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Does anyone remember the meteoric rise and disastrous fall of Long-Term Capital Management (LTCM)? The story is a master lesson in what happens when greed and trading collide. (You can read the full account in the excellent book, When Genius Failed by Roger Lowenstein.)

LTCM was a hedge fund founded in 1994 by John Meriwether, the former vice-chairman and head of bond trading at Salomon Brothers. Two of its board of directors were Myron Scholes and Robert C. Merton, who won the Nobel Prize in Economics for the Black–Scholes model.

It was successful right out of the gate. Returns were an astounding 21% in its first year, 43% in its second year, and 41% in its third year. The pressure was on to continue delivering insanely high returns, but by 1998 the party was over. LTCM lost $4.6 billion in less than four months due to high leverage and fallout from the 1997 Asian and 1998 Russian financial crises.

In September 1998, LTCM received a $3.6 billion bailout from a group of 14 banks, in a deal brokered and put together by the Federal Reserve Bank of New York. The fund was liquidated and dissolved in early 2000. If it weren’t for the bailout, the bond and stock market would have suffered a historic financial collapse.

LTCM shows how even the best and brightest can get it wrong. Their experience is no different from that of us mere mortals.

We feel like we’re on top of the world when we are winning. But when we start losing? Ooh boy. Desperation kicks in and we do anything we can think of to make up for those losses quickly. We lose self-control and suddenly our accounts take a major hit.

Remember what Warren Buffett once said: “The most important thing to do if you find yourself in a hole, just stop digging.”

In other words, STOP what you’re doing, because it is not working. Try something else. That something else could be taking a break from trading. It could be reviewing your trading journal and making note of what strategies have worked in the past to reverse a losing a streak.

You need to separate greed and trading if you want to start winning again. Take your emotions out of the game.

As the story of LTCM shows, nobody has a lock on perfect market performance. Even the “best” systems can go wrong.

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