How many people saw the financial crisis coming and profited from it?

2007 Christmas party at a dear Friend’s apartment in Azabu, Tokyo. He was the head of MacQuarie securities in Tokyo. Champagne was flowing and i was passably drunk. There was a bunch of Lehman, Morgan Stanley, Citi and other dudes, all smart articulate people.

They were talking about the current uncertainty saying it was an opportunity to buy on dips. I rolled in saying this would be the first time sh!t was about to flow uphill. All those delinquent loans would not end well. The two things that people buy on credit are homes and cars. If home loans turn delinquent, then the rest would follow, contagion. I happened to be tracking Japanese car manufacturers US car sales and watched them plummeting. They laughed at me and concluded that i was a drunken lunatic. Point taken…

1 year down the road, December 2008 same party, half the people. The Lehman dudes were gone or at Nomura. One of the guys ran up to me. I was about to duck and hit the floor as if chased by the police: “no

-“No i don’t do drugs anymore, no i did not do your wife, no i didn’t steal anything, you got the wrong guy” routine. He shook my hand and said:

-“You are the only one who saw it coming and had the courage to speak up. Whatever You say i do. What should i do now?”

-“Really?”, i said. “I don’t remember. I might have been seriously drunk”

-“You were a little more than tipsy, but you were funny and more importantly you were right”, he said

I had correctly predicted the crash, and was too drunk to even remember it. Sounds about right:

-“Hmm, Plausible”, i answered. “Alright, so buy when monetary authorities roll out the big guns”,  i said.

-“OK, but Buy what then?”

-“Come on, do i really look like i know? Seriously? Monetary authorities are panicking. They are about to roll out the mother of all monetary bazookas. So, it does not matter what you buy, everything will rally”

-“Yeah, right. You are drunk again” and he walked away

He did not buy and I should have followed my own advice. I gave back a lot of performance in the 2009 rally. I insisted on shorting cyclical stuff when i should have shorted defensives. I was stubborn. I stopped trying to make predictions shortly thereafter.

Now, the implicit question is probably: are we in the same situation now? I don’t know and frankly, it really does not matter. I looked at my forecasting accuracy stats and concluded i should not be in the forecasting business anymore. Not encouraging for the rest of the industry considering i foresaw the crash and the ensuing recovery.

These are the main lessons:


  1. predict the next crash: you will sell too early. It is as useful as forecasting when you are going to get sick. Only hypochondriacs check themselves in hospitals before they get sick. Don’t listen to those market hypochondriacs telling you the mother of all bear markets is around the corner.
  2. Focus on why: what matters more? Why you got cancer or how to cure it?
  3. Duration and depth: when it happened, sell-side “quants” rolled out average duration tables. On average bear markets last for xx months. If You are sick, what would you think of a doctor who would say You will have 39,8 C fever and you will heal in 3 weeks 2 days, 17 hours?


  1. Recognise when it is there: build a system that tells you now it is time to sell and go short. To identify the top, use my floor ceiling method. It works objectively after the fact. Laurent Bernut’s answer to What is the most precise way to draw support and resistance lines for forex trading?
  2. Recognise when it is gone: Everyone got terminally beared up at the end of the bear market. They all, me included, missed the rally. Those who said they bought in March 2009 are like descendants of the Mayflower: deluded liars. To identify the bottom, use my floor ceiling method. It works objectively after the fact
  3. Have a bear market plan: bear markets are notoriously stressful. Not the brightest idea to devise an emergency exit plan when the building is on fire

Do you have any advice, analogies, or even abuse that you can give me so that I dont exit my winning positions too early?

Do you have any advice, analogies, or even abuse that you can give me so that I dont exit my winn… by Laurent Bernut

Answer by Laurent Bernut:

Now, that is an excellent question. You have the right approach to solve it. Change your beliefs and your reality changes. The reason you cut your profits is because you have been burnt with losses and wan to protect some profit. The reason you procrastinate on stop losses is your ego taking over. Awesome question, let’s have fun

Tiger Moms math aptitude

Among the numerous studies on the “Tiger Mom” effect, one of the funniest and most interesting ones happened when they decided to test the mothers’ math aptitude. One university assembled a team of Asian mothers. They gave them a mathematical test. They were primed with dis-empowering stereotypes on females, mothers: “ladies, You may not like math. You probably don’t do a lot of calculus, algebra and trigonometry these days. Sorry about this…”. One month later, they gathered the same moms, administered the same level of test. This time, they primed them with empowering Asian stereotypes, emphasis on education“You are Asians, right? Asians are supposed to be good at math”. Voila, with simple priming, average score jumped 20%. Congratulations, Way to go Ladies!!!

Morales of the story:

  1. if You want to solve the Fermat theorem, something that has eluded mathematicians for centuries, round up a bunch of Tiger Moms. Remind them that if wasn’t for them balancing the family budget, looking after the education of kids, making sure future generations will be financially well off, they would all live under bridges and tunnels, courtesy of their drinking, gambling husbands. In addition, tell them that solving that simple problem will guaranty entrance to top schools for their children. Leave a stack of application forms to Harvard for inspiration and motivation. Come back before it is time to pick up the kids for their piano, math, and karate/ballet lessons. Problem solved. Anything else?
  2. Change your beliefs, they will change your reality. Impact goes as far as muscular mass and oxygen retention in muscles

You are facing a common problem: Cut your winners, ride your losers. (BTW, have You considered a position in the mutual fund industry? Popular skill set You have here)

How to reverse it? Re-parent the orphan

First, You need to know that abuse will not work. Part of your problem is ego fighting back. Ego, in the Jungian archetypes, is the orphan. In your brain, this is the amygdala, one of the most primitive defense mechanisms. Any attack will push the orphan deeper. Not a good idea. Forgive yourself for your mistakes. This will soothe the amygdala

Metaphors work

Have You ever wondered why we memorize stories instead of abstract concepts? So, using metaphors will definitely help You.

Time asymmetry

In a world where You want to ride your winners and cut your losers, the latter will come quicker than the former. That means your account will drop before it rises. This time difference is a feature You must accept. That is part of the game. It takes time for good trades to mature.

