31st December 2011: Trading Books

Market Wizards: Interviews With Top Traders by Jack D. Schwager (Columbia, MD: Marketplace Books, 2006). (TS-3). Schwager’s interviews are frequently at the top of professional traders’ recommended reading lists for their insights into the personalities, backgrounds, decisions and different strategies of traders. Schwager’s follow-up books The New Market Wizards (Columbia, MD: Marketplace Books, 2008) and Stock Market Wizards (Columbia, MD: Marketplace Books, 2008) feature further informative interviews with different groups of traders. Useful for comparison with Brandt, Einhorn, Lewis, and Mallaby below.

 

The Big Short: Inside the Doomsday Machine by Michael Lewis (New York: Penguin Books, 2010). (TS-3). Lewis (Liars’ Poker, Moneyball) profiles the Wall Street analysts and hedge fund traders who foresaw the 2007-09 global financial crisis: Steve Eisman, Mike Burry, Greg Lippman, Charlie Ledley, Ben Hocket, John Paulson and others. The Big Short how credit default swaps and other synthetics of financial engineering were created. Lewis exemplifies how ‘contrarian’ traders think and make trading decisions about financial markets: there is enough journalistic reportage in this book to actually model the trading strategies. For details of J.P. Morgan’s creation of collateralised debt obligations see Gillian Tett’s Fool’s Gold (Little, Brown, New York, 2009). For details of John Paulson’s ‘Soros trade’ see Gregory Zuckerman’s The Greatest Trade Ever (Penguin Books, London, 2009). For the best account of the negotiations behind the 2007-09 global financial crisis, see Andrew Ross Sorkin’s Too Big To Fail (Viking, New York, 2009). For further analysis of the business cycle implications, see Nouriel Roubini and Stephen Mihm’s Crisis Economics (The Penguin Press, New York, 2010).

 

More Money Than God: Hedge Funds and the Making of a New Elite by Sebastian Mallaby (London: Bloomsbury PLC, 2010). (TS-3). Mallaby’s history of hedge funds – financial vehicles that enable pooled investors to speculate on stock-markets – has interviews and historical details which are unavailable elsewhere. More Money Than God explores how hedge funds have evolved over the past four decades, from journalist Alfred Winslow to philanthropy. There are interviews with George Soros, Julian Robertson, Bruce Kovner, Paul Tudor Jones, John Paulson, and details of David E. Shaw’s firm D.E. Shaw and James Simons’ Renaissance Technologies: two ultra-secretive quantitative hedge funds. As with Jack D. Schwager’s series on traders, this is an invaluable book for understanding how hedge funds actually work and the motivations of their founders. For some of the best academic research (and influenced by Isaac Asimov’s Foundation series) see Andrew Lo’s Hedge Funds: An Analytic Perspective (Princeton University Press, Princeton, 2010). For a comparison with ratings agencies, see Timothy J. Sinclair’s The New Masters of Capital (Cornell University Press, Ithaca NY, 2008).

 

Fooling Some of the People All of the Time: A Long Short (And Now Complete) Story by David Einhorn (Hoboken, NJ: John Wiley & Sons, 2011). (TS-4). In 2002, hedge fund manager David Einhorn gave a speech advising investors to ‘short’ Allied Capital. Einhorn’s talk triggered a criminal investigation and maneuvers between Einhorn and Allied Capital. This book can be read as an investigation of corporate governance issues that foreshadowed the 2007-09 global financial crisis. Its primary value lies in revealing the research methods and decisions that a successful value-oriented fund manager uses; the accounting tricks that firms use; and how Kahneman’s biases and heuristics can influence hostile situations. If you want to understand the basics of corporate finance, valuation and fundamental analysis then see the McKinsey model in Tim Koller, Richard Dobbs, and Bill Huyett’s Value: The Four Cornerstones of Corporate Finance (John Wiley & Sons, Hoboken NJ, 2010).

 

Diary of a Professional Commodity Trader: Lessons from 21 Weeks of Real Trading by Peter L. Brandt (Hoboken, NJ: John Wiley & Sons, 2011). (TS-4). Most trading books feature post facto selections of trade examples and market timing. Brandt’s diaries and technical analysis charts convey how difficult trading actually is; the importance of risk and money management; and the struggles to deal with Kahneman’s biases and heuristics. This book dispels the myths of day-trading success and much of the publishing books that Wiley Finance, McGraw-Hill and other publishers release.

