Martin Kronicle

In his awesome new book The Rise and Fall of Bear Stearns, Ace Greenberg spends the majority of the time setting the record straight from divergences from he thought was the truth. The majority of these divergences came from the mouth of Jimmy “I put it to my mouth and I did inhale” Cayne.

This is a blog about trading so I’ll spare you all the details, but frankly, my take on the whole she-bang as delineated in the book, is that dealing with Cayne was like dealing with a teenager for 30 years. He was a complete pain in the ass, but every now and then he’d make a big play in the game, so his parent (Greenberg) would be proud. Cayne’s ego would be his undoing. He fell on his own saber.

Greenberg gives Cayne credit where it was due and appears genuine. I could not tolerate anyone like Cayne and it’s why I enjoy being a prop trader. If you bust my chops enough, I can tell you to “go forth and procreate with yourself.”

What you’ll get from this book is a great history of Bear Stearns, during which Greenberg spent the majority of the career we know him to have had. Bear was 21 years old when Greenberg started and he spent the next 61 years there.

Throughout his career, Greenberg has been a trader first. All the other roles he played or assumed emanated from his role of trader and his understanding of risk management. It appears that he was able to trade his accounts with full discretion — which means that he could buy, sell, and short at will for his clients who trusted him enough to do what was best for them. They still do. Greenberg was born with the perfect temperament for a trader and IMO his next book should be about trading.

I tried to convince his handlers to get him to do a podcast with me, but those of you who know Ace, know that he is a man of few words. If you’re thinned-skinned or not ready for him, he may come across being unintentionally curt. I think he’s just direct and to the point. My dad is that way.

If you’re looking for trading gems, the book is light in this area. But then again, this is not about trading so much as the book is about “the rise and fall” of a firm and its employees that Ace felt greatly responsible for.

One thing that Ace did and owned was to make sure that the house account was purged of all losses post haste: there was no way of getting around this and all the head traders of the various desks had to answer to him first thing Monday morning. Below is an excerpt from Ace in his own words that describes that recurring Monday morning scenario:

“Every Monday I chaired a meeting of the risk committee, whose agenda was to enforce limits on the extent of our capital exposure. Traders from eight or ten departments attended, knowing that yours truly would react quite unhappily if anyone was found to be holding a loss. As a rule, losing positions got sold on Friday, and I didn’t care how nasty a hit we had to take, by 4:00 pm. Monday all the dogs better have been off the books.” (Bold emphasis is mine).

Emerging CTAs and students of trading pay small fortunes for proper training. The single most important take-away should be to keep losses small. The spiritual benefits of not having losses suck up all your attention and energy is so freeing, you can focus on looking for new winners.

The Natural Gas spread known as the Widowmaker has been getting some press recently in the WSJ and in Bloomberg/BusinessWeek, but unfortunately for you the reader, it has been plagued with poor writing. The WSJ ran one called Hedge Funds Whipsawed By Gas Bets, which I’ll dissect for you here.

Not two paragraphs into the article, the authors “anchor” you by stating that “Morgan Stanley Smith Barney clients invested in a $640 million group of funds that have emerged as some of the biggest losers in the turmoil. Hedge funds known as “trend followers”—which chase market movements, rather than making fundamental investment decisions —also appear to have been hurt on bad trades.”

By mentioning the losses, you are anchored into thinking that these clients lost a lot of money, which is not necessarily the case. Trend Followers don’t chase either: they spend most of their time waiting for their buy and sell stop orders to get hit since most markets do not trend most of the time.

Trend Followers, if they even trade spreads, were likely long the spread, not short the spread. Most trend followers trade individual contracts directionally — that is, they are either long natural gas or short it. Two, Trend Followers as a group are technical traders who don’t make “bets” based upon fundamental data…that is the realm of hedgers for the most part.

You want to sell the spread when it narrows or lessens, or becomes more negative. Conversely, you want to own something that will increase in value. This particular spread is one of several natural gas spreads that are highly liquid. You adjust the position size for the very volatility that the articles mention. The 20-day Average True Range (ATR) for the March 2001 contract is about 12 cents and it’s about 10 cents for the April 2011 contract. The ATR is a measurement of volatility. In the case of this spread, and in all spreads, you’re long one volatility and short the other.

click to enlarge

As you can see, the spread weakened a full 30 cents or $3,000 per spread from $0.45 to $0.15. Then it formed what looks like an inverted Head and Shoulders pattern, which can indicate a change in trend to the upside, which is the case here. I’ve applied Victor Sperandeo’s 123 Trend Reversal rules because anyone can use them and they are easy to understand. The breakout to the upside occurs at $0.20 and then the spread goes parabolic.

My guess is the WSJ is looking for some headline grabbing, but to a trained eye, the writing is poor. It took the spread approximately 4 WEEKS to move a total of $0.03 or $300 per spread from May 7 to June 7. A trend follower such as myself would never have been short once the downtrend was broken, in fact, one might have been long at $0.20.

March/April 2011 Weekly Chart (click to enlarge)

I’ve written about the March/April before in John Arnold & The Widowmaker back in November 2009 and this past January for the Huffington Post in Portfolio Heat: Brian Hunter Manipulated Natural Gas.

The March/April (of 2007) spread collapsed approximately $2.50 or $25,000 per spread.

The following year’s expiration, the 2008 March/April spread narrowed $1.40 or $14,000 in approximately 5 months. Had you been short, you could have captured any or all of this move. You can trade these spreads many years out on the calendar. Hunter traded against the trend. If he made a bet, it was that the trend would reverse.

To trade something very volatile, keep your positions small or use options to limit your losses.

Any commodity future contract can become a Widowmaker if you want it to. All you have to do is like Brian Hunter did with the “more-on” strategy: trade big in one contract and use a lot of leverage. When it goes against you, you put “more-on.”

(Click to enlarge)

Jim is suspicious of all governments, as I think you should be. Speaking of governments, I hate seeing nonsensical article titles such as, Obama, Visiting Gulf, Tries To Lift Economy, Mood. I want straight talk and I would never rely on anyone else to lift my mood. He can’t lift the economy either. Who in their right mind would think that any President could do either? A fool would. And Obama is no hero. My buddies in the NYPD are heroes. Obama is concerned with political fallout (his), more than economic fallout (ours). But I digress…

According to the accompanying CNBC clip, Jim is long the Euro, but not because he’s bullish on the EC by any standard. I’ve read and re-read each of Jim’s books, and I’ve interviewed him for this blog twice. I think he’s without peer. In fact, I know he is without peer.

He likes to say that he’s the world’s worst trader. IMO, when he’s wrong, it’s usually because he’s every early on the trade – which might be the case with his Euro trade. Either he’s just missed picking the bottom or he’s a little early on a potential new uptrend.

Jim Rogers Interview

Presidents and Prime Ministers can jawbone all day long. They talk their books (their policies) as well as any money manager. You can see the truth in the price and decipher for yourself the night soil from the proverbial tin of Shinola. The price will not lie. The price has no political agenda.