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.

Anvil! The Story of Anvil & Prospect Theory

Music lasts forever . . . and sometimes the debt does too!
– Steve ‘Lips’ Kudlow, Anvil

Sacha Gervasi‘s Anvil! The Story of Anvil (2008) is more than a documentary on the Canadian heavy metal band Anvil: it’s one of the most poignant films yet on how our beliefs and emotions affect our decision-making abilities.

Gervasi’s film begins with Anvil’s triumph: a support set at Super Rock ’84 Japan where lead guitarist/vocalist Steve ‘Lips’ Kudlow wears bondage gear and plays a guitar solo with a dildo whilst drummer Robb Reiner unleashes fast blast beats.  Anvil’s albums Metal on Metal (1982) and Forged in Fire (1983) combine two different strands of heavy metal music: the New Wave of British Heavy Metal movement of the early 1980s that Def Leppard and Iron Maiden popularised, and outrageous tactics that Motley Crue and other Los Angeles bands would adopt in the mid-1980s.  The other bands at Super Rock ’84 sold millions of albums: Scorpions, MSG (Michael Schenker Group), Whitesnake, and Bon Jovi.

But Anvil didn’t and Gervasi explores why.

Anvil’s peers offer several explanations.  Metallica‘s Lars Ulrich suggests Anvil’s Toronto home disadvantaged them compared to the US heavy metal subcultures in Los Angeles and New York.  Motorhead‘s Lemmy Kilmister believes Anvil’s original lineup had talented musicians who never received their due recognition.  Slash the iconic guitarist from Guns ‘n’ Roses and Velvet Revolver contends that other bands took what Anvil did well and just ripped them off.  Anthrax guitarist Scott Ian just wonders where did Anvil go in the past 25 years?

Gervasi tracks down Kudlow and Reiner who are Anvil’s sole original members to Toronto.  Kudlow’s day job is a driver for Choice Children’s Catering whilst Reiner is a sandblaster.  Bassist Glen Five and guitarist Ivan Hurd struggle to survive.  Anvil’s only gigs are at a local sports bar.  They have no management, no producer, no record label contract and will rely on luck and perseverence to get to the ‘next level’ of their careers.

Anvil! documents Kudlow and Reiner’s attempts to achieve the heights of their Super Rock ’84 Japan success: a disastrous European tour and the recording sessions for This is Thirteen (2007).  Gervasi captures Kudlow and Reiner’s decisions during this process, their rationalisations when things go wrong, and the reactions of other band members, friends and collaborators.  Anvil! is thus less a mockumentary like Bad News (1983) and Spinal Tap (1984) and closer to a great case study in Amos Tversky and Daniel Kahneman‘s Prospect Theory: decision-making about risk where there are differences, known outcomes and unconscious biases.  Despite the improbability of achieving the rockstar dream after 30 years Kudlow and Reiner continue to strive because of their ‘Loser Take All’ passion and self-image, their early success at Super Rock ’84 Japan and the path dependence of their past decisions.

The European tour becomes a series of bad decisions: the tour manager doesn’t book train tickets for transport, Kudlow and Reiner fight with a club owner to pay a gig when only seven people turn up (‘We aren’t getting paid!’), and only 174 people turn up to a Transylvanian heavy metal festival in a 10,000-capacity venue (‘How much love could one person put into something?’).  The tour manager expresses remorse due to hindsight bias, falls in love with and then marries guitarist Ivan Hurd who leaves Anvil in 2007.  Kudlow and Reiner also have to fend against adverse selection when lawyers and others cluster around to take Anvil’s money.  Kudlow takes five weeks off work for the tour in which Anvil makes no money: ‘When we’re on tour we’re on vacation’ he tells Gervasi.

In the tour’s aftermath Kudlow admits to Gervasi why Anvil have not succeeded: they made bad decisions early on in their career, have no management to promote them, the past few albums have poor material and no production, and the band was ripped off by ‘indie’ record labels who never payed their artists (‘99.9% of bands never get paid’).

