What I Learned From Losing $1.2 Million

At the start of 2008, I was a grain trader with less than one year of full-time experience who, through a series of strange events, found himself as the de facto head of my desk’s P&L. Although I had a senior trader who was supposedly in charge, he had brought his own book of business to our desk with him when he had been assigned to our group. This meant that 90% of his time was devoted to running his book, with the remaining 10% devoted to issuing high-level directives that were essentially pass-through messages from upper management who didn’t want to waste their time with a guy like me. Needless to say, this was a tough situation for me to be in.

The book that I inherited when I started working was in terrible shape, and I didn’t need to be a senior guy to understand that. The company I worked for had never wanted to get into grain trading (they focused more on other cash commodities) but had fallen into it and was now stuck with it. The two guys who had started the desk weren’t really traders, and had put a large number of forward corn contracts on the books, in addition to rolling contracts from the 2006 and 2007 crop years forward into 2008.

These contracts were all hedge-to-arrives (a type of contract that only has its futures value priced, with the final cash price determined later) with an average futures price of around $3.50. At the start of 2008, the market was closer to $5.00, which meant that I was paying through the nose in interest costs on my hedge line. As we made our way into 2008, my hedge line actually maxed out, forcing us to go to the bank and take on extended short-term credit to cover our margin calls.

During the spring of 2008, a number of companies in the agricultural markets were shedding assets in an effort to streamline and reduce overhead. My company had the opportunity to acquire one of these discarded assets, a procurement and management group that was being sold off by one of the larger ethanol companies. Management wanted to jump on this opportunity, but there was only one issue—I order to secure the financing, my hedge line needed to be cut in half. The task of making this happen was given to our senior trader, who, having no knowledge of the markets that my P&L was working in, passed it on to me and told me to make it happen.

Over the course of the next week, I searched and searched for buyers who would be willing to contract some forward cash positions with us so we could get rid of our short hedges and bring our line down. Unfortunately, due to the bull market in corn, many of our trading partners had decided to get out of the forward markets, or were buying basis-only (a contract where the final cash price is established at the time of shipment). Ultimately, I made some sales here and there, but still needed to dump about 500,000 bushels of corn for new-crop delivery.

I finally found a willing trading partner in one of the nation’s largest ethanol producers. They had four plants in the area that most of my corn was owned, and were willing to forward contract with us. I made sales to all four plants, getting rid of almost all of my remaining bushels and bringing my hedge line down to where management wanted it. At that point in my career, I was happy that I had managed to do what my management team had asked me to do, and felt like I had done a good job navigating a crazy market to position our company to be more successful. Gold star for me, right?

I had been assured by my senior trader that, because of the circumstances, my P&L would not be held responsible for any losses that we took on these sales. Management understood that the market was volatile, that shorting basis in this market was not what we would normally do, and that I wasn’t responsible for putting these hedge-to-arrive contracts on or rolling them forward. I believed him—after all, he was the guy who was technically in charge, and ultimately he was responsible for this P&L.

At the end of October 2008, the ethanol plant who I made these large sales to went bankrupt. There were some rumblings of it in the market leading up to it, but ultimately, it happened quickly and without much warning. When the corn market collapsed in the third quarter of 2008, the hedging strategy that this company had employed created a situation where they were obligated to purchase corn at prices that were $3 to $4 over the market. They burned through their remaining cash in two months and declared bankruptcy.

I immediately had two problems—first, the counterparty that I had a large position with just defaulted on our contracts. Second, we were now long basis in a market where four of the largest terminals had just cancelled all of their new-crop contracts, thus dumping a glut of corn into the market. I will never forget the president of the company calling me on the phone the next day, blasting me for getting us into this position and screaming that I better have a plan to do something about it.

At the end of the day, we covered all of our positions for a loss of around $1.2 million, just in time for my 18 month anniversary with the company. Fortunately, I wasn’t fired at my performance review.

