he visited local buildings where Rand had lived and held objectivist salons, as well as sites—the Waldorf-Astoria, Grand Central Terminal—that served as inspirations for places in her novel “Atlas Shrugged.”

The meetings are open to the public, and Niederhoffer, who was sitting on a table at the back of the room, swinging his legs, encourages each person to speak. He calls these sessions the New York City Junto, after the discussion group that Benjamin Franklin founded in Philadelphia in 1727, which held meetings for thirty years and eventually became the American Philosophical Society. Niederhoffer’s Junto is more casual, but he takes libertarianism seriously, considering it to be a natural complement to speculating. As a statement on his Web site puts it, “Victor Niederhoffer believes the purpose of life is the pursuit of happiness and achievement, and that the voluntary transactions that flow naturally out of an enterprise system are the key to material and personal freedom, and peace.” In an op-ed article that he published in the Wall Street Journal in 1989, he argued that speculators serve several important economic functions. When a good becomes scarce, he said, speculators bid up prices, which encourages firms to produce more and consumers to buy less, and helps to restore balance to the market. “I am proud to be a speculator,” Niederhoffer wrote. “I am proud that my humble attempts to predict Tuesday’s prices on Monday are an indispensable component of our society. By buying low and selling high, I create harmony and freedom.”

The guest speaker at the meeting was Thomas DiLorenzo, an economics professor at Loyola College, in Maryland, and the author of fourteen books, including “How Capitalism Saved America: The Untold History of Our Country from the Pilgrims to the Present.” DiLorenzo’s subject was the filmmaker and liberal gadfly Michael Moore. Not having seen Moore’s latest movie, “Sicko,” DiLorenzo was at something of a disadvantage, but he expressed outrage at Moore’s failure, in his previous films, to recognize the importance of competition, the virtues of sweatshops, and the depredations of socialism. At one point, Niederhoffer interrupted him and asked, “What are the general principles?” DiLorenzo replied, “Markets work and government-run monopolies don’t.”

At least one member of the audience, a gray-haired man, seemed to think that this was going a bit too far. He cited the Federal Home Loan Banks, an agency that makes mortgages more readily available, and the National Park Service. Don’t you agree that the government does some things well? the man asked. “No,” DiLorenzo replied. “The government has screwed up the national parks. I think capitalism would do a much better job with land.”

Shortly after ten o’clock, Niederhoffer ended the meeting. I was eager to speak to him about the stock market, which had fallen by almost two hundred points that day. “I can’t talk about it,” he said when I approached him. “It’s too painful. I might be able to review it in a few days.” He walked across the room to greet Kenner and Aubrey. He put his son on his shoulders and disappeared onto Forty-fourth Street.

On May 3, 2006, the day that Aubrey was born, Niederhoffer’s wife, Susan, filed for divorce. As his spouse and the legal owner of many of his assets, which he had transferred to her in 1997, she had claim to much of his fortune. For months, the couple’s lawyers argued. Then, in February, Niederhoffer persuaded Susan to drop the divorce proceedings. In return, he agreed to leave Kenner at the end of 2007 and return to her. Then he informed Kenner of the plan.

For now, Niederhoffer shuttles between the women. From Sunday to Tuesday, he and Susan share the house in Connecticut. (Three of their four daughters have left home; the youngest, Kira, attends boarding school.) He spends the rest of the week in Manhattan, with Kenner and Aubrey. “He’s emotionally involved with both of those women right now,” Galt said to me. “He never really leaves women. Wives become extended-family members, like in-laws, or honorary members of the harem. They tolerate it because he’s a flawed genius and a man. They take the good with the bad. It’s all I’ve ever known. All I’ve ever known is we are weird.”

I was having lunch with Galt at a French restaurant near her apartment in Chelsea. Although Aubrey’s birth had been a shock to the family, she went on, her father sees his other children regularly, and he is on good terms with his first wife, Gail—Galt’s mother—who divides her time between New York and Texas. “We’ve become kind of like this very functional dysfunctional family,” Galt said. “To most people, it is completely abnormal, and yet we’ve come to have this somewhat wholesome, happy dynamic. All of the girls are close. My mother and Susan have grown very close.” Recently, Galt added, she, Gail, Susan, and all her sisters except Artemis, who was away, got together to celebrate the third birthday of her daughter, Magnolia. Laurel was not at the party. “Laurel is another story,” Galt said. “Susan and Laurel are not close. There’s nothing happy about that.”

