No Black Swans for these guys

In the previous post I argue that the 87 crash did not sneak up on the top Wall Street traders. On the contrary, they expected it and made a killing on it. Here are some quotes from Market Wizards.

Paul Tudor Jones interview with Jack D. Schwager

The week of the crash was one of the most exciting periods of my life. We had been expecting a major stock market collapse since mid-1986 and had contingency plans drawn up because of the possibility we foresaw for a financial meldown. When we cam in on Monday, October 19 (1987), we know that the market was going to crash that day.

Ed Seykota interview with Jack D. Schwager

I made money on the day of the October 1987 crash. I also made money for the month as a whole, and for the year, as well. I lost on the day after the crash, however, since I was short the interest rate markets. Most trend traders were likely either out or short stocks and stock indexes during the crash.

James B. Rogers, Jr. interview with Jack D. Schwager

I remember why I became even more bearish on the weekend before October 19. The week before, Alan Greenspan announced that the balance of trade was getting much better and things were under control. Two days later, the balance of trade figures came out, and they were the worst in history of the world. Right away I said, "This guy is either a fool or a liar. He doesn't have any idea what is going on." Then on the weekend before October 19, you Treasury Sectretary Baker telling the world we were going to stick it to the Germans by letting the dollar go, because the Germans weren't loosening monetary and fiscal policy as Baker had demanded. It looked like the trade wars of the 1930s all over again.
I was in a panic-and I was alrady short! I called Singapore that Sunday night to add to my shorts. So all those guys who came in on Monday to sell had very, very good reasons to sell, andthere were no buyers araound.

The Black Swan

In Mr. Rithotz's latest week in preview linkfest, there is a link to an article in The Gaurdian that gives a quick review of a new book called "The Black Swan", by Nassim Nicholas Taleb. Here is a little excerpt from the article.

Markets tend to work on the basis that Black Swans either don't exist or appear with such irregularity that they are not worth worrying about. As a result, traders in the City of London went home on the night of August 3 1914 seemingly oblivious to the fact that a world war lasting more than four years would start the next day. Similarly, there was not the slightest suggestion on Friday October 16 1987 that the Dow Jones would lose more than 20% of its value the next Monday. The Nobel prize-winners Robert Merton and Myron Scholes, who put together Long Term Capital Management and convinced their investors that their models made it a sure-fire bet, had failed to factor in the possibility of a Black Swan - in the case of LTCM, the Russian debt default in August 1998.

I'm sorry but I simply do not agree with the author at all. To someone on Main street the crash of 87 might have come out of nowhere but not to the top players on Wall Street. Many of these players were interviewed by Jack Schwager in the first of his excellent "Market Wizards" books. The interviews took place not long after the crash and were very fresh in the minds of the traders. Almost all of them were expecting a large turn in the market and were well positioned for Black Monday. The only exception was the one trader that shunned technical analysis (he was trounced that day). I do not have time to post their comments tonight, but will try to do so in the near future.

Here is an interesting poll. In honor of the 20th anniversary of Black Monday, MarketWatch put a poll together. Although this is not scientific, I still like the fact that there is a ton of skepticism out there regarding the market's rally. While this blog is called The Novice Bear, I have been net long since September 4th after covering my shorts on August 16th. A poll like this makes me happy to be a bull.