Exit plan and the geography of divorce

Exit is like divorce. No-one wants to but roughly half of the population divorces anyways. So, if You don’t think about it before getting married, it may get a lot more expensive than You think. There is a reason “divorced Barbie” is so much more expensive than all the other Barbie dolls out there. She comes with Ken’s house, cars, boats.

The point is You need to have a clear uniform exit plan. There is no such thing as customised exit plan for that particular stock or that particular case. This nonsense will confuse your inner idiot. Complexity is a form of laziness.

Switch from outcome to process orientation

May i suggest You read this piece on the psychology of stop loss. The psychology of stop loss: how You can be 100% right despite 60% failed trades by Laurent Bernut on Alpha Secure. Look at Bill Ackman and Valeant for a great counter-example. Ego took over and clouded his judgement. No-one is immune.

Your new metaphors must emphasize process over outcome

The way i did it: trap price in a box

I remember the day when i moved from semi-discretionary to 100% systematic. I remember it because the next day i was not stressing about all open positions.

That day, i made a commitment that until stop loss, partial exit, time exit were triggered i had nothing to do. After entry, there are only 3 ways stock can go: up, down or nowhere (x-axis: time). Price is boxed.

Of course, things did not always look good. But i thought of those exits as booby traps. until one of them gets tripped, no need for premature action.

I remember that day, because in the afternoon i started watching Shaolin flicks on Youtube to cut the boredom. While my colleagues waiting for announcement, my computer made some awesome Bruce Lee sounds. I was at peace following the exit plan.

Peaceful exit

Once you decide on an exit plan, commit to doing nothing until one of those booby traps gets triggered. It will bring immense peace.

Stock market is a highly competitive sport. Every hundredth of percentage point counts. If you put every single position in a their individual exit box, they will be no need to stress over them. The right exit will show up. This will save terabytes of mental bandwidth

Do you have any advice, analogies, or even abuse that you can give me so that I dont exit my winning positions too early?

Is short selling bad for your psyche?

Is short selling bad for your psyche? by Laurent Bernut

Answer by Laurent Bernut:

“Lo que no mata engorda”, what does not kill you makes you fat. Bob Baerker, a respected short-seller, sums it well.

You are probably alluding to the good and evil battle between the righteous short seller who perceives wrong, the arrogant and corrupt management who falsify their financial statements and price that stubbornly goes up until the final collapse.

Fairness will kill You

Fairness is one of the very few built-in traits in humans. Numerous studies have been conducted on fairness in toddlers. It appears that our sense of fairness predates our language. Even children who turned out to exhibit clinical psychopathic tendencies, dysfunctional amygdala, react to fairness.

So, as short sellers, every now and then, we are tempted to right the wrongs. We engage in a duel with companies and the multitude who buy into the frenzy. One sane mind against a raging mob is still an unfair fight.

A simple advice is to wait until the mob has changed side and starts liquidating its position. You will be vindicated.

Short selling: the spinal tap of investing

Stress volume always at 11

In spinal tap, they can turn the volume at 11. On the short side, stress volume is always at 11, even when it works in your favor. In that sense, short selling is corrosive for your psyche until You learn to manage stress.

It takes time to get there but here are a few techniques that will help You:

  1. Plan your exits: the short side is a bumpy ride. I used to maintain between 40 to 60 shorts at all time. That’s a lot of bumps. It all changed when i set up hard exit rules. Having hard rules for exit is a tenfold reduction in stress. All my Long Only colleagues were glued to the newsfeed to guess what to do next. Meanwhile, as nothing flared up, i was left watching spiritually awakening and highly educational content on Youtube
    1. partial exit: take risk off the table as a short squeeze starts. No-one knows how far price will retrace and gains evaporate, so reduce size
    2. stop loss: never enter a short w/o a stop loss. Never override stop loss. No exception
    3. reversal: there are quite a few false positives. Sometimes, shorts turn into Longs before they trigger a stop loss. Do not ignore what the market is telling you. Market is right, or it can afford to stay wrong, you can’t
  2. Quantify your risk: risk is not a story in the US, China or wherever. Risk is a budget: how much you can afford to lose and keep trading. Accept you could lose that much because:
    1. This is called pre-mortem. It actually releases endorphine and facilitate recovery. The quicker you can put a bad trade behind you, the quicker you can focus on the next one
    2. More often than not, you will lose. Quantification helps you get better at money management
  3. Practice mindfulness: every other spiritual guru talks about mindfulness. In its simplest form, it is the ability to observe what is happening without being sucked into the emotional roller coaster
  4. Welcome to the dark side: the short side will test the darkest corners of your psyche. It will go and elicit fears so deep you did not know you had them. Great, fear dissolves when exposed. I used to journal fears and work through them using Byron Katie’s The Work. Van Tharp recycled this in his fantastic “trading beyond the matrix”. Fear elicitation is a great tool to help you work through your subconscious phobias.


Viktor Frankl, who happened to have survived Auschwitz and Birkenau, said between stimuli and response there is something called freedom. You have the choice of how you will respond. So, fear happens, losses mount. How you choose to deal with them is your path to emotional freedom

Is short selling bad for your psyche?

#Quora: If 90% of traders lose and 10% wins, are those 10% disproportionally made up of very high IQ people?

If 90% of traders lose and 10% wins, are those 10% disproportionally made up of very high IQ peop… by Laurent Bernut

Answer by Laurent Bernut:

No, but for different reasons that the instructive and brilliant answers given by people far more intelligent than yours truly. Making money in the market is a side effect. Yes, You read correctly. Would You like to know why ?

(An entire section of my upcoming book on short selling is devoted to this topic so stay tuned)

The biology of trading:Inner alignment 1

To all of You who believe markets are efficient and think of yourselves as rational investors, how many times did You check your mails today ? 10–20 times. That is Dopamine in action. This is the reward circuitry. Not even Paris Hilton has a life exciting enough to check mails continuously. We do so because our brain releases dopamine (feel good hormone) for mild uncertain rewards.

Have you ever found yourself overriding your risk limit just right around the wrong time? Overconfidence is the ubiquitous plague of traders. Rational investor, would You like proof of overconfidence? Divorce statistics, i rest my case with your multiple ex-wives

Now, when your performance sinks and you can’t think straight, do you pass up trades? Do you find yourself exhausted, irritable? Cortisol

Your average pension fund manager is the direct descendant of someone who woke up in a cave and started running after mammoths for breakfast. Not exactly savvy with probabilities but the survivors got the girls…

The hard wired mind of trading

In the 60s Michael Gazzanika developed the theory of split brain. We, humans, pre-consciously rationalise our decisions. Take a look at the junk in your portfolio. A solid third of it would not even be there if you had to do it all over again.

