Fooled by Randomness (5 page)

Nero’s probabilistic introspection may have been helped out by a dramatic event in his life—one that he kept to himself. A penetrating observer might detect in Nero a measure of suspicious exuberance, an unnatural drive. For his life is not as crystalline as it may seem. Nero harbors a secret, one that will be discussed in time.

JOHN THE HIGH-YIELD TRADER

Through most of the 1990s, across the street from Nero’s house stood John’s—a much larger one. John was a high-yield trader, but he was not a trader in the style of Nero. A brief professional conversation with him would have revealed that he presented the intellectual depth and sharpness of mind of an aerobics instructor (though not the physique). A purblind man could have seen that John had been doing markedly better than Nero (or, at least, felt compelled to show it). He parked two top-of-the-line German cars in his driveway (his and hers), in addition to two convertibles (one of which was a collectible Ferrari), while Nero had been driving the same VW Cabriolet for almost a decade—and still does.

The wives of John and Nero were acquaintances, of the health-club type, but Nero’s wife felt extremely uncomfortable in the company of John’s. She felt that the lady was not merely trying to impress her, but was treating her like someone inferior. While Nero had become inured to the sight of traders getting rich (and trying too hard to become sophisticated by turning into wine collectors and opera lovers), his wife had rarely encountered repressed new wealth—the type of people who have felt the sting of indigence at some point in their lives and want to get even by exhibiting their wares. The only dark side of being a trader, Nero often says, is the sight of money being showered on unprepared people who are suddenly taught that Vivaldi’s
Four Seasons
is “refined” music. But it was hard for his spouse to be exposed almost daily to the neighbor who kept boasting of the new decorator they just hired. John and his wife were not the least uncomfortable with the fact that their “library” came with the leather-bound books (her health club reading was limited to
People
magazine but her shelves included a selection of untouched books by dead American authors). She also kept discussing unpronounceable exotic locations where they would repair during their vacations without so much as knowing the smallest thing about the places—she would have been hard put to explain on which continent the Seychelles Islands are located. Nero’s wife is all too human; although she kept telling herself that she did not want to be in the shoes of John’s wife, she felt as if she had been somewhat swamped in the competition of life. Somehow words and reason became ineffectual in front of an oversized diamond, a monstrous house, and a sports car collection.

An Overpaid Hick

Nero also suffered the same ambiguous feeling toward his neighbors. He was quite contemptuous of John, who represented about everything he is not and does not want to be—but there was the social pressure that was starting to weigh on him. In addition, he too would like to have sampled such excessive wealth. Intellectual contempt does not control personal envy. That house across the street kept getting bigger, with addition after addition—and Nero’s discomfort kept apace. While Nero had succeeded beyond his wildest dreams, both personally and intellectually, he was starting to consider himself as having missed a chance somewhere. In the pecking order of Wall Street, the arrival of such types as John had caused him to be a significant trader no longer—but while he used to not care about this, John and his house and his cars had started to gnaw away at him. All would have been well if Nero had not had that stupid large house across the street judging him with a superficial standard every morning. Was it the animal pecking order at play, with John’s house size making Nero a beta male? Worse even, John was about five years his junior, and, despite a shorter career, was making at least ten times his income.

When they used to run into each other Nero had a clear feeling that John tried to put him down—with barely detectable but no less potent signs of condescension. Some days John ignored him completely. Had John been a remote character, one Nero could only read about in the papers, the situation would have been different. But there John was in flesh and bones and he was his neighbor. The mistake Nero made was to start talking to him, as the rule of pecking order immediately emerged. Nero tried to soothe his discomfort by recalling the behavior of Swann, the character in Proust’s
In Search of Time Lost,
a refined art dealer and man of leisure who was at ease with such men as his personal friend the then Prince of Wales, but acted like he had to prove something in the presence of the middle class. It was much easier for Swann to mix with the aristocratic and well-established set of Guermantes than it was with the social-climbing one of the Verdurins, no doubt because he was far more confident in their presence. Likewise Nero can exact some form of respect from prestigious and prominent people. He regularly takes long meditative walks in Paris and Venice with an erudite Nobel Prize–caliber scientist (the kind of person who no longer has to prove anything) who actively seeks his conversation. A very famous billionaire speculator calls him regularly to ask him his opinion on the valuation of some derivative securities. But there he was obsessively trying to gain the respect of some overpaid hick with a cheap New Jersey “Noo-Joyzy” accent. (Had I been in Nero’s shoes I would have paraded some of my scorn to John with the use of body language, but again, Nero is a nice person.)