Despite all of this, I took away a number of lessons from this that have served me well through my trading career:

Liquidity in cash markets will disappear when you need it most.
When we needed to sell cash grain, nobody was buying, the result of market conditions that were squeezing everyone in the business, from country elevator to ethanol plant to export terminal. Never just assume that you can move your entire position on a whim. Always know what your counterparties are doing with their inventories and buying/selling strategies. Recognize that cash trading is a combination of price and execution, and that true purchase and sale prices need to include the cost of execution.

Always fight for your P&L.
At the time, I was happy that I had been able to do something that helped the overall company (I blame this on being out of college for less than a year and not understanding how things really worked). I didn’t think about the risk to my P&L, or my job for that matter, if this situation went really south. I assumed that, because I had followed orders, I would be rewarded regardless of the outcome. This is not the case. As a cash trader, your greatest asset is a reputation for executing large numbers of profitable trades—your reputation for being a good company man doesn’t get you anywhere.

If management says something, get it confirmed in writing.
If they say they’re going to do something, confirm it in an e-mail. That entire $1.2 million loss hit my P&L. We had just started our fiscal year. I spent the rest of the year crawling out of the hole. The promises of absorbing any losses we took, understanding the situation, knowing that we were doing things differently (less stringent credit requirements, for one) on this trade because we had to—all out the window once reality set in. This was the first time I really learned this lesson, and thankfully, I learned it in time to not let the whims of management dictate where my career ended up.

There are no perfect storms in trading—it can always get worse.
2008 was a crazy year all-around. The bull market took liquidity out of the market, caused a number of companies to increase their storage fees, and made basis levels go crazy. By July, we had all settled into a semi-comfortable state of being, thinking that this was the way the market was going to work from now on—we could ride the waves that we’d been given and be alright.
And then it got worse. The market collapsed, and the things that we all did to survive the initial bull run were now sinking us. The storm changed course, and that comfortable unease that we all had felt suddenly became severe discomfort. You have to be flexible and adaptable in these conditions, willing to switch strategies to keep the boat afloat.

There are traders who have lost more, and probably in more entertaining ways than this, but this remains the biggest loss in my career and the one that I learned the most from. Feel free to share what you've learned from losing money below.

Mod Note (Andy): #TBT Throwback Thursday - this was originally posted on 3/01/14. To see all of our top content from the past, click here.

 
Best Response

Hey man, great post, I appreciate you sharing your lessons which is always valuable for persons who are serious about trading, and here I'll share with you my lessons for losing my money.

When I first started trading I had 10k and as a typical novice you get caught up in wishful thinking. This was about last June when Blackberry was all over the news and polarized predictions on their next ER, it was trading about $14 and like a typical novice, I loaded up with everything on out of money calls thinking I got myself a bargain and couldn't wait to see how they'll prove all naysayers wrong and get myself a six figure payday. Of course I was nervous, after all nobody really knew what would happen and I barely slept the night before their ER which took place 8:30AM the next morning and finally I grind my night away and by the time I woke up it was already 9AM so I immediately sought out for their pre-market trading and you guessed it, wham, i saw red and it was trading close to $10. Before I could do anything, I was wiped out. I was so upset yet still managed to squeeze a few laughs at my own stupidity. And on a anecdote, since I remember my finance professor told us a story of him betting everything on futures and lost all just before marrying, I emailed him that morning telling him a similar thing happened with me hoping to get some empathy, you know what he replied? He said "That's why I have always stressed in class to DIVERSIFY."

You think you learnt your lesson, but have you really? So on my next stint after a couple of months, I scrambled another 20k and this time it was on TSLA, a stock hotter than kate upton, and this time I've already learned a few new tricks and setting up straddle and spread option plays, so I loaded up on out of money long straddle, and I don't remember what the fuck happened but I ended up losing money again despite I have predicted the movement correctly, I think it was a timing issue and I must have gotten nervous and sold early, then it surged and that set me on tilt for a while, and this happened over and over during the coming months, and while I was finally getting my hang of things but I would always win peanuts and lose a farm.