Last year, Galt published a novel, “A Taxonomy of Barnacles,” which she described to me as “an effort to exorcise my demons about living in a family that was different from everybody else’s.” The novel features an eccentric and domineering businessman who has six daughters and desperately wants a male heir. Eventually, he acquires one in surprising circumstances. Shortly after the book came out, Niederhoffer took Galt to lunch at the Four Seasons and told her that her book had been prescient. “Oh, my God, you have a love child!” Galt blurted out. “No,” Niederhoffer said. “I have a son.” A few months later, Aubrey was born.

Kenner, who is fifty-three, told me that she is unhappy about Niederhoffer’s arrangement with her. “Obviously, there is a lot of anger there,” she said. “But it is not just me. There is a baby involved.” I expressed surprise that her relationship with Niederhoffer remained cordial. “We had eight great years,” she replied. “He gave me so much. I am immeasurably better off on so many levels through meeting Victor. He was the best lover I ever had—not just in sexual terms. We wrote a book together. He is a great, romantic, gentle person.”

Niederhoffer declined to discuss his relationship with Susan. As for Kenner, he said, “We’ve had a very fine collaboration and had much pleasure and happiness together, and we have a wonderful son. We’re parents, and we still have mutual respect and admiration for each other.” He went on, “We didn’t have in mind the ultimate outcome, but we created a fantastic legacy—the baby, the books, and the articles.”

On Tuesday, July 17th, the Dow rose above fourteen thousand for the first time. The economy was growing, the long-term interest rate had dropped back to five per cent, and the volatile trading days of early summer seemed largely to have been forgotten. After the market closed, however, Bear Stearns announced that two of its hedge funds, which had investments in securities tied to subprime mortgages, had lost almost all their value. Problems in the subprime market spilled into money markets that banks and other financial institutions rely on to finance their daily activities; several more hedge funds went under; and commentators began to speak of a looming “credit crunch.” Stock markets around the world experienced wild fluctuations.

On Tuesday, July 24th, the Dow fell two hundred and twenty-six points. Two days later, it dropped three hundred and eleven points. Commentators on CNBC were making ominous pronouncements. I sent Niederhoffer an e-mail, saying that I hoped he had been well positioned for the market’s correction. He replied in three words: “I was not.” On Friday, July 27th, the Dow fell another two hundred points, closing four per cent down for the week. The markets were still volatile a week later, when Niederhoffer came into Manhattan for his monthly libertarian meeting. After it ended, we went across the street to a restaurant, where he ordered a cappuccino. He looked pale and haggard, and years older. For several minutes, we sat in silence. Then, in a low voice, he said, “Things have changed totally since we last spoke. The situation is fundamentally different. It is critical.” Kenner and Aubrey joined us, but Niederhoffer hardly seemed to notice them. “We are fighting for survival night and day,” he said when I pressed him for details. “I was caught wrong-footed in the market turbulence. I’m not as smart as I thought I was.”

The previous week, the Chicago Mercantile Exchange, in response to the turmoil in the market, had raised its margin requirements on futures traders, a move that was potentially devastating for Niederhoffer, who had hundreds of millions of dollars in options. He had more money in reserve than he had had in 1997, but he was worried. “It’s a matter of redeploying resources,” he said. “Also, in trying to be courageous in response to the crisis, I put up a lot of my own capital. You remember the story of the Essex and Captain Pollard? We are like a tiny fishing boat off the coast of Alaska that has been caught in the biggest waves in a hundred years.”

Talking about his predicament seemed to improve Niederhoffer’s mood a little. He ate some sorbet and played with Aubrey. Then he said, “Now I have to go home and work.” Kenner got up to leave, straightening her dress and inadvertently exposing a thigh. “Do that again,” Niederhoffer commanded. “Do what?” Kenner asked. “Lift it up,” he said. “It can keep a man afloat.” They both laughed.