Do You find it hard to execute stop losses (Oh, the chapter on the psychology of stop loss is worth the entire book multiple times, i will refund anyone who does not have a aha moment there) ? Ego prevails over profits. Valeant (VRX), case in point…

Subconscious beliefs and fears

Fears exist in the shadows. In his book, Daniel Goleman (the EQ dude) describes elf deception as a built in mechanism that covers its own tracks. we rationalise all the time. Proof? when was the last time you got laid (Maslow pyramid about reproduction)? when was the last time you rationalised a decision ?

Market participants do not trade to make money. Proof?Look at the junk that fester in your portfolio… Some of us trade to prove to someone dead 20 years ago (i-e father, mentor, bully at school, whatever) that they are worthy individuals. Dude, You are beautiful, You are worthy of love.

The floating world of beliefs and fears

Finally, floating at the surface like ice cubes in a single malt are conscious beliefs and fears. Fears of losing your job, fear of missing out, fear of pulling the trigger, fear of inadequacy (smart guys are buying that Enron thing so i will join the party)

Of course, there is the belief You cannot time the market. Who told you that? Journalists and analyst who hug the mike and more importantly yourself when the thing you just bough went south…

Now, let’s quip the IQ myth. Self deception is a mechanism that covers its own tracks. High IQ dudes always have spectacular excuses. I know two types of traders: those who make money and those who have excuses. Which one are You

Bottom line: born to lose

Bottom line, your biology f@#ks you up. Your beautiful mind comes delivered with amazing features, most of which will get You killed on the markets (try fairness for instance). Then, your ego, your subconscious deep rooted fears will supersede your best intentions. Then, there is this floating junk of unchecked beliefs irrational fears.

So, no wonder 90% of the people lose money.

Now, why do 10% succeed? The hero’s journey

They succeed simply because of their inner alignment of their biology all the way up to their daily routines. Great traders are not smarter, they have smarter trading habits. Making money is just the yardstick of inner alignment.

Would You like to know about the three scientifically proven methods to re-align yourself? Then, please follow, or subscribe to my (free) website, or help launching the book

As Arnold, Ze Great Governator said: “Ze hardest part of putting on muscles is getting to ze gym, jaa”

If 90% of traders lose and 10% wins, are those 10% disproportionally made up of very high IQ people?

How significant is following the news for forex trading?

How significant is following the news for forex trading? by Laurent Bernut

Answer by Laurent Bernut:book_buy_sell_sell_new_1024x1024

I know two types of traders: those who trade the newsflow and those who make money. 1) How the brain perceives news 2) What news matters and what does not and how to know which is which 3) Stop Loss and newsflow

  1. The engineered poison of newsflow: Mice on cocaine, fight flight or freeze

A. Play this game to know how brainwashed You really are

Every day, write down whether you agree with the market comment of the chrematocoulrophone (1) “du jour” on Bloomberg TV. They do a superb feat. When market tanks, they dust off some perma-bear and when markets roof it they fish out some perma-bull. Those financial jesters (1) perfectly rationalise what is happening.

Now, take a piece of paper and write whether 1) you agree with the dude 2) whether he is bull/bear. At the end of the week/month, line up agreement and compare the results with your bullish/bearish view of the world. This is confirmation bias in real time.

B. How the brain perceives news

I want to be the first subscriber to a news channel that reports financial trains arriving on schedule. Currently, financial trains have to either beat their consensus timetable or derail to show up on the news. Until then, Disney Channel is good

News is engineered to elicit reaction: sell paper, trade. It activates the mesolimbic reward circuitry (think mice on cocaine) and/or the stress response: fight, flight or freeze. It is crafted to be sensational. The brain picks up on the noise, the flashes, the tone of voice (try and speak like a newscaster to your friends and see how weird it actually sounds)

The problem with either brain trigger is that it distorts reality. Reward circuitry is dopamine which creates cravings, hence the strong addictive mechanism. This is the euphoria superman drug. Bad news for risk management

The stress response releases a powerfully corrosive drug named cortisol that kills libido, constricts bowel movements, triggers panic attacks and inhibits the pre-frontal cortex, otherwise referred to as the thinking brain. So, Yes, science says that being glued to the newsflow actually makes You dumb. Two ways to prove it: anyone who has been on a trading floor when there some “major news” breaks out knows what i am talking about…

More importantly, when you unplug from the matrix, isn’t your thinking any clearer ? You start to have ideas, think more strategically. The brain fog dissipates. This brain fog comes from staring at the newsflow all day.

Newsflow is literally neurotoxic

2) News that matter, those that don’t and how to spot them

Here is a simple test to assess whether news and more importantly their source have worth following:

  1. news can reverse a trend: if any news does not have the power to stop and reverse a trend, then it has no market impact
  2. Persistence: some news cause knee jerk reactions, but then trends resume their course as if nothing happened.

So, in terms of importance, these are the 3 major news that we follow each month

  1. FOMC: everything in the world is priced of the US 10 year bond. In December, when the Fed raised rates, January was not a happy month…
  2. BoJ: October 2012, Bank of Japan decides to debase its currency. It did impact not only Japan but the rest of the world
  3. ECB: has diminishing persistent impact
  4. Pegs: The Swiss have done a great job at fending off “evil speculators”. Brexit too. We have currency peg alerts on Google, but we stay away from pegged currencies such as HKD, HUF etc anyways

The rest, whether it is non-farm payroll, CPI, PPI, MoM retail numbers, consumer confidence survey, housing starts, inventory or tea leaves expert forecasting, all this rarely elicits anything beyond: “yeah, yeah, pass me the salt, please”. There is immediate market impact, but no trend inversion and no persistence of signal.