Clearly, John was not as well educated, well bred, physically fit, or perceived as being as intelligent as Nero—but that was not all; he was not even as street-smart as him! Nero has met true street-smart people in the pits of Chicago who exhibit a rapidity of thinking that he could not detect in John. Nero was convinced that the man was a confident shallow-thinker who had done well because he never made an allowance for his vulnerability. But Nero could not, at times, repress his envy—he wondered whether it was an objective evaluation of John, or if it was his feelings of being slighted that led him to such an assessment of John. Perhaps it was Nero who was not quite the best trader. Maybe if he had pushed himself harder or had sought the right opportunity—instead of “thinking,” writing articles and reading complicated papers. Perhaps he should have been involved in the high-yield business, where he would have shined among those shallow-thinkers like John.

So Nero tried to soothe his jealousy by investigating the rules of pecking order. Psychologists have shown that most people prefer to make $70,000 when others around them are making $60,000 than to make $80,000 when others around them are making $90,000. Economics, schmeconomics, it is all pecking order, he thought. No such analysis could prevent him from assessing his condition in an absolute rather than a relative way. With John, Nero felt that, for all his intellectual training, he was just another one of those who would prefer to make less money provided others made even less.

Nero thought that there was at least a hint to support the idea of John being merely lucky—in other words Nero, after all, might not need to move away from his neighbor’s starter palazzo. There was hope that John would meet his undoing. For John seemed unaware of one large hidden risk he was taking, the risk of blowup, a risk he could not see because he had too short an experience of the market (but also because he was not thoughtful enough to study history). How could John, with his coarse mind, otherwise be making so much money? This business of junk bonds depends on some knowledge of the “odds,” a calculation of the probability of the rare (or random) events. What do such fools know about odds? These traders use “quantitative tools” that give them the odds—and Nero disagrees with the methods used. This high-yield market resembles a nap on a railway track. One afternoon, the surprise train would run you over. You make money every month for a long time, then lose a multiple of your cumulative performance in a few hours. He has seen it with option sellers in 1987, 1989, 1992, and 1998. One day they are taken off the exchange floors, accompanied by oversized security men, and nobody ever sees them again. The big house is simply a loan; John might end up as a luxury car salesman somewhere in New Jersey, selling to the new newly rich who no doubt would feel comfortable in his presence. Nero cannot blow up. His less oversized abode, with its four thousand books, is his own. No market event can take it away from him. Every one of his losses is limited. His trader’s dignity will never, never be threatened.

John, for his part, thought of Nero as a loser, and a snobbish overeducated loser at that. Nero was involved in a mature business. He believed that he was way over the hill. “These ‘prop’ traders are dying,” he used to say. “They think they are smarter than everybody else, but they are passé.”

THE RED-HOT SUMMER

Finally, in September 1998, Nero was vindicated. One morning while leaving to go to work he saw John in his front yard unusually smoking a cigarette. He was not wearing a business suit. He looked humble; his customary swagger was gone. Nero immediately knew that John had been fired. What he did not suspect was that John also lost almost everything he had. We will see more details of John’s losses in
Chapter 5
.

