Editor's note: Today, we're continuing our holiday series by revisiting some of our favorite essays from Stansberry Research and our affiliates. Marc Chaikin, founder of our corporate affiliate Chaikin Analytics, first shared this issue in July. In it, he explains how one trader's spectacular rise and collapse offers a lasting lesson in risk management every investor should understand...
Brian Hunter made more money in a single month than most folks make in a lifetime... before he caused one of the biggest hedge-fund blowups in history.
You see, Hunter was a commodities trader. But he wasn't the typical, brash Wall Street type.
Hunter grew up in Canadian farm country near Calgary. He was quiet and kept to himself. But he loved crunching numbers. And he was good at it.
In college, Hunter majored in physics. Then, he got a master's degree in mathematics.
That gave him an advantage over his future colleagues in the financial markets. Soon after graduating in the late 1990s, he joined the natural gas futures trading desk at a Calgary-based company called TransCanada (now called TC Energy).
Hunter quickly learned the fundamentals of the natural gas market. His experience primed him to become one of the most profitable energy traders in the world.
Then, in 2001, Hunter joined the natural gas trading desk at financial-services giant Deutsche Bank (DB). And he took off...
Hunter made the bank $17 million during his first year. The next year, he tripled that figure, bringing in $52 million. By 2003, he was the head of Deutsche Bank's natural gas trading desk.
His division was poised to have another big year. But disaster struck...
In December 2003, natural gas prices went higher instead of lower – the opposite direction of Hunter's bet.
That cost the bank more than $51 million in losses in a single week.
Hunter blamed the losses on Deutsche Bank's electronic trade-monitoring and risk-management software. He said it stopped him from exiting bad trades early, which could have mitigated the losses.
The next year, Hunter left Deutsche Bank. It didn't take him long to find a new job.
But at his new firm, poor risk management and bad speculating eventually led to a colossal blowup – one that offers a valuable lesson to investors today...
Risky Bets Paid Off... Until They Didn't
A former natural gas trader at Goldman Sachs (GS) hired Hunter to work at the energy desk of Connecticut-based hedge fund Amaranth Advisors.
At first, Amaranth kept Hunter on a tight leash. The firm knew of his big swings at Deutsche Bank.
But Hunter was a pro. He and his group steadily generated annual returns of 20% to 40%. So Amaranth gave him more leeway to make trading decisions.
In 2005, Hunter saw an opportunity in his main market: natural gas...
Oversupply had driven natural gas prices down, which he thought was unsustainable. And he expected prices to rise. So he bought millions of dollars' worth of options at bargain prices.
Then, Hurricane Katrina slammed into the southeastern U.S... followed by Hurricane Rita not long after.
The two storms devastated America's oil and gas production. Transportation in the Gulf region stalled. And natural gas prices soared.
Hunter's bets on natural gas paid off massively. He made $1 billion for Amaranth that year. That earned him a nine-figure bonus.
Hunter's hot streak continued into 2006. By that April, he helped Amaranth amass a roughly $2 billion profit.
He was so bullish on natural gas prices for the winter that he made huge leveraged bets. And he used swaps and derivatives to get around Amaranth's position-size limits.
Since Hunter had brought in so much money, the firm stopped watching him closely. Amaranth also allowed him to relocate to his own office closer to home in Canada.
Then, his good luck unraveled...
An unexpectedly warmer winter sent natural gas prices plummeting.
Hunter was sitting on billions of dollars' worth of options and derivatives on natural gas. They were bleeding millions every time natural gas prices fell by even a single cent. And his bets were too large to get out of if the market turned.
Eventually, Amaranth was in the hole for $6.6 billion – all thanks to Hunter. The firm imploded.
Hunter single-handedly caused the collapse of one of the world's largest and most successful hedge funds. Put simply, it was because of his overleveraged, one-way bet on natural gas in 2006.
Spectacular busts like Amaranth aren't a regular thing on Wall Street. But they teach us a valuable lesson...
Losses like this can happen if money managers don't have the tools they need to manage risk and exposure in the markets. That's true for individual investors, too.
So make sure you have the proper tools – and a plan – to manage risk. That way, you won't be riding your portfolios to zero.
Good investing,
Marc Chaikin
Editor's note: Last week, Marc Chaikin went on record with his most serious market warning in years. After predicting the past two major crashes, he now says hundreds of stocks could face sudden, brutal sell-offs. In his briefing, he unveiled new software designed to help you lock in the highest potential gains ahead of the "flash crashes."
Further Reading
When markets become overly concentrated, even great stocks can swing wildly. Diversification doesn't just protect your portfolio – it protects your mindset. Learn how spreading risk the right way can help you stay calm and capture long-term gains.
When you buy a stock, there are only two possible outcomes: It can go up or go down. That's why winning investors aren't just great stock-pickers... They're great at controlling their emotions. One simple approach can prevent fear and greed from turning good investments into costly mistakes.