Kudlow’s solution is to approach producer Chris Tsangarides who worked with Anvil to record a new album.  Kudlow struggles to raise the $13,000 that Tsangarides requests: he lasts eight hours at a telemarketing job run by Anvil’s fan club president before turning to his sister who is a successful businesswoman and gives him the money.  The band decamps to Tsangarides’ studio in Dover, England, to write, record and mix This Is Thirteen
(2007).  The studio appears to consist of a band gear room, a vocalist room, and an audio engineering room with Protools software and a small mixing desk.  (Although Gervasi doesn’t explore it further the studio shots suggest that Tsangarides is also down on his luck and that his surface altruism hides the more pragmatic motive of generating income from any source to survive and trading on his past with Black Sabbath and Judas Priest).  Reiner argues with Kudlow over the lyrics and poor takes, and storms out.  Kudlow apologises and tries to bring Reiner back with a reminder about their teenage pact whilst Tsangarides tries to de-escalate the conflict and deal with the inevitable group tensions during the recording process.  Kudlow and Reiner reconcile during a Stonehenge visit.

Afterwards, Kudlow uses guerrilla marketing tactics to visit the offices of US record companies, and receives no interest after two weeks.  Kudlow then visits EMI Canada’s officer where an A&R manager turns off This is Thirteen after hearing Kudlow’s over-the-top vocals.  Gervasi ends Anvil! with an unlikely triumph when a Japanese promoter who saw Anvil on their European tour books the band to play a Tokyo festival.  Kudlow and Reiner worry backstage about if anyone will turn up and emerge to find the room full of thousands of fans who remember their Super Rock ’84 Japan performance.

Tversky and Kahneman’s work on Prospect Theory is central to Anvil!‘s narrative about Anvil’s tours and album recording sessions.  Kudlow’s nostalgia about Super Rock ’84 Japan highlights why he has an emotional overinvestment in Anvil’s self-image and appears stuck in a time-warp.  Others share this: bassist Glen Five is an Anvil fan whose belongings are in a garage because he can’t afford a house, the European tour manager has plenty of love and passion but fails in strategic execution, and Kudlow’s wife admits near the film’s end that because of her interest in 1980s heavy metal music and lifestyles she had wanted Anvil to succeed commercially in a moment that has passed.  Kudlow is overconfident about Anvil’s chances, he manages risks through the affect heuristic of immediate problems rather than consequences, and illustrates the knowing-doing problem of knowing what the barriers are and yet not developing mitigative strategies to bypass them.  Gervasi hints that Anvil might have pursued other options, from doing children’s parties at Kudlow’s catering firm to Reiner’s private collection of landscape paintings.  Luckily, Anvil!’s success has opened up new possibilities for Anvil including a MySpace page and street team.

Anvil frequently make comparisons between themselves and the successful bands at Super Rock ’84 Japan.  This is a self-narrative that illustrates Tversky and Kahneman’s anchoring a  cognitive bias which focuses on specific information in decision-making.  Anvil! would be even more interesting if it contrasted Anvil’s underdog failure with the comparison bands who have all run into major problems yet survived due to business savvy managers and major label support: albums recorded for tax purposes (Anthrax), management problems and hostile fans (Metallica and its managers QPrime), lineup, recording and tour problems (Anthrax, Black Sabbath, Guns ‘n’ Roses, Iron Maiden, Judas Priest, Motorhead, Velvet Revolver), and peaks and troughs in their careers (Anthrax, Black Sabbath, Bon Jovi, Iron Maiden, Metallica, Motorhead, Scorpions).  Nor are the costs of these ‘sucesses’ explored: on the first date of Anvil’s European tour Kudlow reunites with Twisted Sister guitarist Eddie Ojeda who looks to be a drugged, emaciated mess.

If that’s heavy metal ‘success’ then Anvil’s hometown longevity, label independence, lifelong friends and supportive family may have been a better long-term choice.