Victor Niederhoffer

The Education of a SpeculatorThe Education of a Speculator

John Wiley & Sons, 1997.
ISBN: 0-471-13747-2

The following review is reprinted by permission of Barron's Online.

This author, long the top trader for Wall Street wizard George Soros, warns that we shouldn't expect to learn the secrets of success ``for the price of a book.'' He is too modest. By just about any standard, this eminently readable, witty tome is one of the great tours de force of investing literature, a must for any serious investor's library.

Over 400-odd pages, tackling everything from the training of a young gambler, the impact of the weather on the markets, panics and the nature of games, Victor Niederhoffer gives us page after page of distilled investment wisdom. Taken together, this is pure nectar to those who aim for consistently superior stock-market performance.

Up front, Niederhoffer declares himself a contrarian, happily demolishing momentum investing, random-walk theory, short-selling and virtually every other heresy that has ever become popular. This is done not with the short, chopping strokes he used to become a world squash champion for a decade, but rather with the carefully constructed, well-reasoned arguments that reflect an academic career spanning Harvard, the University of Chicago and the University of California at Berkeley. When it comes to making money in the markets, Niederhoffer, who now heads his own firm, always has traded off statistical anomalies. An example of classic opportunity, as he sees it, was the Tokyo market after the Osaka earthquake led to the collapse of Barings, a test of 15,000 on the Nikkei and a famous magazine cover story forecasting that the Japanese market would soon fall to 8,000. Brokers were in disarray, but he saw only opportunity. He rushed into the fray and made money. With Japan's stock market again in disarray, this might be well worth noting.

Niederhoffer, of course, was for years Soros's point man - making profits for both his famous boss and their clients. Lots of money. Had you invested $1,000 with Soros in 1969, it would have grown to nearly $2 million today. Niederhoffer's contribution to these gains, along with his insights of how the maestro works, are explained in The Education of a Speculator and are well worth reading.

His basic rule is clear: Use the scientific process, which ``consists of reducing the margin of uncertainty about phenomena.'' Much of this is achieved by what he calls the ``feedback loop,'' his theory that the odds in favor of reversals versus continuations in market trends run at five-to-one. To prove his case, Niederhoffer cites studies showing that the average rebound from a worst-performing year is a gain of 20.2% in the next year. When applied to common stocks, this ties in with the Soros observation that ``the worse a situation becomes, the less it takes to turn it around - and the bigger the upside.''

Fascination forces one to look for clues to Niederhoffer's achievements, especially since, unlike Soros, he wasn't born ``a natural.'' The roots of his bulldog determination may lie with his parents' strange way of babysitting the young ``Vickie.'' In order to have some quality time during the winter, they would put him in the deep end of an empty swimming pool. When he had laboriously crawled up to the shallow section, they simply would move him back to the deep end.

Thoughout this book, rules for making money flow from page to page, as do concrete examples on how not to lose money. This isn't the kind of pablum that populates investment newsletters and flows before the eyes of every investment professional every day. Here the data are at the level of a doctoral dissertation.

The author shows the correlation between volcanic eruptions and the performance of grain futures. He sets out the motivation for traders to ``pocket the spread'' by positioning within zones set by limit orders. And he does much more.

Niederhoffer makes short shrift of gambling. The take at racetracks, he notes, is around 15%-25% of the wager on each race. That is before the bookmaker's spreads and the overhead of admission and transportation. However, while he is in that world, he demonstrates how to ``Dutch a bet'' - a way to lay off and remake the wager so you can't lose either way.

Stock trading, he concedes, can come a close second to outright gambling. On that score, he tells of a friend who lost everything in silver. By way of consolation, Niederhoffer ran all of this person's trades through his computer - posting buy decisions as sales and sell decisions as purchases. The result was the same: a loss of everything. It wasn't the market that wiped out his friend's fortunes, but rather that the broker's and floor trader's cuts were too great. Hence the success of the buy-and-hold strategy exemplified by Warren Buffett.

This book helps lay bare a multitude of other scams and deceptions - and looks at how and why they work.

Niederhoffer asserts that investors are like oxen. ``If one ox is separated from the herd, it exhibits agony until it can plunge back into the herd.''

by JAMES COXONBarron's Online

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