His advice is all well and good but "skilled risk managers" can be just as dumb as everyone else. This has been proved multiple times in just the last few decades alone.
His advice is all well and good but "skilled risk managers" can be just as dumb as everyone else.
I work at an investment bank and I can safely confirm that most professional investment managers and risk managers fall for this type of stuff all the time.
If you want an example, look as Nassim Taleb's idiotic moves. Here's just one from 2010:
So in 2010 Taleb's advice to short U.S. Treasurys. How'd he do in the last 5 years? If he followed his own advice then he lost almost half his money on that trade as US Treasury rates fell dramatically since then.
I'm not picking on Nassim Taleb. He's a smart dude. But everybody - everybody - makes dumb investment decisions.
One difference between professional traders and amateurs is that pros don't judge a trade by its outcome but by the idea and its execution. What makes something a good trade is if it is a good idea at the time based on the available information. But even the best idea may not work out and that's where risk management comes into play. Conversely, you can also make money on a bad trade, but it's still a bad trade. A professional trader's job is not to predict the future but to make good trades.
Taleb's idea may have been good at the time that simply did not work out. Of course, his statement tells you nothing about the concrete implementation of this idea which more often than not will make all the difference w.r.t. a trade's outcome. Maybe he even did actually make money from the idea. There's really nothing to suggest that he would have shorted in 2010 and just held the position since then.
Shorting treasuries in 2010 was a popular sentiment. I'm sure you could have found a similar suggestion in the WSJ at the time. It is extremely unlikely, given Taleb's background as an options market maker, that he would have expressed that trade simply as an unhedged position in cash treasuries or the futures while he sat bleeding money for five years straight. It's an important distinction to make and I think it comes back to my original point about risk management. It is one thing to make a prediction and it's a separate step to then formulate a trade that captures upside if your prediction is correct and limits your downside if your prediction is incorrect. From a trader like Taleb, I think that's implicit in his statement, but maybe it wouldn't be so obvious to a layperson.
Taleb was very precise in what he said, and he didn't say anything like what you are attributing to him. There wasn't any real nuance, he really just said it was a good idea to short treasuries:
Taleb has written literally hundreds of pages on risk management and if you don't consider any of that as context, I guess you could assume he literally meant to get short some delta one treasury product. I think that's a little bit naive but whatever.
You have to switch it from Russian (ру́с) to English. He says you want an "active position" where you "benefit from rise [in rates]." The video then shows Hugh Hendry, who has basically the opposite position but for European government bonds. He is short rates (so long bonds) but he has an options position which fixes his maximum loss at some known value. Hendry spells it out, but I think given Taleb's background, he probably meant something like that (but in reverse).
He says you want an "active position" where you "benefit from rise [in rates]."
Rates went down dramatically. In fact, they were cut almost in half. He was completely wrong on this prediction over the last 5 years. Maybe he was early - doubtful - but over a 5 year time frame that's as good as wrong.
but he has an options position which fixes his maximum loss at some known value
If you are long an option then it fixes your maximum loss at some known value. If you are short an option, then your maximum loss is infinity.
But let's be real. Even if you are long an option, that option will expire. Over 5 years you probably rolled that option a minimum of a few times and more likely several dozen times. Almost every time you would've experienced a loss.
Why is it bad to admit that he Taleb was just spectacularly wrong on this position? (Just like 99% of other professional investors that expected rates to spike up dramatically from 2010 to 2015).
Okay, I watched a bit of the video now (thanks for linking to it). I still don't see what's so ambiguous about "stay short Treasury bonds", he says it quite directly, and as far as I can tell from the video he means it, but maybe I'm wrong. He also says in that video says you should buy deep out of money options on gold/other metals in case hyperinflation happens.
So first, as far as I can tell, he really did say and mean those things.
Second, the suggestions, the bet on rising interest rates, as well as the bet on hyperinflation, are, I think, ignoring basic macroeconomics, and they pretend that some really implausible outcomes can happen. Maybe you would hedge the bet, and have other trades that bound your losses, but they would still have lost money. I don't think it matters that much that with a cleverer execution they would have lost less money. The point is that they were wrong in the first place.
> I'm not picking on Nassim Taleb. He's a smart dude.
No, but you should pick on him, in a public-figure kind of way, I mean, not personally. He very publicly said (I paraphrase) "all macroeconomics is nonsense, you should short treasuries". His advice ran against solid macroeconomics and was demonstrably wrong. It wasn't just "dumb" advice, it was advice that deliberately ignored all sense and deliberately plumped for a dubious economic theory.
If I said something really stupid, I would expect to be called out on it. In general, I think, people would be better off if bullshit got called out.
“You have a very small probability of making money,” he said.
“But if you’re right, you’ll never see a public plane again.”
-Taleb, on shorting treasuries
Maybe not important, but in the video minimax linked to in another comment, he said that about buying far out of money options on precious metals to bet on hyperinflation happening, not shorting treasuries to bet on rising rates.
Not to kneejerk defend Taleb, but I believe his stated position is that he loses money on his trades almost all the time, and then makes it all back and more when a black swan event occurs. I don't believe a black swan has occurred in the treasury market in the last 5 years, so it would be interesting to hear if he's still waiting for one there.
If you're interested, here's a good article behind rationale and personality of Nassim Taleb's strategy. http://gladwell.com/blowing-up/
Everything in options trading is probability-based. So you can either buy a $1 lottery ticket that wins $1000 for 0.01% time, or sell a $1 lottery ticket to one counterparty that may only be redeemed for $1000 for 0.01% of time.
So for the lottery buyer, you know you're going to lose most of the time; so you size your bets accordingly to your expected value (formally known as Kelly's Criterion) to ensure that you still have enough stake while you're losing most of the time to keep betting and win in the long run when your loss rate regresses to the mean probability.
Likewise, the lottery seller's P&L profile is like an insurance disaster company. On most days, you steadily collect the insurance premium from your policyholders. But you have to size your "risk pool" and watch it carefully to ensure that you are well-capitalized to be able to pay out insurance claims when disasters hit. And if your expected value, again with Kelly's is no longer viable, you'll have to either sell your insurance policies to another trader or buy a hedge to re-insure yourself (formally known as keeping delta, gamma or vega neutral depending on the risk type in the options market).
Nassim Taleb's strategy involves mostly buying option straddles on indices and also large-cap blue chips. With options, based on expiration date and the current market's implied volatility, he can pick and choose accordingly the daily "loss rate" he is willing to take and also more importantly, what he thinks the market's "real volatility" level should be over the current "implied volatility" expressed in the options pricing.
So by sizing his bets properly, choosing an option series that limits his daily decay and expresses his opinion about volatility, he is able to make money over the long run (e.g., 2008 when the market mispriced volatility and VIX shot up to 200 and SPY went down a lot; his straddle gained in both implied and realized volatility).
There is an extensive Wikipedia article[1] on this topic. Here's an excerpt:
In economics and finance, a Taleb distribution
is a returns profile that appears at times
deceptively low-risk with steady returns, but
experiences periodically catastrophic drawdowns.
The general idea is that because black swans occur infrequently, their risk is significantly under priced by most people.
NB: Taleb does not advocate investing using a Taleb distribution; instead he warns against that sort of investing.
By definition, a specific Black Swan is unpredictable, but in general the likelihood of any Black Swan event is higher than the markets factor in.
You'll never pick the day it happens. But if you invest everyday, eventually you'll be right (according to the theory). Take a trade that will almost certainly lose you 1% per annum BUT, in a Black Swan event will return you 1000%. Every year you 'bleed', and it takes guts to keep investing. Then one day something hits the fan, and you were the only one exposed to the upside.