I then started a log, tracking all my trades and recording my lessons. I realized that through trading, you get to see yourself a lot more clearer, your personality or characteristic weaknesses are blatantly exposed. If you ever catch yourself in such moment, never let go easily until you really learn something from it. What I realized in terms of my own weakness is that I needed to be convicted, as if my balls should be made of iron. First of all, I didn't have a range for myself, at what point do I cash out my profit and at what level should I cut loss? So when things do go your way, your greed/fear makes you think it'll rise even higher and you sit and wait until it goes bad, and when it go bad, you sit even longer hoping things will go good again. Secondly, I realized that even making money is not as easy as I thought, it takes a very deep appetite to be able to sit tight through hard times - that is not selling at a loss too early, and to hold yourself from selling too early when sunshine beams on you. It really isn't easy even to make money, it takes underwear full of iron balls and knowledge and instinct and everything in between to become rich trading. No kidding.

Slowly I was getting some successes after half a year of losing money which probably in the 50k range, Experience made me a much better trader and I was paying attention to risk, and most recently, I made 15k in 1 week doing swing trades, shorting covered options and all. I thought I was on my way to recover all my prior losses, and then the hardest strike struck. In fact this happened just last week, the friday before last week I bought 40 contracts of TSLA puts strike $180 at nearly $5.50 so cost me 22k, it was trading at $183ish and I thought it was already pushing limit and should fall next week, but obviously spending 22k like that is way too risky and I thought of it too, so I planned to sell 40 puts strike $175 for $3.5 or something like that, so I would receive 14k premium and in effect I was paying 8k for the $180 contracts, and most importantly, I would hedge my downside risk should the stock keep on rising next week - if it indeed go down next week, I was going to make money as long as the stock falls below $178; if the stock goes up, depending on how much, I could buy to cover my shorted contracts strike $175 for cheap and hope it to fall again. But what happened was that after I paid my 22k, the stock rose steadily all day long, which eroded the price premium of the $175 puts to $2.5 and maybe it was greed, I was just reluctant to short for that price, eventually I decided to carry the risk with me through the weekend and thinking even with a small fall in price next Monday, I could get $3 or more. So with the stock closed at 186 on friday, it then opened at 194 the next monday, holy shit my $5.5 is now worth $2, 22k became 8k, so without much hesitation I bought another 40 of the same contracts to average my cost down to $3.75, now I dont need the stock to dip below 180, as long as it flirts with 188, I was bound to make money again, sounds great, but the stock just never looked back, it reached for $199 and closed at $196.5, I decided to wait patiently, so Tuesday came, great, it pushed for $200 and closed at $196.6 and by this time, given the erosion on the time value of money, my contract is only worth 80 cents, and I don't know what got into my head, but I thought the stock topped out, it should fall tomorrow however slightly, so I bought another 220 contracts to make it even 300 contracts and making my average cost $1.5, so another 2 or 3 dollar dig tomorrow should recover me all my costs which was already 50k, see how cost average is a deadly double-edge sword? So here came wednesday, which the stock never got below $195, even at an average cost of $1.5, I would only get 70 cents back since they are expiring on Friday, but the fact that the day went without it going up, so I decided to wait another day and was prepared to exist within a 10k loss range, and boy oh boy how I had no room for even such an negotiation, the stock opened at fucking $204, and my fucking contracts were now at 25 cents range. From up 20k in my account all of sudden down 50k in 3 days by 3 trades, I couldn't be more ripped inside. Within half a year I lost 100k along with my heart.

So the lessons? I'm sure each gets something valuable from my disaster, but I swore since that day, never to conduct another trade without a formal plan or strategy, and never ever again try to pick up a nickel before a train, always, I mean always give yourself room to maneuver, let it be money or time. Pick up books now, read about the companies you trade, study them and follow them, learn the market and theories and techniques. Observe coldly, strategize thoughtfully and strike deadly.

To me, trading successfully takes a magical combination of will, knowledge, instinct, experience and a touch of luck. While luck may make or break one, but after all these, I'm convinced that it ain't luck that will make one rich trading.

 

Thanks for your story, do day traders ever do DCF modeling ?. and the only way to get experience to learn from the mistakes.