During the next two weeks, I tried repeatedly to talk to Niederhoffer. Part of the reason for his reticence was that he feared a leak. Hedge funds depend on access to borrowed money. If lenders learn that a fund is in trouble, they might decide to stop giving it money—which can have disastrous consequences for the fund. On July 30th, Sowood Capital Management, a Boston-based fund, announced that the assets under its management had lost more than fifty per cent of their value in a few weeks, and the fund closed shortly afterward. By mid-August, two funds operated by Goldman Sachs had lost about a third of the value they’d had at the beginning of the year. Goldman decided to invest two billion dollars of its own money in one of the funds, Global Equity Opportunities, and it persuaded several wealthy investors to put up another billion dollars on favorable terms.

The spectacle of one of Wall Street’s most profitable firms being forced to shore up one of its flagship funds suggested some of the pressures that Niederhoffer was confronting. In today’s interconnected financial markets, there is no such thing as an isolated incident. When a dramatic event occurs in one sector, the effects are felt in others. The Goldman funds were computer-driven funds, and their software programs had failed to predict the size and speed of movements in the stock market. Prices had got “way out of whack,” David Viniar, Goldman’s chief financial officer, complained. “We were seeing things that were twenty-five standard-deviation moves several days in a row.”

Like Niederhoffer’s funds, the Goldman funds were heavily leveraged. For every hundred dollars of capital that the Global Equity Opportunities fund owned, it had borrowed about six hundred dollars. When a fund is leveraged six to one, a five-per-cent fall in the value of its portfolio becomes a thirty-per-cent loss in capital. “Leverage is a double-edged sword,” Richard Bernstein, an analyst at Merrill Lynch, wrote in a note to clients a few days before Goldman announced its efforts to prop up the Global Opportunities fund. “It enhances returns on the upside, but also makes underperformance more rapid and severe.”

Of course, Niederhoffer was aware of these dangers. But, between the middle of 2003 and the start of this year, the financial markets had been mostly calm. Stock prices had gone up, and, atypically, they had done so in a fairly straight line, with only two significant reversals, in May, 2006, and in February, 2007. From Niederhoffer’s perspective, the decline in market volatility was a welcome development, because it made his options trading much less risky. With prices steady or rising, he was less likely to be caught on the wrong end of a big market move. As the quiet times continued, many investors were lulled into believing that a less volatile era had begun. Alan Greenspan, who was the chairman of the Fed until February, 2006, helped to feed this illusion by talking about how financial innovations, such as the development of asset-backed securities, had spread risks more widely, making the market less vulnerable to shocks.

The crisis in the subprime-mortgage market changed all this. In the stock market, volatility was more pronounced than it had been for years. Even on days when the Dow closed just a few points down, prices lurched around. On Friday, August 10th, the Dow fell more than two hundred points before recovering at the close. On Thursday, August 16th, it fell almost three hundred and fifty points before closing down just fourteen points. A measure of market turbulence which many traders watch closely is the Chicago Board Options Exchange Volatility Index, known as the VIX. Between January, 2003, and January, 2007, the VIX fell from more than thirty to about ten. By the end of July, it had surged above twenty, and on August 16th, the day before the Fed cut the discount rate, it hit thirty-seven.

The surge in volatility prompted the Chicago Merc to raise its margin requirements for options on S. & P. 500 Index futures twice, first from two per cent to three per cent, and then from three per cent to four per cent. Niederhoffer was asked to double the amount of capital supporting his positions, and he found it difficult to raise the necessary cash. Some of his investments had lost a lot of their value, and the value of others was difficult to determine. There were so many moving parts in his portfolio that he wasn’t sure where he stood. When a trader can’t meet his margin requirements, he is at the mercy of his creditors. As Niederhoffer’s financial situation deteriorated, ADM Investor Services, a Chicago-based brokerage firm that caters to futures traders, ordered him to liquidate some of his options positions. Working late into the night, Niederhoffer berated himself for leaving himself so exposed. Referring to the margin calls, he said to one acquaintance, “I shouldn’t have been in the position where it could have had such an impact.” Despite the lessons of 1997, and the precautions he had taken, he was again in over his head.

