SNB Crisis

The Event that Made Me Wash my Hands of FX

John Putman II shares a personal account of the SNB’s decision to unpeg the franc from the euro and the

Every trader who has been active in the markets for any length of time knows this one single truth: you cannot account for, or completely hedge risk away – not all of it. Eventually you are going to find yourself in the market during an event that simply changes or redefines everything you think you know about risk, and then it will happen again.

RISK, RISK NEVER CHANGES

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I have been in and around the markets since the age of 19. From personal experience, I know risk comes at you from numerous angles and it is impossible to avoid. I have worked, traded and lived through the crash of ’87, the dip of ’89, the meltdown in Asia in the mid 90’s, the crash of 2000, the loss of the Twin Towers, the Refco Bankruptcy and a host of smaller market shocks.  None of that would prepare me for the volatility of January 15, 2015.

 

YOUR WORST TRADE IS YET TO COME

 

While I was studying for my Series 3 in the early 2k’s and establishing my track-record in Forex, I stumbled across a copy of The (Mis)Behavior of Markets by Benoît B. Mandelbrot at the local bookstore. It put into simple terms much of what I inherently believed about risk, but either lacked the research to support or simply was unable to formalize on my own.  I came away from that book with clarification on four basic beliefs:

  1. Your worst trade is yet to come
  2. It will happen sooner than you think
  3. It will happen more often than you think
  4. Risk is impossible to quantify

“Real markets are wild. Their price fluctuations can be hair-raising – far greater and more damaging than the mild variations of orthodox finance. That means that individual stocks and currencies are riskier than normally assumed. It means that stock portfolios are being put together incorrectly; far from managing risk, they may be magnifying it. It means that some trading strategies are misguided, and options mis-priced…” 
 Benoît B. MandelbrotThe (Mis)Behavior of Markets

 

Throughout my entire professional career – especially after Refco – I’ve tried to prepare myself for the next shock, how I might handle it, what the contingency plan is and how to move forward after the fact. The problem with planning for market shock is, it’s impossible to properly estimate volatility and even if you could, you would still have to assume the risk if you want trade.

 

Now the Forex world was chaos and I was in the middle of it again.

 

I had models that projected potential declines of 1000 pips, but you can never know when. At the end of the day if you’re going to be in the market you have to bite the risk bullet and hope you survive.

 

THE TREND IS YOUR FRIEND, UNTIL IT ISN’T

 

The days leading up to January 15, I was short CHF. Most of my exposure was in a set of long NZDCHF trades. I had taken a short-term trend signal on a dip despite my longer-term models signaling for counter-trend shorts.  It was that longer-term model that saved me from real account damage, that and a lot of luck. The only reason I had abandoned the long trades is they had popped in my favor and I quickly covered them the day before after about 48 hours in the trade.

You always hear “The Trend is Your Friend”. Truth is, there is no single approach that doesn’t bring significant risk with it if you trade it long enough.

I LOVE WHAT I DO BUT I WONT DO IT FOR YOU: THE REAL IMPACT OF THE SNB FOR ME

 

Having survived the initial move, the real risk for me personally began to settle in. What were the next steps?  After a long hiatus from managed funds I had decided late in 2012 it was time to give it another shot.  The Refco BK had put a serious dent in the finances of the company – and in my own pocket as well – most of it to never be recovered.  The decision to tackle all of it again wasn’t made lightly.

 

There was new compliance and oversight requirements, new reporting and backup plans, many procedures that were going to cost a lot of money in an area that had diminishing institutional interest and a lot more competition than when I started. However, I felt I still had something to offer, so, after a lot of thought and planning, I updated the grid where I build the Machine Learning models and proceeded to get to it.

 

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By 2014 I was back to trading a model built just for my target market and in that year, I managed to grind in 11% utilizing a very conservative risk profile. If the correlation to existing models was low enough, I should be able to find institutional funding. Things were good, but now they weren’t. Now the Forex world was chaos and I was in the middle of it again. “Once, again…!”

 

At the end of the day if you’re going to be in the market you have to bite the risk bullet and hope you survive.

 

Before I even understood all of the impacts, the damage on the broker end, the multitude of accounts blown up, before the dust ever settled, I knew that was the end. Even though I lost nothing, there in the shadow of the greatest volatility I had ever seen I knew I could never risk other people’s money to this market again.

Everything I had worked for, everything I had suffered through and sacrificed to make this happen across a 15 year stretch, was gone.  My 30’s and half of my 40’s dedicated to a goal that I no longer dared chase. It still kicks me in the gut when I think about it today, but at that moment there wasn’t a lot of time to think because I knew the aftershocks were on their way.

 

SHOULD I STAY OR SHOULD I GO

 

I’ve been here before.  When the scandal surrounding Refco first broke out it was mayhem. My phone literally rang 100 times a day for nearly two weeks. People I knew, people I didn’t know, everyone looking for clarity as to what to do next. The overwhelming question: “Should we pull our funds?”

in the shadow of the greatest volatility I had ever seen I knew I could never risk other people’s money to this market again

That same question hung over me now, would my broker survive this, could they, and if they did how would their response or even more likely the regulators’ response impact our ability to trade.  And, if I did pull the funds what should I do with them? If I sat on the money, the track record for the ML Model was done. Even though I had almost immediately decided not to manage funds there were other consulting avenues I could pursue, using the returns as proof of the modeling quality.

I called a family member who is part of our portfolio:

  • “I’m watching it are we okay?”
  • “We’re not in it but that’s not what I’m worried about, this could be Refco all over again”
  • The phone clicked off.

Time to pull the money and time to say goodbye: I spent the better part of 2015 watching this play out, waiting for all the ripples to hit the shoreline and the waters to calm. I was fortunate that a few of my old clients continued to reach out here and there for ML work, but even that began to weigh on me. The impacts of Refco and now the SNB and the responsibility I feel to the people I work with and the risk I feel this market presents for all but the most savvy, outweighed any desire I had to capitalize on it.

 

The conversation I had with a colleague at IBM in 2012 continued to echo in my thoughts. In his attempt to bring me back into the hedge-fund world he said something that ultimately convinced me in 2015 to walk away:

“We have a fiduciary responsibility to do the very best we can for our clients. Even if the systems aren’t perfect, we have to make sure we’re giving them the best we are capable of…”

Now, I wasn’t so sure of this and doing nothing, at least for me, seemed like an appropriate response in a market capable of such tremendous volatility.

I DON’T TRUST YOU ANYMORE

Just this month I shuttered the doors to my company, wrapped up my final consulting gig and washed my hands of FX as a business.  I still trade, always will. It is something that I know how to fit into my own risk profile. I know where it belongs, how much I can lose etc. But I have made changes.

Truth is, there is no single approach that doesn’t bring significant risk with it if you trade it long enough.

After the Refco BK where funds were so callously trodden upon by the judge – who ruled unsecured accounts could be used to satisfy other debts – and the broad industry impact of the SNB, I no longer trust brokers to survive. So, I’ve reduced my overall exposure to FX and now notionally fund the account, with just enough to keep margin requirements in check. If my broker does go under some day, they will do it with a lot less of my cash than before.

 

 

 

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