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Fascinating read about Long Term Capital Management

July 1st, 2010

A while ago I got a bunch of books from Amazon that I’m currently going through. I just finished a real page turner that I definitely recommend to anyone, even vaguely, interested in financial trading. It is the story of Long Term Capital Management (LTCM) and the people behind it, a lot of professors, MIT graduates and even two Nobel price winners (every Swede knows that Alfred Nobel didn’t consider Economics a real science and that the prize in Economics really is given by the Swedish Riksbank in memory of Alfred Nobel, and not by the Nobel Committee itself). What I find the most interesting is the belief that these guys had in their models of the world and that markets are rational and efficient. This lead them to take risks that were hard to understand and quantify. Essentially they never closed positions for loss, they waited til they reversed and showed a profit. They could do this for a long time because they had large sums om money and could get loans from a number of banks.

I find myself in the same situation (but at a much smaller scale of course) with the range trading strategy implemented in my Green EA. The strategy and model was based on a currency (or whatever really) that traded in a defined price range. Both currencies I traded with the strategy, AUDNZD and EURCHF, had been confined in a range for over 10 years when they both broke out at almost the exact same time this spring. AUDNZD reversed back into the range (within safety limits), but EURCHF is currently about 1400 pips outside and really shows no signs of reversing. Had I let this roll all my accounts would have been destroyed now (just like the demo that I haven’t interfered in here).

The same happened to LTCM. They traded a lot of different instruments (focus on bonds) in a lot of different regions, that normally hedged each other. Anyway, I don’t want to give away the ending. Read it yourself :)

When Genius Failed: The Rise and Fall of Long-Term Capital Management

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