A trading friend of mine emailed me:

“Hi Michael – An old friend called me yesterday. He is a very successful neurosurgeon and a very good person as well. His only downfall in his mind is his lack of success in the trading world. After we exchanged pleasantries he asked me what I thought about the stock market. After a brief pause I responded, “I think the stock market is going up!” He then mentioned he subscribed to a couple of very expensive forecasting services one of which is run by a live “guru” who won a big trading contest several years ago. His next question was how could I disagree with the guru? I then responded, “You asked me what I thought about the stock market and I told you it is going up because it IS going up right now. Look at the chart!” We laughed as I was not being mean but simply offering him an observation of what the market is doing right now not what I think the market is going to do. I then told him I don’t ever have a clue what the market is GOING to do and anyone who says they know is either a very big liar or an idiot. I simply respond to a set of rules for trading and I guess I am dumb enough to just keep following them to the best of my ability. I then reminded him of two very important lessons that he should be learning right now.

#1: No one really KNOWS what a market is going to do although many profess to know.
#2: If you follow the beliefs and more importantly the advice of others you and you alone are responsible for your results be they good or bad. Van Tharp calls this phenomenon “respondability.” The only person responsible for your results is in the mirror.

Amaranth loses…so who wins? This blowout has the smell of a few big winners – maybe one big winner. It reminds me of Barings Bank. One dumb bet (Nick Leeson is now played by Brian Hunter) with some smart winners on the other side. Think the winners will be on the front of Time Magazine?

A reader, Chris Dugan, forwarded me this comment on Amaranth from Bernie Schaeffer:

“It’s amazing to me that Amaranth seems to have relied on the same “principle” as did the disgraced managers of Long-Term Capital, “stewards” of what was (until Amaranth) the biggest blow-up in hedge-fund history. Simply put, this “principle” holds that various historical relationships between various markets will “mean revert” once they begin to diverge significantly from the norm. The mean reversion principle has become an article of faith among many of the major hedge funds. Given the alleged sophistication of these supposedly risk-savvy players, it is shocking that a principle that thumbs its nose at the “fat tail” events that are far, far more common than any modeling ever suggests continues to have holy-grail status. And then, when funds like Long-Term Capital and Amaranth blow up, the ready excuse is “who would have thought such a ‘highly remote’ event would ever occur?”

He added:

“The lesson here is that these models that are so avidly followed by those who should know better have been dead wrong and continue to be dead wrong about the odds of so-called rare events. The equity markets have been in a derivatives-induced coma for several years now, and my sense is that the upcoming fourth quarter is about as ripe a period as I can imagine for this coma to come to an abrupt end. Regardless of which way the break goes, we will likely have derivatives pain, which almost certainly means more hedge fund pain. An upside breakout can blow away those who’ve been heavily overwriting calls; a downside break creates potentially huge liability for those who have sold a massive quantity of very low delta puts that have thus far been “free money,” month after month. In other words, market moves may begin to feed on themselves rather than mean revert, and some players will pay – big time – for this.”

Now that is a great view from Bernie Schaeffer.

A recent article PDF about religion and money. An excerpt:

In a recent survey of people with at least $25 million to invest, “hard work, smart risk-taking and God” were credited for wealth accumulation. Last week, Time magazine’s cover story asked “Does God Want You To Be Rich?”

This is all, quite literally, a Holy Grail IMHO. That’s not me professing a religious view one way or the other. I just see it difficult for rational investment choices to blend with ‘faith’ – whatever it might mean to whoever.

Here is a copy of a recent Amaranth conference call (PDF).

Janice Dorn (site) submitted this article:

Pain is what you walk through. Misery is what you sit in. Take an old pair of jeans and cut a hole in one of the front pockets. Now, start pouring sand into that pocket. What happens? Sand runs down your leg and to the ground. What do you do? Keep pouring until the sand is up to your ankles? Your knees? Your waist?

(more…)

From the wires today:

“Oil exporting countries may consider a cut in output after crude prices fell below $60 a barrel on Monday for the first time in six months…The oil price fall over the past month has been accompanied by investor selling in oil and other commodity markets, mainly on concerns that economic growth in the US is slowing. “There is a concern by hedge funds that oil and commodities are no longer the one-way bet they once were,” said an Opec official.”

No longer a straight line up? Nothing a little manipulation can’t fix. At least they are honest about the lack of a free market, eh?