Every August, Niederhoffer throws a big party in New York City, to which he invites dozens of regular contributors to his Web site as well as some of his friends. This year, there were about seventy-five guests. Most were New Yorkers, but some had come from as far away as England. For three days, Niederhoffer entertained them at his expense. On Friday, he organized a trip to the New York Botanical Garden and to a Mets game. On Saturday, he hosted a beach outing at Coney Island and a dinner at Delmonico’s, near Wall Street. On Sunday, he provided a picnic brunch in Central Park’s Conservatory Garden.

As the crisis in the market spread, Niederhoffer had briefly considered cancelling the party, but he decided that to do so would have alerted people to his troubles. At three o’clock on Saturday afternoon, I saw him in the crowd on the boardwalk at Coney Island, across from the Cyclone roller coaster. As usual, he wasn’t difficult to spot: he was wearing yellow trousers and a yellow T-shirt that said “Chief Speculator” on the back. On the beach, his staff had set up a blue canopy, and about a dozen people had gathered underneath it, taking shelter from the sun.

Niederhoffer had Aubrey on his shoulders, and he seemed to be in a better mood than when I had last seen him. He makes frequent visits to Coney Island and Brighton Beach; the house he lived in as a boy was about half a mile east of where we were standing. “We are going on the Wonder Wheel,” Niederhoffer said, gesturing over his shoulder at the slowly turning Ferris wheel, which dates to 1920. While he was gone, I spoke with two of his guests, a young Liberian M.B.A. student who said that he had recently posted an article on DailySpeculations.com about gambling on thoroughbred racing, and an older Frenchman who traded stocks at a Wall Street firm. The atmosphere was friendly and relaxed. None of the guests mentioned Niederhoffer’s financial predicament.

At 6 P.M., the party reconvened at Delmonico’s, which Niederhoffer had reserved for the evening. After cocktails in the dark-panelled bar, his guests entered the ornate dining room, where a Broadway tap dancer and a family of Hawaiian singers performed. I was seated next to Laurel Kenner and Aubrey, but didn’t see much of Niederhoffer, who was wearing a lilac jacket and spent most of the evening table-hopping. After dessert was served, he stood up to speak.

“This is a historic gathering,” he said, swaying slowly back and forth. “We are here in the middle of one of the greatest turmoils in Wall Street history. I am sure that many of you are keen to know how we are doing. Well, I can tell you that it has been very difficult. The battle has been joined, and it is still to be determined who the victor is. I always say that when you are in the middle of one of these situations it is better to say nothing. If you say you are doing badly, it gives ammunition to your enemies. If you say you are doing well, you are tempting fate. . . . We will see what happens and who wins the final point.”

Later in August, after the Federal Reserve cut the discount rate—the rate at which it lends to banks—the markets calmed down; but Niederhoffer’s woes continued. In September, he was forced to close two of his funds, including his flagship, Matador, which had declined in value by more than seventy-five per cent. After cashing out many of his investments, Niederhoffer repaid his lenders and returned what money was leftover to his clients. He laid off several employees and consulted with his lawyers. Meanwhile, rumors circulated on the Internet that, for the second time in a decade, his funds had “blown up.”

Had he been able to wait a little longer before liquidating his trades, his funds might have recouped most of the losses. After the Federal Reserve cut interest rates again, on September 18th, the stock market rallied further and volatility decreased. Still, Niederhoffer sounded philosophical. “The market was not as liquid as I anticipated,” he said. “The movements in volatility were greater than I had anticipated. We were prepared for many different contingencies, but this kind of one we were not prepared for.” Niederhoffer was still trading for his own account, and for some remaining clients. “My basic ideas about the creative power of the market, buying in panics, buying on weakness—I don’t think what has happened has anything to do with that stuff,” he said. “I am going to keep going, for better or worse.” ♦