Nero felt ashamed of his feelings of Schadenfreude, the joy humans can experience upon their rivals’ misfortunes. But he could not repress it. Aside from it being unchivalrous, it was said to bring bad luck (Nero is weakly superstitious). But in this case, Nero’s merriment did not come from the fact that John went back to his place in life, so much as it was from the fact that Nero’s methods, beliefs, and track record had suddenly gained in credibility. Nero would be able to raise public money on his track record precisely because such a thing could not possibly happen to him. A repetition of such an event would pay off massively for him. Part of Nero’s elation also came from the fact that he felt proud of his sticking to his strategy for so long, in spite of the pressure to be the alpha male. It was also because he would no longer question his trading style when others were getting rich because they misunderstood the structure of randomness and market cycles.

Serotonin and Randomness

Can we judge the success of people by their raw performance and their personal wealth? Sometimes—but not always. We will see how, at any point in time, a large section of businessmen with outstanding track records will be no better than randomly thrown darts. More curiously, and owing to a peculiar bias, cases will abound of the least-skilled businessmen being the richest. However, they will fail to make an allowance for the role of luck in their performance.

Lucky fools do not bear the slightest suspicion that they may be lucky fools—by definition, they do not know that they belong to such a category. They will act as if they deserved the money. Their strings of successes will inject them with so much serotonin (or some similar substance) that they will even fool themselves about their ability to outperform markets (our hormonal system does not know whether our successes depend on randomness). One can notice it in their posture; a profitable trader will walk upright, dominant style—and will tend to talk more than a losing trader. Scientists found out that serotonin, a neurotransmitter, seems to command a large share of our human behavior. It sets a positive feedback, the virtuous cycle, but, owing to an external kick from randomness, can start a reverse motion and cause a vicious cycle. It has been shown that monkeys injected with serotonin will rise in the pecking order, which in turn causes an increase of the serotonin level in their blood—until the virtuous cycle breaks and starts a vicious one (during the vicious cycle failure will cause one to slide in the pecking order, causing a behavior that will bring about further drops in the pecking order). Likewise, an increase in personal performance (regardless of whether it is caused deterministically or by the agency of Lady Fortuna) induces a rise of serotonin in the subject, itself causing an increase of what is commonly called “leadership” ability. One is “on a roll.” Some imperceptible changes in deportment, like an ability to express oneself with serenity and confidence, make the subject look credible—as if he truly deserved the shekels. Randomness will be ruled out as a possible factor in the performance, until it rears its head once again and delivers the kick that will induce the downward spiral.

A word on the display of emotions. Almost no one can conceal his emotions. Behavioral scientists believe that one of the main reasons why people become leaders is not from what skills they seem to possess, but rather from what extremely superficial impression they make on others through hardly perceptible physical signals—what we call today “charisma,” for example. The biology of the phenomenon is now well studied under the subject heading “social emotions.” Meanwhile some historian will “explain” the success in terms of, perhaps, tactical skills, the right education, or some other theoretical reason seen in hindsight. In addition, there seems to be curious evidence of a link between leadership and a form of psychopathology (the sociopath) that encourages the non-blinking, self-confident, insensitive person to rally followers.

People have often had the bad taste of asking me in a social setting if my day in trading was profitable. If my father were there, he would usually stop them by saying “never ask a man if he is from Sparta: If he were, he would have let you know such an important fact—and if he were not, you could hurt his feelings.” Likewise, never ask a trader if he is profitable; you can easily see it in his gesture and gait. People in the profession can easily tell if traders are making or losing money; head traders are quick at identifying an employee who is faring poorly. Their face will seldom reveal much, as people consciously attempt to gain control of their facial expressions. But the way they walk, the way they hold the telephone, and the hesitation in their behavior will not fail to reveal their true disposition. On the morning after John had been fired, he certainly lost much of his serotonin—unless it was another substance that researchers will discover in another decade. One cab driver in Chicago explained to me that he could tell if traders he picked up near the Chicago Board of Trade, a futures exchange, were doing well. “They get all puffed up,” he said. I found it interesting (and mysterious) that he could detect it so rapidly. I later got some plausible explanation from evolutionary psychology, which claims that such physical manifestations of one’s performance in life, just like an animal’s dominant condition, can be used for signaling: It makes the winners seem easily visible, which is efficient in mate selection.