The Mida Formula: A Trillion Dollar Bet is a 1999 BBC Horizon Documentary. It details the mathematical Black-Scholes formula that revolutionized the options industry. Its inventors received the Nobel Prize in Economics for their work, and the formula was utilized by Long Term Capital Management (LTCM). LTCM was a hedge fund that grew to be massive based on the initial returns, but then collapsed, losing billions and nearly bringing down the entire financial system with it.
The hedge fund believed that they could actually eliminate risk. In hindsight, we can see that actually wasn’t true. Yet this story seems to repeat over and over again…someone claims they have a found a way to always win, but these people never last very long. Risk is a part of trading. While we can control it, we can’t eliminate it, nor do we need to.
As traders, as long as our wins are bigger than our losers, even if we only win half the time (or less, or more) we can still be profitable. LTCM was blinded by their view that they couldn’t lose. Their models were based on market remaining relatively stable. Markets don’t stay stable for long. There are always things that shake up the market, resulting in price moves that are much different than the recent norm.
Accept risk, understand it will always be there, and use methods that accommodate for changes in the market.
You May Also Like:
Floored: Into the Pit (documentary) – A fantastic look at the Chicago trading pits, and the traders who made their livings there.
Quants: The Alchemists of Wall Street – Interesting documentary on trading and quantitative analysts/programmers–or “quants” who are behind the mathematical and financial models used today.
Black Wednesday – Documentary on the 1992 GBP crash where George Soros made approximately $1 billion in profits.