Episodes 149 & 150 ... Aaron Brown (59:21, 64:19)

Interesting guy ... clearly not a conventional thinker or person ... I enjoyed it.

At AQR ($200 billion quant fund) for a decade
Didn't like the commute to AQR
Liked reading numbers in back of newspaper (sports and financial statistics) as a boy
Read Thorp's Beat the Dealer, fascinated by it
Grew up in the western US in the 1960s (Seattle)
Became obsessed with money around age 14 in the early 1970s
People who lost their jobs in the neighborhood disappeared; it was creepy
Very shy kid, 14 years old, tried to play poker to make money, and it worked
Went to Harvard, took a lot of math and statistics, graduate courses only, Harrison White signed off on it
Harvard grad students are dumber than Harvard undergrads, classes more interesting at grad level
Becoming better known as pro poker player ... also did a lot of sports betting
It's hard to scale up when you win at poker
Your unconscious brain wins poker at the highest levels, not understanding the numbers
Have to enlist your unconscious brain to win at high levels of poker
Don't let fear and greed drown out the quiet voices in your brain
Good traders use their unconscious brain to make good trades
Sleep deprivation stimulates a certain kind of learning
You need to know yourself, what motivates you
Your conscious brain isn't consulted when you make decisions, you just make up excuses after the fact
1978-79, people didn't really know how to trade options
If you could do option math in your head, you could make money
Floor trading options you can pick up crumbs, but you can't scale
They were worried about the speed of sound in a 20 foot radius around options specialist post [not the speed of light as in the HFT age, a funny comment]
You had to physically be in the pit, and the trades were small time, no big lots
Couldn't get rich betting sports games, but you could get rich running a bookie operation
Entered Ph.D. program in finance at U. of Chicago
Managed billion dollar bond fund in the 1980s
Head of mortgage securities
Crash of 1987 hurt everyone
Became a professor for a time
Went to work for JP Morgan
It's easy to make money, but hard to keep it
Invented the term "risk management" (outside of the insurance industry), didn't mean "risk minimization"
Front office risk manager decides how much traders can bet
CEO talks to middle office risk manager who talks to the front office risk manager who talks to the traders
Started at AQR in May 2007 and crisis hit in August 2007
Cut risk in late July 2007 just by chance
Losing a worst-case loss for a year every day, day after day, for three days
Cliff Asness called the bottom of it, whether by chance or not, no one knows [Cliff is now a billionaire]
Quant equity crisis of 2007, everyone forgot about it after the 2008 crisis hit
Featured in Scott Patterson's book, The Quants
3000 longs and 3000 shorts simultaneously, make tiny gains with massive leverage, that's the idea
Quant equity funds all had overlapping positions, this was part of the problem
Funds don't have to report their short positions, only longs
Brokers can tell you what is Hard To Borrow
Quants are engineers, logical ... learn from mistakes
Quants don't like to change bet size just because of losses, hate drawdown control policies
Down 10% in a month, whether through losses or redemptions, clients can terminate contracts
Let investors out who want to get out, you don't want them in your fund anyway
You never want to be in a trade where the risk is managing you
All words for risk have some opinion attached to it (either positive or negative)
Traders have a very different idea about risk
Risk is something we exploit, it's like energy, and we respect it
Most people like predictability, but some people are more spontaneous
Gamblers and thrill seekers trade with no edge
The goal of trading is making money, that's your job, nothing else matters
Most people don't know why they do what they do
Most people who try to trade are pursuing some silly illusion
The best traders do it because they can't imagine doing anything else
You want to start risk taking when you're young, can't do it when there are "adult stakes"
The best traders are really bad about explaining how they manage risk
Traders who try to swing big to make up for past losses, it's a disaster
But you have to be willing to make big bets even after a series of losses
How far do things have to go against you before you know that you're wrong?
Traders internalize two ideas: they might be right and they might be wrong
How much does it make if you're right, how much does it lose if you're wrong?
Only need two scenarios in your mind for any trade
You equally weight both scenarios in your mind
How much are you willing to lose when you're wrong? Must decide this first
Most traders leave too much money on the table most of the time
Most traders spend 80% of pre-trade strategy about capping the downside
They should spend 80% of the time figuring out what they're going to do if they're right
How do you exit a trade when you're right? This is the key question
Some people want to win a lot of pots (at poker) instead of winning a big pot
You have to know who you are ... do you prefer scalping (winning lots of pots) or holding for a larger gain (winning an occasional big pot)?
You should know your profit ratio: average win on winning trades divided by the average loss on losing trades
Your win ratio is going to be whatever it is... think harder about your profit ratio
Don't try to guess what will happen, just prepare for what might happen
Risk avoidance mistake: start small and then get bigger (you should reverse this)
Plan for success! Pick a size and stick with it
Emotional decision making means reckless decisions
Focus on median outcomes (not the average outcome) ... look for good median outcomes
Kelly Criterion teaches us that if you take more risk, all you do is increase probablity and size of bad outcomes
Every trader MUST understand the Kelly Criterion (read Thorp's book)
Haghani experiment with bet size with biased coin very telling ... most people (financial professionals) went broke!
Every finance professor in the country should have been shocked by the Haghani Experiment (but they didn't care)
Things happen that you can't put in your probability model
1% of the time you have no idea what's going to happen -- it's not predictable
Takes significant amount of resources to maintain a Value at Risk model
Good non-specialist description of VaR: Financial Risk Management for Dummies (a book he wrote)
Kelly Criterion teaches you to design trades with maximum loss in mind given your edge ... gets you in the right ballpark
Haghani Experiment proved most people have no idea how to size a bet
Professional gamblers he asked all instantly knew the optimal bet size in the Haghani Experiment
His website: www.eraider.com (lots of fascinating stuff on there)