Niederhoffer Discusses Being Wrong

Victor Niederhoffer on Being Wrong Read his interview in the New Yorker Magazin http://www.newyorker.com/reporting/2007/10/15/071015fa_fact_cassidy

Hoodoos, Hedge Funds, and Alibis: Victor Niederhoffer on Being Wrong 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. www.csinvesting.wordpress.com Teaching/Studying/Investing

Page 1

Victor Niederhoffer on 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. www.csinvesting.wordpress.com Teaching/Studying/Investing

Page 2

Victor Niederhoffer on Being Wrong

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-betrue 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. www.csinvesting.wordpress.com Teaching/Studying/Investing

Page 3

Victor Niederhoffer on Being Wrong

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 www.csinvesting.wordpress.com Teaching/Studying/Investing

Page 4

Victor Niederhoffer on Being Wrong

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 www.csinvesting.wordpress.com Teaching/Studying/Investing

Page 5

Victor Niederhoffer on Being Wrong

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? www.csinvesting.wordpress.com Teaching/Studying/Investing

Page 6

Victor Niederhoffer on Being Wrong

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."

Kathryn Schulz is the author of Being Wrong: Adventures in the Margin of Error. She can be reached at [email protected]. You can follow her on Facebook here, and on Twitter here. This interview is part of a series of Q and As in which notable people discuss their relationship to being wrong. You can read past interviews with mountaineer Ed Viesturs, This American Life host Ira Glass, celebrity chef Anthony Bourdain, Sports Illustrated senior writer Joe Posnanski, education scholar and activist Diane Ravitch, and criminal defense lawyer and pundit Alan Dershowitz.

www.csinvesting.wordpress.com Teaching/Studying/Investing

Page 7