Red Blooded Risk (The Secret History of Wall Street)

"Applied probability" is something I love to dig always... In fact, books like "The Black Swan" and "The Signal and The Noise" remain my all time favourite. Now, we got this book from Aaron Brown... another "applied probability" stuff with a very special name: "Red-Blooded Risk" taker... Hmm... Something interesting....

Aaron Brown started by define the differences between risk and danger(opportunity)... "Risks are two sided, you can win or you can lose. Dangers and opportunities are one sided...Dangers and opportunities are often not measurable. Risk however are measurable... Dangers and opportunities often come from nature. Risks always refer to human interactions and their level must be under our control..." From there, the author managed to classify 4 different groups of risk takers:
1. Coward - Treats risks as dangers.
2. Thrill seeker - Treats risks as opportunities.
3. Cold-blooded - Treats both dangers and opportunities as risks.
4. Red-blooded - Excited by challenges, but not to the point of being blinded to dangers and opportunities.

Overall, this book presents plenty of ideas on how to be a practical risk-taker. In fact, it is more than investing and financial stuff. To me, it is more like a guide towards risks in life. The whole book combines the real experiences from the author along with the historical episodes that happened in real life. After all, the author is famous as Quant's Quant. Hence, he is absolutely the right person to comment on it.

The best part is... this book contains series of "secret history of Wall Street" along with the diminishing function of money. (Paper money will fade to insignificant economic importance, to be replaced by derivative-like arrangements.) In fact, this is the first book that defended speculators, derivatives and the financial market as a whole. Read this:

Everyone is greedy and finance would be a strange career choice for someone without and above average interest in money. The sin is to be interested only in money.

Finance is just another business, or to be evaluated by how much it improves things for customers, what resources it consumes and the quality of jobs and quantity of profits it creates. It has no mystical value like "making the economy more efficient" and a person who makes that his justification for a huge paycheck is likely looking for an excuse, not a reason. 

Value investor provide liquidity because they buy when others sell and sell when others buy. They are the one kind of speculator polite people like to talk about. They give the markets rationality and liquidity.

Momentum investors give the market volatility. They are behind bubbles and crashes, and they suck liquidity out of the market. But, without them you have no market, or at best a quiet market that adds little economy value.

One silly thing you read about futures markets is that they are zero-sum. But, a bank is also zero-sum. Every dollar in interest paid to depositors is paid by borrowers. Yet banks add tremendously to economic growth. Money itself is zero-sum. It represents an asset to its owner and an equal liability to everyone else. In the case of futures markets, and derivatives in general, since each user has a different numeraire, each one can count a net profit in economic value. Insisting the markets are zero-sum is a symptom of not understanding numeraires.

An even sillier charge is that futures markets are a casino where speculators create risk that spills over and harms the real economy. Of course they are casinos where speculators create risk. If speculators went away or stopped creating risk, the markets would collapse, and they would take their vast economic value with them.

Relatively, compares to the other applied probability stuff (ex. The Black Swan), I thought this book is a more entertaining read. However, I cannot deny on its prolixity and disorganised structure on his articles. In fact, some chapter titles tend to be misleading as the contents may not focus 100% on the title itself. Perhaps, this is due to the author's style of tracing to the origin of the origin. End up, readers might felt a bit of mess and find it hard to concentrate.

As a summary, this is one of another great work on applied probability. If "The Black Swan" and "The Signal & The Noise" deserved 9/10, this book at least scored evenly at 9/10 too. Like I mentioned above, it is the prolixity that bring certain damages to a supposed great book. Other than that, I thought this is a book that benefited me so much. Thumbs up for the author to come up with such a nice writing!

Finally, I picked up some of the nice quotes that I personally love it so much. Well; again, perhaps more prolixity than ever; but catch the point, as it represents some splendid wisdom....

A frequentist might test hypotheses at the 5 percent level... What if the 95 percent she's right about are trivial things we knew anyway and the 5 percent she's wrong about are crucial?

If you take an optimal amount of risk- not more and not less- you can be certain of exponentially growing success... Taking less risk than is optimal is not safer; it just locks in a worse outcome... Taking more risk than is optimal often leads to complete disaster. ~~~ John Kelly

The forms of money that stimulate the economy are those that equate constraints and goals of important risk-taking activities. At the moment, financial derivatives are the most important form of money used in advanced economies.

Mutation is almost always bad for the individual, but the optimal amount is good for the population.

To take advantage of evolution you need to add some randomness to your learning and experiences. ... The more you read, the less certainty you find. The people with the most narrow and rigid views have generally read the least.

You cannot understand the economy without understanding the markets, and you cannot understand the markets without trying to beat them. 

Kelly showed that beyond a certain point, more risk only increases the probability of bad outcomes. Moreover, taking less than optimal risk actually guarantees doing worse in the long run; it only appears to be a safer course.

The reason the portfolio of all seven commodities did so much better than the individual assets when we invested 100 percent of our money is not that diversification lowers risk and lower risk is good; it's that it just happened to produce a portfolio with near the optimal amount of risk.

More and more transactions are mediated by direct good exchange, automated clearing by Internet bidding or matching, and goods delivered by status rather than equal value by transaction... Paper money will not disappear or lose its value, any more than gold lost its value when paper money arrived. But, paper money already lost its place as an economic driver.

You could fight a war for any stupid reason you liked (in fact, in most wars one or both sides claimed to be fighting for peace), except one: you couldn't fight a war against taxes.

Socially, you can be a loner. You're not interested in other people's opinions, since those are what made the market inefficient in the first place.

If you cut losers faster and let profits run longer, you'll have a lower accuracy ratio but a higher performance ratio. Attempting to increase the accuracy ratio by sacrificing performance ratio seldom works. Therefore, the usual advice is to target a specific performance ratio, adjusting your trading if necessary to get to that target, but only to monitor the accuracy ratio. When accuracy ratio is high, bet bigger, when it's low, bet smaller.

Organisations depend on complex information flows. Unless there is constant, rigorous testing of that information, its quality will be very poor. That lack of quality will be obscured by...the poor quality of the data. The poor quality will be further obscured by systems and people that force the data to be consistent.

Bad data leads to inefficiency and uncontrollable risks. Even if it didn't, given the vast sums spent on processing data, it's worth spending a little effort to make it good.

They say if you work in kitchen you'll never eat at a restaurant. Well, I never worked in a restaurant kitchen, but I'll never believe a number unless it's something I can validate.

Success requires innovation, and innovation implies frequent failure. Failure isn't the problem. Slow and expensive failure is. Fail often, fail fast, and fail cheap is the formula for success.