or, more precisely, that other people believe they know more than they do. But there were plenty of people around that table who sold options, who thought that if you were smart enough to set the price of the option properly, you could win so many of those $1 bets on General Motors that, even if the stock ever did dip below $45, you’d still come out far ahead. They believe that the world is a place where, at the end of the day, leaves fall more or less in a predictable pattern.
The distinction between these two sides is the divide that emerged between Taleb and Niederhoffer all those years ago in Connecticut. Niederhoffer’s hero is the nineteenth- century scientist Francis Galton. Niederhoffer called his eldest daughter Galt, and there is a full-length portrait of Galton in his library. Galton was a statistician and a social scientist (and a geneticist and a meteorologist), and if he was your hero, you believed that by marshaling empirical evidence, by aggregating data points, you could learn whatever it was you needed to know. Taleb’s hero, on the other hand, is Karl Popper, who said that you could not know with any certainty that a proposition was true; you could only know that it was not true. Taleb makes much of what he learned from Niederhoffer, but Niederhoffer insists that his example was wasted on Taleb. “In one of his cases, Rumpole of the Bailey talked about being tried by the bishop who doesn’t believe in God,” Niederhoffer says. “Nassim is the empiricist who doesn’t believe in empiricism.” What is it that you claim to learn from experience, if you believe that experience cannot be trusted? Today, Niederhoffer makes a lot of his money selling options, and more often than not the person to whom he sells those options is Nassim Taleb. If one of them is up a dollar one day, in other words, that dollar is likely to have come from the other. The teacher and pupil have become predator and prey.
3.
Years ago, Nassim Taleb worked at the investment bank First Boston, and one of the things that puzzled him was what he saw as the mindless industry of the trading floor. A trader was supposed to come in every morning and buy and sell things, and on the basis of how much money he made buying and selling he was given a bonus. If he went too many weeks without showing a profit, his peers would start to look at him funny, and if he went too many months without showing a profit, he would be gone. The traders were for the most part well educated and wore Savile Row suits and Ferragamo ties. They dove into the markets with a frantic urgency. They read the
“He was always so conceptual about what he was doing,” says Howard Savery, who was Taleb’s assistant at the French bank Indosuez in the 1980s. “He used to drive our floor trader (his name was Tim) crazy. Floor traders are used to precision: “Sell a hundred futures at eighty-seven.” Nassim would pick up the phone and say, “Tim, sell some.” And Tim would say, “How many?” And he would say, “Oh, a social amount.” It was like saying, “I don’t have a number in mind, I just know I want to sell.” There would be these heated arguments in French, screaming arguments. Then everyone would go out to dinner and have fun. Nassim and his group had this attitude that we’re not interested in knowing what the new trade number is. When everyone else was leaning over their desks, listening closely to the latest figures, Nassim would make a big scene of walking out of the room.”
At Empirica, then, there are no
“Pallop, did you introspect?” Taleb calls out as he wanders back in from lunch. Pallop is asked what his PhD is about. “Pretty much this,” he says, waving a languid hand around the room.
“It looks like we will have to write it for him,” Taleb chimes in, “because Pollop is very lazy.”
What Empirica has done is to invert the traditional psychology of investing. You and I, if we invest conventionally in the market, have a fairly large chance of making a small amount of money in a given day from dividends or interest or the general upward trend of the market. We have almost no chance of making a large amount of money in one day, and there is a very small, but real, possibility that if the market collapses we could blow up. We accept that distribution of risks because, for fundamental reasons, it feels right. In the book that Pallop was reading by Kahneman and Tversky, for example, there is a description of a simple experiment, where a group of people were told to imagine that they had $300. They were then given a choice between (a) receiving another $100 or (b) tossing a coin, where if they won they got $200 and if they lost they got nothing. Most of us, it turns out, prefer (a) to (b). But then Kahneman and Tversky did a second experiment. They told people to imagine that they had $500 and then asked them if they would rather (c) give up $100 or (d) toss a coin and pay $200 if they lost and nothing at all if they won. Most of us now prefer (d) to (c). What is interesting about those four choices is that, from a probabilistic standpoint, they are identical. Nonetheless, we have strong preferences among them. Why? Because we’re more willing to gamble when it comes to losses, but are risk averse when it comes to our gains. That’s why we like small daily winnings in the stock market, even if that requires that we risk losing everything in a crash.
At Empirica, by contrast, every day brings a small but real possibility that they’ll make a huge amount of money in a day; no chance that they’ll blow up; and a very large possibility that they’ll lose a small amount of money. All those dollar, and fifty-cent, and nickel options that Empirica has accumulated, few of which will ever be used, soon begin to add up. By looking at a particular column on the computer screens showing Empirica’s positions, anyone at the firm can tell you precisely how much money Empirica has lost or made so far that day. At 11:30 a.m., for instance, they had recovered just 28 percent of the money they had spent that day on options. By 12:30, they had recovered 40 percent, meaning that the day was not yet half over and Empirica was already in the red to the tune of several hundred thousand dollars. The day before that, it had made back 85 percent of its money; the day before that, 48 percent; the day before that, 65 percent; and the day before that also 65 percent; and, in fact, with a few notable exceptions—like the few days when the market reopened after September 11—Empirica has done nothing but lose money since last April. “We cannot blow up, we can only bleed to death,” Taleb says, and bleeding to death, absorbing the pain of steady losses, is precisely what human beings are hardwired to avoid. “Say you’ve got a guy who is long on Russian bonds,” Savery says. “He’s making money every day. One day, lightning strikes and he loses five times what he made. Still, on three hundred and sixty-four out of three hundred and sixty- five days he was very happily making money. It’s much harder to be the other guy, the guy losing money three hundred and sixty-four days out of three hundred and sixty-five, because you start questioning yourself. Am I ever going to make it back? Am I really right? What if it takes ten years? Will I even be sane ten years from now?” What the normal trader gets from his daily winnings is feedback, the pleasing illusion of progress. At Empirica, there is no feedback. “It’s like you’re playing the piano for ten years and you still can’t play ‘Chopsticks,’” Spitznagel say, “and the only thing you have to keep you going is the belief that one day you’ll wake up and play like Rachmaninoff.” Was it easy knowing that Niederhoffer—who represented everything they thought was wrong—was out there getting rich while they were bleeding away? Of course it wasn’t. If you watched Taleb closely that day, you could see the little ways in which the steady drip of losses takes a toll. He glanced a bit too much at the Bloomberg. He leaned forward a bit too often to see the daily loss count. He succumbs to an array of superstitious tics. If the going is good, he parks in the same space every day; he turned against Mahler because he associates Mahler with the last year’s long dry spell. “Nassim says all the time that he needs me there, and I believe him,” Spitznagel says. He is there to remind Taleb that there is a point to waiting, to help Taleb resist the very human impulse to abandon everything and stanch the pain of losing. “Mark is my cop,” Taleb says. So is Pallop: he is there to remind Taleb that Empirica has the intellectual edge.
“The key is not having the ideas but having the recipe to deal with your ideas,” Taleb says. “We don’t need