Useless does not mean worthless. It means those indicators will be baked in the thought process that will ultimately lead to the decision on rates. They are important components, like the windshield on your car, but what You care about is your automobile, not its parts

3) Stop Loss and news

Beginners want to stay in control. Veterans know control is an illusion. Beginners like to keep a tight leash. Veterans allow markets to breathe. Beginners’ tight stop losses get tripped all the time. Veterans love their long lunches…

Tight stop losses means bigger positions. Combine this with crushing leverage and this is a recipe for a toxic neurococktail: cortisol is a powerful chemical that numbs any pains. It is present in all traders experiencing high stress and in harmful concentration in those who blow-up. Game Over

Forex seems to have more randomness than other data series (at least those i have worked on) on identical sub 30 mn periodicity. I don’t know why and it is irrelevant, frankly. What matters is how the noise gets cancelled in the order management logic.

To that effect, i am the proud inventor of French Stop Loss. We follow a scale-out/scale-in model. Rather than anchoring all stop losses on the latest position’s stop loss, we use the one prior (+ a cute little zest “bien sur”). This gives a lot more wiggle room to positions. Cons: This reduces position size and performance acceleration, Pros: this reduces the number of stop losses, increases win rate, lowers avg loss. Bottom line, this stop loss method is fashionably late, hence French Stop Loss, of course

The point of that digression is that allowing the market to digest knee jerk reactions to news materially increases trading edge


We have three configs for our risk management: autopilot, monetary cavalry and Elvis. Autopilot is our standard config. It is on except for one week every month

Elvis does exactly what it says on the tin: rock n’ roll… Our metric is reproduction rate. Our units are Buffets and absolute. But, damn, those valleys are a seriously bullish signal for the adult diaper industry

More importantly, monetary cavalry is named after the main central banks. The week they come up with some announcement, we tighten risk. This is the only type of news where we take action to reduce risk. Sometimes we end on the profitable side of things, and sometimes we don’t. We have made a conscious decision to earn a little less than we could, because we do not want to lose a lot more than we should, and neither should You

How significant is following the news for forex trading?

The short-selling world according to DARP

Most market participants look at the short-side through their Long Only perspective. They believe that if they apply the same logic that has made their success on the long side to the short side, WorldAccording toGarpthen it should work. It should work but it does not. The Short side is still Terra Incognita, a vast continent populated with savage speculators. It obeys its own rules, its own dynamics. Newcomers to the world of short selling tend to be either too early or too late. Profitable shorts are at least as plentiful as long ideas. Market participants just don’t look for the right clues.
Stage 1: Contrarian shorts: from stratosphere to ionosphere
Market participants often come to short selling from the Long side. They believe in fairness. What is cheap should progress to fair valuation. Conversely, what is expensive should revert to fair valuation. Fairness is one of the very traits that transcends culture, race, and age. Toddlers have deep sense of fairness, long before they can speak. We are hardwired for fairness in a world that is not. Carrying that subconscious belief in the markets is a deadly virtue.
Market participants often see themselves as the lonely voice of reason amidst a delusional crowd. They may be right, eventually, but meanwhile  one single individual battling a mob is still an unfair fight. Stocks that have reached stratospheric valuations often have enough momentum to push to the ionosphere, before gravity reels them back in. Stocks on PE of of 100 have escaped the gravity of reason. They might as well go to 150, 200 or 3000. This is the rarefied atmosphere of permanently high plateau, paradigm change, because like before, “this time, it’s different”
Short selling something that does make sense does not make sense either. As Keynes used to say, markets can stay irrational longer than we can stay solvent.
From a portfolio construction perspective, this does not make sense either. On the long side, market participants expect fundamentals to improve and stocks to go up. They are in for the long haul. Meanwhile, on the short side, they expect imminent collapse. So, they are Long trend following and short mean reversion. Those have diametrically opposed reward to risk profiles. They have different P&L distributions and different sets of risks. Risks that are different do not cancel each other out but compound as they quickly realise. It is always painful to watch a short book accelerate faster than a dull long one.
Once market participants re-acquaint themselves with the old adage “the trend is your friend”, they are scarred enough to move to the next stage.
Stage 2: crowded shorts: the province of fundamental short sellers
The last 5% around the top and the bottom have claimed more market participants than the 90% in between.
When short selling by anticipation fails, market participants turn to shorting by confirmation. They wait for fundamentals and newsflow to deteriorate enough to place a trade. They have been scarred before, so they want every box ticked, every fact checked.
What they fail to realise is that if there is sufficient evidence to conclude that it is a short, there has probably been enough warning signs for long holders to bail for some time.
By the time short sellers have accumulated sufficient evidence to build a short case, long holders have left the building. Short sellers are left battling with one another over a dry bone. Those shorts  make sense, but they rarely make any money.
In fact, the reward to risk curve has inverted. Outcome is binary: either stocks goes to zero, either there is some corporate action: takeover, management change etc. One of my  London ex-colleagues used to say that a distressed stock going from 1 Euro to 50 cents is still a 50% decline. True: 1 to 0.50 is -50%, but only after 6 or 7 nasty short squeezes. The question is not whether stocks will get to zero, the question is will you still be there by then ?
In my time as a dedicated short seller, brokers used to call and pitch “structural shorts”. Structural shorts trigger a deep seated Pavlovian reflex: it makes me want to
  1. buy the stock
  2. graciously offer the borrow for free
  3. and send a box of chocolate to whomever wants to short. Chocolate  is a good therapy for smoothing the rough short squeezes ahead
Stage 3: Frustration and the despair of structural shorts
Contrarian shorts hurt. Fundamental shorts do not contribute much either. At this stage, market participants realise that the beliefs they hold about short selling may be right in theory, but still losing money in practice. Frustration and despair sets in. They have a couple of shorts and “hedge” their portfolios via futures. At that stage, market participants have literally no idea on what and how to sell short.
What happens when we lose your car keys in a dark corner of a parking lot? We go and look for them under a lamp post, where there is light of course. Market participants look for those structural shorts that will go down forever so that they can throw away the key and go back to their longs.
Market participants who publicly profess their hunt for structural shorts are unfit for managing people’s money for two reasons:
  1. Divorce from reality: Structural shorts are like market gurus: they are a dime a dozen. Profitable structural shorts are like market wizards, good luck finding one. Borrow is expensive and long holders have left the building a long time ago
  2. Abdication of responsibility: when they say they want structural shorts, what they mean is they do not want to be bothered with the short side anymore. They want to find something that they can throw in the short book and “forget about it”. This is an implicit acknowledgement of failure. They are happy to collect fees, but reluctant to do the work. There is obviously no hedge, no downside protection, no free lunch and eventually no happy ending.