‘The critical investment factor is determining the intrinsic value of a business and paying a fair or bargain price." W.B." we venture the motto, Margin of Safety.” Ben Graham
 

Thanks for the post, just want to stress this, one more time, because it is something that I have also learned and can't stress enough how important this is :

'I realized that through trading, you get to see yourself a lot more clearer, your personality or characteristic weaknesses are blatantly exposed.'

No matter how well do you think you know yourself and what you are capable of, its just a small bit in comparison to what you find out once you start trading. Learn from it, one of the most important lessons in life.

 

AWESOME post! Great insights and great lessons to be aware of going into the business. Without a doubt one of the most beneficial posts I've read on here to date. Thanks!

"I know you think you understand what you thought I said but I'm not sure you realize that what you heard is not what I meant."
 

Great post! I have a few stories of how we needed to off load inventory and losing a couple of wheelbarrows of cash in the process.

Get everything in writing or on a taped line.

CNBC sucks "This financial crisis is worse than a divorce. I've lost all my money, but the wife is still here." - Client after getting blown up
 
Working9-5:

Great post! I have a few stories of how we needed to off load inventory and losing a couple of wheelbarrows of cash in the process.

Get everything in writing or on a taped line.

Taped line won't do. Writing won't do - unless you specifically object to it in writing, and are over-ruled. And even so, who will you be asking for the tape from? You need your boss' permission for it, and when shit the fan nobody cares. Really, your loss - your problem. Can very easily blame OP for having faced just one counter-party as opposed to diversify his risk. I've lost money as a sales person in the past, you sweat a lot. It's painful, especially as a junior when you don't know how to deal with it yet... Later on you can always blame a junior for it ;)

 

I agree about shouldering the blame for my loss. My P&L, my problem. At the same time, I can honestly look back at that situation and say that I never would have made that trade had it not been for the extenuating circumstances surrounding our company--and that's where I think it's important to get those circumstances documented in writing. You might not win in the end, and management can always change their minds, but you have a better chance at getting the outcome that you were promised if you cover as many bases as possible.

That being said, I can think about that trade now, with six years and a boatload more experience behind me, and I know there were a dozen things that I would have done differently to mitigate the risk. I'm thankful that I learned how to take a hit and recover early in my career, and ultimately, it didn't do anything to derail my career path like I thought it was going to at the time.

 

I am interning with a small fund that invests in Renewable Energy projects and we have been looking at trading wheat futures as a potential hedge, got an interesting insight into the market from a futures trading company and that time period was just a nightmare for everyone!! Seems like you made the best of a shitty situation though, which is all you can ask really!

 

Apologize if this sounds like a naive question but it seems like your market risk became credit risk... and is it not ultimately the cdt risk managers at fault for sanctioning concentrating your counterparties.

Regarding your basis risk do you just mean the spot vs. futures diff, and why wouldn't your firm allow you to hold the position if it was only basis risk?

 

Basis is a component of the final cash price of a contract--futures price plus basis gives you your final cash price. The vast majority of grain trades on basis and basis risk is your market risk--when you establish a position, you are going long or short basis. Basis can still be volatile but not as volatile as the board, so there's far less risk hedging your cash position and trading basis. The difference between the spot cash price and the nearby futures is the spot basis in a particular market, but there are forward basis markets as well and you can usually find liquidity up to 12-14 months out.

I had both market and credit risk. My inventory was all hedge-to-arrive with farmers--we were in a neutral basis position at the start. In previous years, it had been possible to make hedge-to-arrive sales in the market to offset the futures we had sold against our HTA purchases and stay basis-neutral (the company had done this in 2006 and again in 2007 shortly before I was hired). That option went away in 2008, so we had to make cash sales, which did allow me to offset my futures position but made me short basis. That was my market risk.

The credit risk was the same credit risk that we take on with any counterparty--and in this case, upper management overruled the credit department and waived our usual credit requirements. Although we had previously established credit with this company, the size of the to-arrive receivables normally would have required more due diligence on the part of credit, but I was told not to worry about it and to just make the sales and credit didn't put up much of a fight.

 

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