Monday, November 9, 2009

Taking incalculable risks (and facing the abyss)

There are two choices in life, Aaron Brown (The Poker Face of Wall Street, Wiley, 2006) writes. You can take the conventional route, opting for what life offers in low- and calculable-risk opportunities, or you can move along a less crowded road, embracing incalculable risks. Brown suggests that the most common reason for embracing risk is pure egotism. “I’ve never met a successful . . . trader who didn’t believe he or she was better than everyone else. Some make it obvious, but for most it is a quiet article of unexamined faith. If you have it, it’s impossible to settle for what everyone else gets, however comfortable that is in absolute terms.” (p. 3)

Brown offers some rules for taking incalculable risks—rules intended to prevent certain failure, not a recipe for success.

First, do your homework. “Think like a middle-class person. Is there a safe way to get the same result? Can any of the risks be calculated? . . . In traders’ terms, you must take risk only when you’re getting paid enough for it.” (p. 4)

Second, strike for success. Brown quotes Dickson Watts (see my posts of 8/23 and 8/24 for a summary of his classic Speculation as a Fine Art) and advises us to act quickly and decisively once we make up our minds to act. “Go for maximum success, not minimum risk.” (p. 4)

Third, “make the tough fold.” Or, in trader talk, “Your first loss is your least loss.” Brown continues: “As you attack incalculable risks, you learn things that help you calculate. If the result of that calculation suggests that you are not getting sufficient odds to justify further investment, give up just as quickly and decisively as you began.” (p. 5)

Brown admits that the application of these rules will leave the trader in a lot of tight spots. “Rule 2 tells you not to hold anything back as you strive for success, and 3 tells you to give up often. If you keep anything in reserve, if you bet only what you can afford to lose, if you insist on a good plan of retreat, you should stick to risks you can calculate.” Because the only safety net Brown offers is the character, talents, and will of the trader himself. The thought of being friendless and broke in a strange place, he says, striking an existential note, cannot fill the all-in trader with despair. (p. 5)

And he continues, sounding ever more like the gambler. “If your goals are modest and you have adequate resources, you are likely to succeed. . . . If your goals are wildly ambitious relative to your resources, you’re likely to fail. But you might succeed. If having a real chance of succeeding—and a real chance of failing—is more attractive to you than what life offers in low-risk and calculable options, this book can guide you along the treacherous path you’ve chosen.” (p. 6) In fact, it doesn’t. But that’s not the point. Brown has framed the risk/reward scenario in its extremes. Each individual trader has to decide how far out on the ledge he’s willing to go.

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