What I Learned From Losing $200 Million

The 2008 financial crisis taught me about the illusion of control, and how to give it up.

By Bob Henderson   December 24, 2015

I’d lost almost $200 million in October.  November wasn’t looking any better.

It was 2008, after the Lehman Brothers bankruptcy. Markets were in turmoil. Banks were failing left and right. I worked at a major investment bank, and while I didn’t think the disastrous deal I’d done would cause its collapse, my losses were quickly decimating its commodities profits for the year, along with the potential pay of my more profitable colleagues. I thought my career could be over. I’d already started to feel those other traders and salespeople keeping their distance, as if I’d contracted a disease.

My eyes started to fill from a sudden wash of gratitude and relief that came, I think, from no longer being alone.

I landed in London on the morning of November 4, having flown overnight from New York. I was a derivatives trader, but also the supervisor of the bank’s oil options trading team, about a dozen guys split between Singapore, London, and New York. Until this point I’d managed the deal almost entirely on my own, making the decisions that led to where I ... we ... were now.

But after a black cab ride from Heathrow to our Canary Wharf office, I got the guys off the trading floor and into a windowless conference room and confessed: I’d tried everything, but the deal was still hemorrhaging cash. Even worse, it was sprouting new and thorny risks outside my area of expertise.

In any case, the world was changing so quickly that my area of expertise was fast becoming obsolete. I pleaded for everyone to pitch in. I said I was open to any ideas.

As I spoke, I noticed that one of the guys had tears welling up in his eyes. I paused for a second, stunned. Then my own eyes started to fill from a sudden wash of gratitude and relief that came, I think, from no longer being alone.

Stress testing is a standard technique derivatives traders use to test how their portfolio will perform in an imagined “worst-case” scenario. The problem is that “worst-case” is subjective, making stress testing as much of an art as a science, and exposing the trader doing the testing to something called the “illusion of control.”

The psychologist Ellen Langer coined the phrase in 1975 to describe “an expectancy of personal success probability inappropriately higher than the objective probability would warrant.”

Experimental evidence for the illusion goes back at least to 1965, when one research team found that college-educated employees of AT&T asked to press buttons to illuminate lights had the tendency to believe they had more control than they actually did, even when the lights lit randomly, and even when they used pen and paper to track their results.

In another study, done in 1992, a group of Israeli college students was found to be more willing to bet on dice, and to bet bigger, before they rolled than after, reflecting the belief that they had control over their rolls. Such a preference for prediction over postdiction had been observed before, but this study also found that the preference grew stronger when the students were threatened with an electric shock if they guessed wrong—evidence that stress amplifies the illusion of control.

Langer’s work showed that the illusion is also intensified by “skill cues”: circumstances that make people feel like they’re engaged in acts of skill rather than luck. Such cues include competition, choice, and familiarity with the task at hand.

Therefore people will tend to overestimate their prospects in a game of pure chance even more than usual if they face a nervous-looking opponent, or if they pick rather than get assigned a lottery ticket, or if they’re given the chance to familiarize themselves with an apparatus that’s simply spitting out random numbers.

Or, I might add, if they’ve toiled over complicated mathematical equations to back up their decisions.

I thought I knew what I was getting into. I’d helped my bank win the fateful deal by developing a complex option on crude oil, together with a risk management strategy. My equations told me how I could buy and sell simpler financial products over time to approximately offset my daily gains and losses on the option I’d sold.

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