 

Thinking, Fast and Slow by Daniel Kahneman (New York: Farrar, Straus & Giroux, 2011). (TS-1). Kahneman (awarded the 2002 Nobel Prize in Economics) and his late colleague Amos Tversky pioneered the study of psychological biases and decision heuristics. Kahneman distinguishes between System 1 (fast, emotional) and System 2 (slower, methodical, logical), and how these different cognitive systems affect us. An excellent primer on how to think, reason, and decide more effectively, which makes accessible over four decades of Nobel Prize-winning research. Effective trading is about making reasoned decisions in a fast, volatile environment. For an example of how event risk and volatility can affect decision-making and financial models, see Roger Lowenstein’s When Genius Failed (Fourth Estate, London, 2002) on the 1998 collapse of the hedge fund Long-Term Capital Management.

 

Unconventional Success: A Fundamental Approach to Personal Investment by David Swensen (New York: The Free Press, 2005). (TS-3). Swensen is the successful investment manager with Yale University’s endowment fund. Unconventional Success distills his insights on the investment process; how to develop an investment portfolio; the different asset classes; and the role of asset allocation over market timing (trading). Swensen — like John C. Bogle (founder of The Vanguard Group), Burton G. Malkiel (A Random Walk Down Wall Street), and others — recommends that you put most of your money into a low-cost index fund like Vanguard or Dimensional Fund Advisers. Swensen’s companion book Pioneering Portfolio Management (The Free Press, New York, 2009) deals with active managers in an institutional funds context. If you want to understand the institutional money management approach, see Richard C. Grinold and Ronald N. Kahn’s Active Portfolio Management (McGraw-Hill, New York, 1999) for quantitative and risk management processes, and Antii Ilmanen’s Expected Returns (John Wiley & Sons, Hoboken NJ, 2011) for asset allocation decisions.

 

The Predators’ Ball by Connie Bruck (New York: Penguin USA, 1989). (TS-3). In the 1980s high-yield or junk bonds led to a mergers and acquisitions bubble. Bruck profiles junk bonds trader and market creator Michael Milken (now a philanthropist) and the major deals that his firm Drexel Burnham Lambert financially engineered. The Predators’ Ball has substantive insights and journalistic reportage on Milken’s thinking and strategies, similar to Lewis (The Big Short) and Mallaby (More Money Than God). This period is also covered in the Adam Curtis documentary The Mayfair Set (1999). This is a cautionary tale of ethics and power: Milken essentially created and monopolized the junk bond market but acted unethically and was involved in the Ivan Boesky scandal. The epochal RJR Nabisco deal is covered in Bryan Burrough and John Helyar’s influential Barbarians At The Gate (Collins Business, London, 2008). For a comparison of Drexel Burnham Lambert with the private equity firm Kohlberg Kravis Roberts see George P. Baker and George David Smith’s The New Financial Capitalists (Cambridge University Press, New York, 1998).

 

Inside Job (Sony Classics, 2010). (TS-3). Charles Ferguson’s Academy Award-winning documentary dissects the 2007-09 global financial crisis and its roots in a housing speculative bubble, the failure to regulate derivatives markets, and a ‘winner takes all’ trading culture. Features interviews with George Soros, Nouriel Roubini, Raj Rajaratnam, and others that summarise complex issues.

 

Million Dollar Traders (BBC2, 2009). (TS-3). European hedge fund manager Lex Van Dam and ex-trader Anton Kreil supervise 8 novices who run a hedge fund in London’s Cass Business School for two months. Several weeks into the project, the 2007-09 global financial crisis begins, and each trader reacts in different ways. Interesting for its use of simulation learning, event arbitrage and how the various personalities deal (or don’t) with stressful situations and uncertain decision-making. In one sequence, the cameras reveal that Kreil is having instant chat messages with outsiders using a producer’s account: Van Dam may actually be trading against the novices.

 

The Mayfair Set (BBC, 1999). (TS-3). Adam Curtis (The Century of the Self, The Power of Nightmares, The Trap, All Watched Over By Machines of Loving Grace) profiles a group of entrepreneurs associated with London’s Clermont Club, including Jim Slater, James Goldsmith and Tiny Rowland. The Mayfair Set documents their stock-market deals and internecine fighting from the late 1950s to the 1980s mergers and acquisitions bubble in the United States. Curtis links together fears about national sovereignty, business cycles, financial innovation, media battles, and luck. Jim Slater’s Return To Go: My Autobiography (Weidenfeld & Nicolson, London, 1977) recounts the Slater Walker years whilst Geoffrey Wansell’s Tycoon: The Life of James Goldsmith (Grafton, London, 1987) is an insightful, semi-authorised account of how Goldsmith pioneered mergers and acquisitions raids and asset management techniques.