From the Associated Press today:

“Oil prices have dropped 23 percent since the middle of July, attributed to ample global inventories, eased worries about supply threats from Iran and Nigeria, receding fears about this year’s Atlantic hurricane season and as signs of economic weakness in the U.S. point to a possible softening in demand for energy. “The hedge funds and investors have been bailing out because geopolitical tensions have eased and they also realize that inventories are high during this period of seasonably weak demand at the end of summer,” Shum said.”

The funds I know have not “bailed.” They are just short energy now – making money on the down trend.

Brian Cypher writes:

“The reason I wanted to write to you is your posting on Amaranth. When I read that, I thought “Amaranth must have made a huge directional trade or continually scaled into long positions as gas went down. They totally disregarded any portfolio risk analysis measures.” I couldn’t believe that a firm like this, which had attracted “smart” money, could make such a grossly over-weighted trade not only in monetary terms but in ego as well. Even if they would have just limited their total portfolio exposure to 5% (approx. $475 million) to the Natural Gas market, the loss would have been limited to that or at best 50-60% loss of that 5% or $250,000,000 or so. I don’t get it but then I do and it makes my personal goals that much more attainable. This is just one more example of how trends will continue to persist in markets.”

From a reader:

“Strangely now Amaranth is saying they are “eliminating energy trading from our strategy”. I wonder how that will help? Wouldn’t the same style of crazy leveraged bets be ruinous in another market as well? Amaranth went on to say “liquidity dried up so quickly that the fund was not able to unwind its energy positions.” WHAT?? NG contracts are not liquid? Something is wrong here. Could Amaranth have had such a large position that they were a significant percentage of the entire open interest? Michael, I think this is a better chart than the one you posted on your blog.”

“It clearly shows a downtrend in 2006. Why would somebody bet that prices would go even higher when they peaked last year and hadn’t really come off that much since? That is, if one is looking for weather correlation, shouldn’t there be a tighter spike with rapid decline after Feb? To me, if you weren’t in on the 2005 uptrend, it appears that one should have put on a small short position in Feb 2006 with a wait and see attitude and a stop order. Was Amaranth buying all the way down expecting an even higher price than December 05 peak at $11.20? Maybe hindsight is 20/20, but it sure looks like a downtrend to me.”

From a reader today:

This is one sentence from a Bloomberg story on Amaranth’s conference call this afternoon:

Amaranth founder Nicholas Maounis, speaking on a conference call with investors today, said his firm considered the market moves that caused the losses a ‘highly remote’ possibility. (Emphasis mine) The firm’s energy investments were ‘fully consistent’ with its strategy, he said.

First of all, we know that ‘highly remote’ events are not that remote after all. Long-Term Capital learned the hard way, but by now everyone else should know that ‘remote’ stuff happens!

Second, he claims that the energy investments were fully consistent with their strategy? How is that possible? They were supposed to be a multi-strategy fund, but they had 50% of their capital in energy trades. In fact, it looks like they had 50% of their capital in ONE trade. How is that consistent with ‘multi-strategy’?

I received a call today from a well-known trend following firm. My friend wanted to vent/laugh a little at the irony in the definition of Amaranth:

1. Any of various annuals of the genus Amaranthus having dense green or reddish clusters of tiny flowers and including several weeds, ornamentals, and food plants. Also called pigweed.
2. An imaginary flower that never fades.

But he quickly turned serious about the $4.6 billion dollars transferred in the zero sum game of the markets. He noted that Morgan Stanley had declined to invest with his firm due to perceived ‘riskiness’, but that same Morgan had lost their shirts in Amaranth.

He went on to question the blind sheep plowing money long only into “commodity funds.” He then told me that 21 of their 26 positions in their portfolio are “shorts.” Market is down – follow the trend.

So how bad was the ‘Pigweed’ fund blowup?

“Many investors, meantime, want out. Some are so anxious to exit their positions that they’re willing to sell their stakes in the fund for less than half what they were worth at the end of August, according to Hedgebay, which operates a secondary market for hedge fund holdings. For example, people who had $1-million (U.S.) invested in the fund a few weeks ago are now willing to sell their position for $400,000, said Hedgebay co-founder Jared Herman in an interview from Connecticut. Investors are now willing to pay $300,000 for that stake.”

Put all your eggs in one basket (one market) and allowing a young thirty something to pull the trigger with no risk management…and none of this is a surprise. The surprise to me is who was invested in this donkey show.