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Lessons From Victor Niederhoffer

By Matt Koppenheffer – Updated Apr 5, 2017 at 5:27PM

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What can we learn from the trials and tribulations of this notorious trader?

"Eccentric" would be a very mild adjective to apply to trader Victor Niederhoffer -- and I'm not even talking about his trading strategies.

For those not familiar with Niederhoffer, he's a University of Chicago Ph.D., a former professor of finance at Cal Berkeley, and a well-known trader renowned for his unconventional trading style and offbeat personal life. Through his first hedge, Niederhoffer Investments, he returned an impressive 35% per year over a number of years, until his fund was stopped cold by the Asian financial crisis in 1997. It took such massive losses that it was forced to close its doors.

Down but not out, Niederhoffer got back into trading for himself in 1998, and later opened two new funds, Matador Fund and Manchester Trading. After performing notably well through the first few years of existence, both funds ran into trouble over the summer, during the housing-sparked credit crunch. Matador was closed last month, after reportedly sustaining losses of 70% or more, and a report from today's Wall Street Journal suggests that the loss of a major investor in Manchester Trading may doom that fund as well.

Trading bad!
Being a fundamental investor myself, and a conservative one at that, the urge is to pile on with the usual comments of how the short-term trading that Niederhoffer relied on -- only holding positions for a matter of days, or even hours -- is a recipe for disaster over the long term. He made himself a relatively easy target for such comments by giving demonstrations on the piano of how he saw certain market movements emulating classical music. Just today, he wrote on his website ( of ties between market movements and architectural forms: "Today, the market action in S&P looks like a cathedral."

But taking that approach would hardly be worth anyone's time. To some, I'd be preaching to the choir; to others, I'd be part of the group that "just doesn't understand." Nobody would really be any better off for it. So instead, let's see what else we can take away from Niederhoffer's career.

"I'm not as smart as I thought I was"
The words above came from Niederhoffer, quoted by New Yorker writer John Cassidy in a conversation that took place in August, after his funds had already taken a beating. They're words from which all investors can benefit, regardless of how we approach the market.

Multiple studies in the area of behavior finance have shown that overconfidence plays a significant role in helping investors shoot themselves in the foot. In an article originally written in 1999, Whitney Tilson named a number of ways that overconfidence plays into an investor's downfall, including overtrading, believing that you are an above-average stock picker, and insufficiently diversifying your portfolio.

Niederhoffer could certainly give a nod to the relevance of keeping overconfidence in check.

More than you know
In his 11,000-word opus on Niederhoffer, John Cassidy quotes Niederhoffer follower James Lackey (that's not a pun) as saying, "What [Victor] taught me was how to approach the market as a whole, and how to analyze it scientifically."

The quote reminded me of the book by Legg Mason (NYSE:LM) star Michael Mauboussin, More Than You Know. In the book, Mauboussin stresses the idea of thinking outside the box when it comes to investing. He explores areas of science and psychology to gain insights into how the markets function, and how investors can avoid pitfalls that come from our natural hardwiring.

While I would steer clear from following Niederhoffer's train of thought on the S&P's current cathedral shape, I believe that looking outside of the usual avenues for ideas and insight can be very useful. Back in mid-July, Niederhoffer mused on some aspects of the Muir Woods in Northern California. Here's one of his insights:

The forest thrives and benefits after many seemingly disastrous events. Fires clear the underbrush. Dead trees still standing provide cover for much flora and fauna. Trees contain so much water that there is still much biomass left when they die, and they contain the nutrients and moisture that other plants or fungi need for survival. This situation is called a biological legacy by the scientists, but is just known as a gift by the laymen.

The number of, the amount of time in between, and the extent of watershed declines that the market has witnessed in the last year, as well as the resilience of the market to these declines, is a good measure of the health of a system. It is often good for future growth, to see decimated parts of the market landscape, such as the US real estate sector which has currently taken it on the chin, or the Saudi Arabian market that is down 75%.

Value investors like Berkshire Hathaway's (NYSE:BRK-A) (NYSE:BRK-B) Warren Buffett, who are often happiest when the market is down, would likely echo Niederhoffer's sentiment: When the market gets ahead of itself, corrections, crashes, and the like often clear out deadwood to let more light in on the strong companies that survive.

Maybe boring isn't so bad after all
Turning once more to the New Yorker article, Niederhoffer was quoted as saying (prior to his troubles this summer), "The idea that you can make a lot of wealth in a steady, unspectacular fashion, with no great gyrations, is a canard."

Maybe today Niederhoffer is rethinking that philosophy. Or maybe he believes that his second big blow-up is just another great gyration in his lifetime of trading. For the rest of us, though, the career of Victor Niederhoffer may be another reminder that, although it hardly makes exciting conversation at cocktail parties, investing conservatively and building wealth slowly over time isn't such a bad way to go after all.

More financial Foolishness:

Fool contributor Matt Koppenheffer does not own shares of any of the companies mentioned in this article. The Fool's disclosure policy has never heard a stock's chart pattern played on a piano, but has played the Internet Bubble Crash on its electric guitar.

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