At this stage, market participants resort to futures. They realise their vulnerability both versus the markets and versus their investors. The problem is futures do not offer much protection when markets tank. Besides, investors are understandably reluctant to pay exorbitant fees for something they can do themselves. They are willing to pay as much

Stage 4: Unplug from the matrix: reality is the time in between the “shoulds”

Between the time when Valeant was puffed up to “unsustainable valuations”, and the first analyst to throw the towel with a “Sell” rating, share price actually did go down by roughly -80%. There was no “beam me down Scottie”, exchange between share price and the deck of the Enterprise. Share price did go down over time, but market participants were institutionally blind to it.

Persistent short sellers one day wake up to the fact that between the time when “valuations should normalise” and when “company should collapse”, there is an extended period of time when share price actually does come down. Reality is the time in between the “shoulds”.
Stage 5: DARP: the un-sexy flip-side of GARP
Under-performing stocks are everywhere. They rarely reach extreme valuations, so they never feature on everyone’s target short list. They just trail their sector, the benchmark and eventually drop in absolute as well. They just slowly fade into oblivion, and this is why we have a collective institutional blindspot. There are three main reasons for this: psychological and wrong assumptions
Analysts color blindness
Analysts are color blind: everything has to be either rosy or dark grey. They are usually prompt to raise their ratings and their estimates when fundamentals improve. They are late to downgrade their ratings as they do not want to jeopardise their relationships with corporations, infuriate their investment banking colleagues and volunteer for the next chopping block. Estimates fall but not nearly as fast as they were once raised. There is built-in institutional inertia to factoring decline in ratings and estimates. Meanwhile, old stock market darlings just drop off the conversation and gradually fade into oblivion.
The second reason is psychological. As scientific as it may sound, fundamental analysis is inherently subjective. Facts just aren’t data; they are weaved into “logical” arguments called investment thesis. For fundamental participants to admit a stock could be a short, they must first go through the intellectual divorce of accepting that it is no longer a Long.
Fundamental market participants grieve their way into short selling. They go through the Kubler Ross cycle of grief. Only in the final stage do they finally wake up and accept that the stocks they once loved could be short. Everything prior is discounted, or ratonalised.
DARP: the un-sexy flip side of GARP
Many market participants invest on the Long side following a Growth at Reasonable Price (GARP) methodology. They look for visible growth prospect with reasonable valuation support. They shy away from hyped stocks.
Frothy valuations is the premium market participants put on growth prospects. Once growth prospects disappoint, the premium gets arbitraged away. Valuations come down to reasonable level, on par or at a slight discount versus their peers. This gives the illusion of fair valuation or discount relative to peers.  There is no news flow that would draw attention, such as big earnings revision, or product recall. Yet, growth may continue to be sluggish. Growth stocks move to the value camp, and value stocks drift to value traps. Stocks imperceptibly under-perform their peers, the market. Welcome to the world of Decline at Reasonable Price (DARP).
This notion of DARP is difficult to comprehend for most fundamental investors. They practice Growth at Reasonable Price (GARP) on the Long side.  So, they believe they should do the opposite on the short side. They naturally tend to look for unreasonable valuations coupled with unsustainable growth prospect, or even imminent collapse. As we saw before, the last 5% to the top and from the bottom have claimed more participants than the 90% in between.
Investors struggle to find shorts because they look for the wrong clue. They focus on rich valuations when they should look for relatively sluggish growth. This puts a glass ceiling on share price appreciation, i-e the famous “valuations stay cheap for a reason” argument.
In a nutshell, there is no smoking gun on the short side: profitable shorts do not stand out. The best way to picture a profitable short is to think of it as dull long stocks. On the short side, boring is good. Boring under-performs.
Conclusion: Empty your cup
The short side is is a vastly unexplored continent: the Terra Incognita of short-selling. It has its rules and its dynamics, largely unexplained.
Market participants come to the short side full of the assumptions they carry over from the Long side. The theory that they bring along has a sobering encounter with reality. This brings frustration, disappointment, anger and eventually atonement.
Yet, success on the short side carries its own rewards. Those who master the skill can craft their own performance profile, levy higher fees, attract and retain investors.
The short side has more than one paradox. Whilst volatility is elevated, success comes from looking for stocks that other investors casually dismiss as boring.
Let us know what You think, your experience. Comments are always welcome. Please share with your friends and colleagues

#Quora: What’s the biggest mistake that stock market investors make?

My answer to What’s the biggest mistake that stock market investors make?

Answer by Laurent Bernut:

Short answer: Absence of exit plan. The only soldiers who go to combat w/o an exit plan are Kamikaze. They don’t need one because they expect to die. Unfortunately so do a lot of market participants.082115-Tradingsecrets-01

The apparent simplicity of the answer hides sophisticated concepts that can be broken down in two part: statistical and psychological trading edge

I Statistical trading edge

A Stock picking is overrated

Most market participants believe that stock picking is the alpha and omega of alpha generation. Stock picking is merely everything that precedes entry. It excludes bet size and exit. Unfortunately, stock picking has little influence on the statistical trading edge

Trading edge = Gain Expectancy = Win% *AVG Win% – Loss% *AVg Loss%

1 Stop Loss is the most important variable in a trading system

Stop Loss has direct impact on 3 out of 4 components: Win%, Loss% (1-Win%) and Avg Loss%. Furthermore it has impact on trading frequency: the tighter the stop loss the higher the frequency and vice versa for Buy and Hope

Oops, this just proved that exit is the most important factor.

Please read further about the psychology of stop loss, even if you do not agree

2 Don’t call the race before the finish line

As can be seen, entry has some influence on Win% and Loss%, but nearly not as much as exit. The only time the amount of money that has been made/lost is known with irrefutable certainty is after exit, when open risk is closed

The corollary is that poor entry can be salvaged, poor exit can’t. If You do not have a proper exit plan, You will fail to appreciate the exit plan the market has in store for you

3 Money is made in the money management module

Secondly, Stock picking excludes bet sizing. Bet sizing is the most important determinant of performance

Here is an interesting story to prove this point. When I was at Fidelity, I was running my algo across all managers’ portfolios. My unbridled ambition was to help them trade better 0.05% at a time (multiply this 0.05% by 20 and you are in the rarefied atmosphere of outperformers).

