Many authors recommend to follow some procedure or method, consisting from a number of steps, to reach a desired goal. There are many “How to …” books, which popularize such approach. But, the main problem with this approach is that even if we do most of the steps in the right way, still even a single mistake/error will undo most of the prior efforts. In other words, in the real world such approach will fail, in many cases. Let us consider some historical examples.
Example 1, LTCM crisis
Long Term Capital Management (LTCM) was a hedge fund, created and managed by John Meriwether, in 1993. There were many PhDs and several Nobel Prize winners, who guided LTCM. LTCM’s main strategy was to make convergence trades. Convergence trades involve two assets whose prices must converge with time. The strategy was profitable until 1998 default of Russia when the strategy failed. Unfortunately for LTCM, the banks on which the strategy of the rubble hedge relied on, collapsed too. In the end, it was rescued by FED. It received a $3.6 billion bailout from a group of 14 banks, in a deal brokered and put together by the Federal Reserve Bank of New York. See [1-3].
Example 2, a pioneer of day trading (Jesse Livermore)
Jesse Livermore is considered a pioneer of day trading, who used technical analysis as the main tool for taking investment positions. He was the basis for the main character of “Reminiscences of a Stock Operator”, a best-selling book by Edwin Lefèvre. At one time, Livermore was one of the richest people in the world. In the Panic of 1907, Livermore's huge short positions made him $1 million in a single day. In 1908, he listened to advice from cotton trader Theodore H. "Teddy" Price, who told him to buy cotton, while Price secretly sold. He went bankrupt but was able to recover all of his losses. In 1915, he filed for bankruptcy again. He was able to recover from several bankruptcies, except the last. On Thanksgiving day, November 28, 1940, just after 5:30 pm, Livermore fatally shot himself with a Colt automatic pistol. Police found a suicide note: "My dear Nina: Can't help it. Things have been bad with me. I am tired of fighting. Can't carry on any longer. This is the only way out. I am unworthy of your love. I am a failure. I am truly sorry, but this is the only way out for me. Love Laurie". See [4-6].
In both cases, the risks associated with the rare events were ignored. As results, the execution of the methods failed. The main conclusion, we can derive, from these examples is: “avoiding mistakes/errors is more important than scoring big wins”. This truth is counterintuitive. It was brought into public view by Charley Ells in a “Financial Analysis” paper titled “The Loser’s Game”, in 1975 and his classic book “Winning the Loser’s Game”.
A simple way to avoid big mistakes is to ask ourselves the following question: “What happen in the worst case?” and to develop a plan to reduce loses in the case. Let us consider an example.
Helen has 1 million of satoshis in her hardware wallet. If she keeps all her digital assets in this hardware wallet and the wallet will be hacked then she will lose the whole her digital wealth. This will be very painful emotionally and economically. To reduce risks associated with this rare event, Helen follows the main principle of risk management: “Do not put all eggs into a single basket” and creates 99 virtual wallets. In each wallet (99 virtual and 1 hardware), she puts 10,000 satoshis. If her hardware wallet will be hacked then the loss will be only 1% of her total digital wealth. 99 virtual wallets do not exists in the real world, when they are not used, therefore it is not possible to hack them when they do not exist in the real world. See [7-9].
Even so, that a risk to be hacked it seems a rare event, it will be a big mistake to ignore the risk and loses associated with it. The risk must be diversified, hedged, or sliced into smaller parts. If Bybit would followed Helen’s approach it would not lost 1.4 bln.
P.S. “The big difference between those who are successful and those who are not is that successful people learn from their mistakes and the mistakes of others.”
— Sir John Templeton, CFA
References:
1. https://www.bauer.uh.edu/rsusmel/7386/ltcm-2.htm
2. https://www.investopedia.com/terms/l/longtermcapital.asp
3. https://en.wikipedia.org/wiki/Long-Term_Capital_Management
4. https://jesse-livermore.com/
5. https://www.investopedia.com/terms/j/jesse-l-livermore.asp
6. https://en.wikipedia.org/wiki/Jesse_Livermore
