The Best Trader in the World Worked for Bernie Madoff
This is a cross-post from James Altucher‘s blog Altucher Confidential. His previous appearances on the Freakonomics blog can be found here.
The night Bernie Madoff got caught for running a $60 billion Ponzi scheme I got a call from my friend “Eddie” (not his real name) who for many years worked for Madoff. I couldn’t tell if he was crying but he was very upset. “I can’t believe it,” he said, “Bernie was like a father to me. Mark Madoff was like a brother to me.” We spoke on and off all night as more news came in and he came to grips with the new world he was living in.
I called Eddie yesterday and said I wanted to write an article about him and how I thought he was the best trader I ever knew. I’ve met and worked with over a thousand traders. I traded for hedge funds. I ran a fund of hedge funds. I’ve written five books on trading. And Eddie is the best trader I’ve ever come across.
He laughed. He laughed for two reasons. One is that he never thinks he’s a good trader. Two, he was afraid his name would be used. “I can’t have my name out there. I can’t be associated with Madoff at this point,” he said.
Eddie lived next door to me for years. We met in 2004 or 2003. He always wanted to work with me because he had read my articles and books about trading. I always said no. I never told him why I didn’t want to work with him. It was because I would’ve brought his results down. I wasn’t as good as him by a long shot.
But every day he wanted to talk his trades with me. He’d stop by and we’d chat for an hour or so about, always about trading. Sometimes I avoided him for weeks at a time. I don’t really know how to talk to people; I’m not very good at it sometimes. My daughter, Josie, would see Eddie in the street and say, “Hey, there’s your friend, lets go talk to him.” And I would be like, “Josie, shut the F up and keep walking so he doesn’t see us.” But 6 year-olds don’t really understand awkwardness.
Eddie worked on the prop trading desk for Madoff, which was separate from the hedge fund that was later exposed as a fraud. One time Eddie and I were riding into the city together when he told me he wanted to move to the hedge fund side but that Bernie wouldn’t let him because he said Eddie wasn’t ready. Eddie couldn’t understand it. “I’ve put up good results on the prop side,” he told me. “I’ve had 35 up months out of the past 36. I’m up a huge amount of money for him. Why won’t Bernie put me on the hedge fund side?”
Right there I came up with an idea that I instantly thought was brilliant, one that would not only solve Eddie’s problem, but would benefit me immensely. “Why don’t you ask Bernie if you could set up a feeder fund into the hedge fund side,” I suggested. “I can help you raise the money for it. With Bernie’s results I can raise over $100 million no problem.”
What a stupid stupid man I am. Thank god Eddie just laughed and said, “I don’t know, James. I just want to trade.” Otherwise we might both be in jail or the targets of federal prosecutors or something worse.
On Bernie’s advice, Eddie ended up leaving the Madoff firm and went to work for other hedge funds where he continued to rack up successful year after successful year, proving that it didn’t matter whether he was at Madoff or sitting at home, or sitting anywhere for that matter. He knew how to trade. I saw him trade everything from stocks to carbon credits, to electricity futures to fish oil futures over the years. He’s married to a beautiful wife. Has beautiful kids, lives on a farm with views in every direction, collects beat up race cars and fixes them. He escaped the misery. Because he was a dammed good trader.
And now for some Madoff stories.
One time Eddie brought me in to meet Madoff. I’ve written about this before and why they rejected me. Mark Madoff (R.I.P.) took me aside and pointed out all the prop traders sitting in the desks outside his glass office. “See all those traders out there?” He said. “Most of them are useless. Computers are much better.” I think Mark Madoff was legit and didn’t know what was going on. Maybe he was also stupid and turned a blind eye, which one can argue makes him just as illegal. But he seemed focused on just building up the prop side, which I knew through Eddie was completely legit.
On the night that Bernie got caught Eddie was telling me, “Oh man, if I had stayed there I probably would’ve lost a million dollar bonus. I can’t even imagine what all those guys are going to do.” A few weeks later I ran into “Meade” (not his real name). He had earned and then lost well over a million dollar bonus when the fraud was revealed. I think there’s a trial still going on because he once ran into Andrew Madoff in the street and beat the crap out of him. A lot of pain happened. Eddie was lucky. But there’s always a reason people are lucky.
I followed Eddie’s trades almost every day for years. Here’s what I think made him a great trader.
A) Humility. Eddie never thought that he was a good trader. He moved into the smallest house in the world, a thousand miles from the city, because he assumed he was going to be fired any day for making a horrible trade. He still thinks this way. Humility is not something you can learn. As an example, the worst trader I know is always convinced he is right. He calls me up and says, “Why is the market doing this? Doesn’t everyone see that it’s being manipulated by the government and by the big funds?” My friend, the mad trader, never admits he’s wrong. And every day he loses money. If you’re Captain Ahab, there’s only one way this story ends: Moby Dick kills you. Every good trader I know is infinitely humble.
B) News arbitrage. Let’s say some data about oil reserves was going to come out at 10am. Eddie would pick a basket of oil stocks with relatively low volatility. He’d have an idea of how the data was going to come out and how the stocks would react and he’d make his bet. If the data came out differently than he expected, he’d get out instantly. If the data came out as he expected but the stocks reacted differently than he thought they should, he’d be out within five seconds. He had no religion when it came to the markets. If they didn’t move the way he wanted he didn’t come up with conspiracy theories to support his case. He got out. He didn’t lose money. That was his only religion.
C) Low volatility. Eddie always went into stocks with low volatility. He didn’t want to take the chance that he’d go to the bathroom, potentially standing right next to Bernie Madoff at the next urinal over, and then come back to his computer and a stock would be 10 percent against him. He’d get comfortable with a stock like HPQ. He’d learn how it worked. He’d watch how the specialists on the floor of the NYSE would play the stock. He’d learn who the major players were in the stock. If someone was selling 3,000,000 shares he’d watch and wait for the selling to be over. Then he’d start buying. If the seller started again, he’d get out. Otherwise, he’d ride the stock for a few minutes and then get out. He had about five stocks like this and he told me it would take a few months to really learn the behavior of some stocks.
D) Know your stats. Eddie studied his own statistics every night. For instance, one time he noticed that for several months he had basically broken even on Ford stock. Ford was one of the stocks he had spent months studying to get used to its behavior. He thought Ford was going to be a big money maker for him. But when he saw that over time he had broken even on Ford over a several month period, he dropped it. “I didn’t understand it like I thought I did,” he said. As simple as that.
E) Look for outliers. Eddie would take a basket of stocks, like all the natural gas stocks. They all traded together. If one of them was veering off, i.e. not trading with the rest, he’d look to see if there were big sellers or any big news. If there was no big news, he’d go long the stock. If he lost money on it after a few seconds, he’d get out of it. Otherwise, he’d wait for it to trade with the rest of the group.
One final point: You know how Eddie met Madoff? He was in Grand Central one day and found a wallet with a thousand dollars in it. He called up the number on the business card in the wallet and returned it. The owner of the wallet was a trader who worked right next to Mark Madoff. They hired Eddie on the spot.