It soon dawned upon my thickness that the same stocks were featured in in my esteemed colleagues’ portfolios. Nothing surprising there, everyone has access to the same research and there is healthy cross pollination. What was surprising was that despite low dispersion of holdings, there was high disparity of performance and volatility: despite owning the same stocks, some people were making a killing, while others were getting killed.

Conclusion: the difference that made the difference is not stock picking, it is bet sizing

4 Blow-ups and feed free-loaders

Watch your winners, but watch your losers more closely. Interesting story: i once had the opportunity to analyse multiple portfolios over many years across many managers on a trade by trade basis. The most important findings were:

  1. Winners look big to the extent that winners are kept small: If You exclude the worst three detractors, everyone would have outperformed the benchmark every year: 100% outperformance 100% of the time (before costs)
  2. Free loaders are performance killers: winners and losers are visible, so they get dealt with. The problem is to identify positions that are neither one nor the others, free loaders. They do not contribute enough to compensate for blow-ups and do not lose enough to be visible. They mobilise resources that should be deployed on productive assets. The psychological consequences is called capacity: you are at capacity when inertia sets in, when you do not want to take a trade because you think you are too big

The two issues that cause managers to underperform are directly related to Absence of EXIT policy

II Mental edge: 90% of trading is mental, the other half is good math

Optimism peaks before entry. After that, emotions kick in. The ultimate proof of this is divorce statistics…

1 Pre-mortem

Few market participants give bet sizing the importance it deserves. It is often either conviction (feel good) based or equal weight. Once they are in a position, things change. Or, more accurately, their perception change: they have either too much or too little of a stock.

The concept of pre-mortem is finally finding its way in decision making: Nobel prixe winner Daniel Kahneman, Dan Gilbert (positive psychology Penn U), Hal Hershfield (future self). The idea is to visualise the worst possible outcome and plan accordingly.

If for every trade You are about to take, you visualise a stop loss, something interesting will happen: you will size positions smaller. That is a natural reaction.

In other words, the most important question about fund management is: could i live with earning a little less than i could or could i afford to lose a lot more than i should ?

Again, the only way to grasp this is to mentally think about exit first

2 Kubler Ross: market participants grieve their way to selling

I am a professional short seller. On the short side, you make money by selling along people who liquidate their long position. You lose money by selling short crowded shorts…

There are many psychological charts about euphoria to despondency. They are all nice, adorable and lovely, but they are written from people whose perspective is to go Long. They do not understand the psychology of selling. There is one model that grasp the emotions we go through; the psychology of grief popularised by Elizabeth Kubler-Ross

The view from the short-side: how we process emotions and the market signature of the 5 stages of grief Kubler-Ross by Laurent Bernut on Alpha Secure

Market participants grieve their way into liquidating losers and are too complacent when leaving winners.

3 The psychology of stop loss

Even if You do not agree with what you have read so far, You must read the post below.

All diets w/o exception have failed: statistics show that we are all getting fat year after year. Diets address the wrong problem. They talk about what we eat, not about how we relate to what we eat. Diets are a psychological issue, not a physiological one.

Stop Losses are exactly the same. They are an identity issue, not a statistical one. The ego associates being profitable with being right. So, losing money is an attack on the ego. We rationalise, change our beliefs (Festinger and ognitive dissonace, Gazzanikas and split brain theory) rather than kick out losers.

Read this post to learn how to reframe your beliefs and execute stop losses like you brush your teeth.

The psychology of stop loss: how You can be 100% right despite 60% failed trades by Laurent Bernut on Alpha Secure


Making money in the market is about having an edge. There are two types of edge: statistical and mental. The only ways to tilt your trading edge is to start with the end in mind: think about how you are going to exit before you enter

What’s the biggest mistake that stock market investors make?

@Quora: What is the point of hedging a portfolio instead of closing losing positions?

My answer to What is the point of hedging a portfolio instead of closing losing positions?

Answer by Laurent Bernut:

It seems like You are experiencing pain right now. This is clouding your judgment. So, let&s do a step-by-step approach’ 1. Emotional relief, 2. Boundaries, 3. Recovery 4. New rules

1. Emotional and Financial capitals: forgiveness and dissociation

You can recover from financial losses over time, as long as You recover from emotional losses. So, We need to get out of your emotional pain first.

The power of forgiveness

Village PeopleForgive yourself for losing money. Make peace with yourself. You made a bad a decision. It is alright.  In Jungian archetypes, this is called re-parenting the orphan. You soothe yourself as if You were soothing your child who got hurt. This is no new age fell good stuff: i am a professional short seller, not a cat lady.

There is solid academic research that links forgiveness and learning ability. Bottom line, if You beat yourself up, You create trauma and are statistically more prone to relapse. The Village People masculine approach  to taking losses like a man  may result in storing memories in the hippocampus (trauma, pain), rather than the pre-frontal cortex learning centre.


No problem can be solved at the level it was created“, Albert Einstein, patent clerk

This is a cool jedi trick. Put yourself in the shoes of someone You respect for her investing/trading skills. Really feel being that person. How would she react ? Would she be calm, composed ? Would she have slow or fast breathing ? Try to emulate this person both physically and mentally.

While You do that, exhale twice as long as You inhale, and widen your vision from tunnel to peripheral, look up a bit.

When You have impersonated this person, ask yourself how would this person solve the problem ? Take a pen a paper and write it down. Do not commit to memory. The chemical reconstruct we call memories are highly fickle and inaccurate.

This is a powerful exercise that frees up some mental bandwidth. Stress triggers the fight flight syndrome. This hijacks the prefrontal cortex and hijacks the thinking brain. This exercise frees up mental bandwidth. Practice often and You will be the iceman on the trading desk

2. Set boundaries

Mad Max

“Hope is a mistake”

Hope is a mistake“, Mad Max, Aussie philosopher

If You ask this question, it is probably because You thought this “soft patch” would go away and You would be back on happy street in no time. You ignored the signals and You got caught in a storm with a t-shirt, didn’t You ?

Stock repair strategies as we use in options world never really do the job properly and they cost a lost of mental capital. Bad idea. Same applies to your situation.

You were probably optimistic and failed to think about stop loss. You probably don’t believe in them and may buy into the “buy and hope” fairy tale. Well, the best car in the world would not even sell 1 unit if it did not have good brakes.

At this stage, You will have to decide a NUMBER of the loss You can afford to sustain. Not maximum pain, just how much can You afford to lose so that You can recover within 6 months ? Repeat the exercise and stretch the time horizon, 1 year, 2 years 3 years, 5 years etc. Stop when You come to the same number at various intervals. Focus on the recovery period.

This neat jedi trick invokes the “future self” and reframing: it focuses on recovery as opposed to pain.

Write that number down and commit now to liquidating everything if your losses reach that point. No negotiation, no investment committee, just out

The way to make it more acceptable is to tell yourself being right means following a process, being profitable is an outcome, not a process thought.

3. Recovery: two certainties in life: death and short squeezes

“There are unknown unknowns”, Great War Criminal

There is no way to tell how long a bear market will last. Forget about the talking heads, They did not see the bear coming, so they probably won’t see it go either

One rule of thumb about hedging: it gets expensive during sell off, so be patient. Wait for a squeeze to hedge. They come once a month. Politicians feel compelled to flap their mouth at regular intervals during bear markets… So, don’t worry, someone is coming.

When short squeeze comes do this:

  1. Reduce your exposure: reduce size of positions that stress You the most. Reduce until You can sleep if You are not mathematically inclined. You have to do it, it is part of hedging
  2. The smart way to reduce risk is to sell call against your holdings: You collect premium and reduce exposure
  3. Do not trade VIX options to hedge: this is for losers, amateurs and TV talking heads
  4. Long put spread: skew changes marginally during squeezes. So, this is time to put on put spreads. Put spreads are volatility structures that will make money if the markets fall between a ceiling and a floor. Risk is capped and so is profit potential. It is not very risky
  5. Don’t waste time looking for the golden fleece of safe asset class that does well in bear markets: The only asset class that fits this profile is cash.
  6. Avoid short selling yourself, delegate: short selling requires a level of skills that takes time and practice to mature. You should delegate this to a professional short selling manager.
  7. Be careful with selling index futures: Shorting S&P futures while being Long small caps it not a hedge. You are implicitly Long small caps and short large caps. Large caps fare better in bear markets, small caps get crushed. So, this feeling of being hedged is illusory at best

4. New rules

The best time to repair the rof is when the sun is shining“, JFK, Great XXth mystery

Hedging is like swimming lessons, It is a bad idea to think about taking swimming lessons when You are drowning.

The market is a joint venture between Murphy and Marcelus Wallace. Murphy makes sure that if something goes wrong it will. Then, Marcellus gets medieval on your a@#.

Bottom line: be prepared. Decide your hedging strategy before you put on a trade.

The best advice about position sizing I can ever give is: size your position not thinking how much you could make, but expecting them to fail and how much You can afford to lose.

What is better in the end, earning a little less than You could, or losing a lot more than You should ?

Good luck, and practice the first two mental exercises. May the force be with You

Subscribe to our website. There are resources that will help You navigate rough times:

Alpha Secure Capital | Alpha Secure Capital

What is the point of hedging a portfolio instead of closing losing positions?

@Quora: Do simpler trading strategies make the psychological aspects of trading more manageable thus making them better for rigid implementation …

My answer to Do simpler trading strategies make the psychological aspects of trading more manageable thus making th…

Answer by Laurent Bernut:

Excellent question. Complexity is a form of laziness. 1) The privilege of simplicity is that it imposes itself, even to those who do not understand its sophistication 2) Simplicity is the exact opposite of easy.

Complexity is fragile

I have met many people trading complex strategies. I have had the privilege of meeting many people with long track record. I have yet to meet trading complex strategies with a long track record.

Complexity gives an illusion of control. It is also highly specialised. So, it tends to fall out of sync. then, traders start drifting and tweaking and add one more widget instead of subtracting.

As the Great Chinese philosopher Bruce Lee used to say: ultimately, perfection runs into simplification.

Complexity is a form of laziness:

People who settle for complex solutions have not worked hard enough to simplify them. It is easy to throw another oscillator in the mix. It is simplistic to optimise for a moving average. Below is my screen, no indicator, no oscillator, nothing, just the purity of the price:

In fact, the opposite of simple is not complex. The opposite of simple is easy.

The privilege of simplicity is that it imposes itself, even to those who do not understand its sophistication. We can understand it. It intuitively imposes itself.

Simple is not rigid, it is fluid

You will know that You are on the right track when You start subtracting instead of adding to your strategy.

I started off with 9 exit conditions. Now, I have 2: trend reversal and stop loss.

I started off with 3 distinct strategies. Now, i have 1 unified strategy. It knows when to suspend trading, reduce risk. Hint: the answer is not in the Buy/Sell signal but in position sizing and rejection of small orders…

But behind this simplicity there is immense relentless kaizen. It took me years to see what was in front of me. We do not see things as they are. We see them as we are.

Simple is a way of life.

The false comfort of complexity

People are intimidated by complexity. If it is simple, they believe that anyone could do it, therefore it cannot work. Picasso once drew a picture on a napkin to a restaurant owner and then asked for an astronomic sum. He then told it took him 30 years to draw those simple lines.

People often mistake simplistic and simple. I often ear that what i do is superficial. Perfect, “let’s step into the math then” and 5 minutes down the road, they have an angelic blank stare and conclude it is too complicated.

Simple rules

  1. Stop Loss: 2nd most important variable
  2. Position sizing: money is made in the money management
  3. Exits: You have to get off the bus at some point
  4. Entries: vastly overrated
  5. Above all: clarity of purpose, of formalisation. Be specific, very specific

Do simpler trading strategies make the psychological aspects of trading more manageable thus making them better for rigid implementation …

10 myths about short selling

Steven Spielberg’s movie Jaws has changed forever the way we perceive sharks. Did you know that deep in the comfort of your house lies  something 150 times deadlier than any great white shark ? The probability of dying falling out of bed is 1 in 2 million.  The probability of dying as a result of an exploratory shark bite is 1 in 300 million. Fortunately, we are not on the menu; sharks apparently don’t like junk food.
Like sharks, short sellers are fragile and misunderstood creatures. They are not the nefarious speculators. We are your pension’s best friend
[This is one of the chapters of the upcoming book: “the wisdom of short sellers”. We value your comments and feedback. So, please, help us helping You]

Myth 1: short sellers destroy your pensionbest-friends-forever-glitter-for-myspace

Would it be fair to say that people who hurt your pension should to be fired ?
According to, around three quarters of active managers trail their benchmark year after year. Your pension account is therefore better off with passive funds rather than expensive active managers. In bear markets, active managers might claim they outperform their benchmark, when the reality is they still lose money.
Your pension account does not need short sellers in bull markets. During bear or volatile markets, short sellers do make money. Counter-cyclicality is in the job description. So, all your pension account need is an allocation algorithm (see chapter on asset allocation by trading edge) to deploy between passive long funds and active short sellers.
Conclusion: Who is your friend ?
  1. Long Only active managers who have a sustained long term track record of hurting your pension
  2. Short sellers who will make money when the going gets rough.

Isn’t it fair to say that short sellers should be your pension’s new BFF ?

Myth 2: Short sellers destroy companies

The wisdom of short sellers is rarely welcome at executive boardrooms. As a result, they cannot bring healthy balance to the Dunning Dunning-KrugerKruger (*) dark side of the force. Senior managements at companies like Apple (round 1), Lehman Brothers, Kodak, Enron, GM,  Volkswagen are perfectly arrogant, incompetent and stubborn enough to run their venerable institutions into the ground themselves. Short sellers do not compound sub-optimal executive decisions, otherwise referred to as stupid mistakes. They see something going down  and just hop on for the ride.
 (*) Dunning Kruger effect is a cognitive bias in which people are so incompetent that they actually believe they are talented. This affliction is quite prevalent with senior management operates at such altitudes in the layer cake that they incorrectly believe it does not have to stink any more. This is reinforced by an obedient bozocracy,  bureaucrats whose sole “raison-d’etre” is to vigorously acquiesce.

Myth 3: Short sellers manipulate markets

Back in the days, a celebrity hedge fund titan used to publicly announce his investments in Japan. During the ensuing rally, retail flow remained strangely net seller, despite all the hype on investment blogs and chat rooms. Moreover, after-hours dark pool activity showed big blocks were exchanged. Someone was going through great length to discreetly unload a big position…
Had this manager done the exact same thing with a short instead of a long position, he might have attracted a different kind of attention. The public and the regulator do not take it kindly when someone publicly short sells across the nation pension funds large holdings. If You are a short seller, You will be audited. So, it is in your own self preservation best interest to strictly abide by the Law at all times.
If your business model revolves around putting on big short positions and then talk your book, then stop reading this, go buy some coffee mugs and lots of cheap coffee, because “los Federales” are on their way.

Myth 4: Short sellers want the demise of the economy

As we will see in this book, short Selling is a relative game. It comes down to selling the stocks that trail the index and buying the ones that outperform it. There is nothing nefarious about this type of arbitrage.
When market participants turn a bit more risk adverse, speculative stocks tend to come down harder and faster than the boring ones. Your average pension fund manager certainly had initial healthy professional skepticism as to the long term prospects of internet start-up or biotech venture. Yet, he just felt pressured into buying, because everyone else did and he did not want to be left out trailing the index. This would cost him his job. Now, that things have hit a bit of a “soft patch”, he is left scrambling to liquidate this toxic nonsense. It is unfortunate that pension accounts end up littered with hollow buzz stocks, but again, short sellers are not responsible for other managers suboptimal investment decisions. They just short-sell underperformers.

Myth 5: Short sellers destroy value

Short sellers do not destroy any more value than shareholders create any. If You buy a house, a car, a pen today for 100 and resell it tomorrow for 105 without having done anything to improve it, You have not created any value. You have just made a profit of 5. This comes from a confusion between market capitalisation, value and valuation. The press likes to associate market capitalisation going up or down with value creation or destruction. Warren Buffet said: “price is what You pay, value is what You get”

Myth 6: short sellers are responsible for the collapse of share price

Short sellers need to borrow stocks in order to take short positions. Borrow availability is usually between 5 and 10% of the free float, or shares publicly traded. This represents between on and two weeks of trading volume. Short sellers do not have the fire power to durably affect share price.
Short sellers and big mutual funds have access to the same information. Share prices collapse as result of Long-Only heavy artillery selling, not small time short selling BB gun.

Myth 7: Short sellers accentuate market volatility

Some jurisdictions ban short selling. As a result, buyers can only purchase from a long seller. Sellers can only sell to Long buyers. This widens the bid/ask spread, which increases daily realised volatility. Market participants sell short for different reasons. It is often a way to hedge other transactions such as options, convertible bonds, preferred stocks, baskets etc. Inability to sell short reduces liquidity, increases volatility and ultimately penalizes all market participants. Banning short selling is often a sign of immaturity.

Myth 8: short selling increases risk

In theory, unsuccessful shorts can rally multiple times but only drop by 100%. Short-selling is risky, no doubt.
Yet, adding a short book to a long one reduces correlation to the index. It reduces portfolio volatility. The ability to sell short enables alpha generation not only in up but in sideways and down markets.
Think of it as boxing. If You stepped into the ring with Mike Tyson, and chose to punch only with your right hand, what was a tough fight to start with, will be a brief one too.

Myth 9: I don’t need to sell short during bull markets. I will just put on some shorts when the market turns bearish

Short selling is a muscle. It atrophies when not exercised. It is safer to learn the craft during bull markets when the long side can sponsor the tuition. Waiting for the bear market to show up is too little too late. It takes time, effort and money to master the skill, especially the mental side of short selling. Meanwhile, investors are notoriously impatient during bear markets. “the best time to repair the roof is when the sun is shining”, JFK

Myth 10: Short selling has infinite downside potential

If short sellers allow their positions to go up against them multiple times, then they deserve to be un-apologetically weeded out. Short-sellers is an extreme market sport. Joe Campbell got famous after breaking the three basic rules of short selling:
  1. always place a stop-loss: if You don’t have an exit plan, then You will not like what the market has in store for You
  2. control risk through position sizing: the most important question about fund management is: would You rather earn less than You could or lose a lot more than You should ?
  3. stay away from crowded shorts like penny stocks: risk is a binary event: either bankruptcy or recovery.

[Comments, feedback are uppermost welcome. This is a collaborative effort]