Expect the Unexpected

It is the thirteenth day of the great eighteen day War of Mahabharata. In an attempt to capture the eldest Pandava Yudhistira, the Kaurava commander Dronacharya has laid out his best formation, the Chakravyuha, the unbreacheable spiral within spiral kind of formation. In the meanwhile, Arjuna, who alone knows how to breach the formation, has been cleverly drawn away from the main battle by a select brand of mercenary warriors. The well laid out plan is thus in place. Nobody among the Pandavas knows how to break the Chakravyuha. The one person who knew it i.e. Arjuna is away from the battle. Yudhistira is therefore ripe for the picking. The Great War is set to end on the thirteenth day by his capture or death.

Unknown to the Kauravas, Abhimanyu, the son of Arjuna, has knowledge of how to break into the Chakravyuha. Arjuna had described this to his mother while he was still in her womb. But by a quirk of fate, his mother Subhadra had fallen asleep(she hardly would have been interested in this detailed description of a War formation!) before Arjuna could describe how to get out of the formation. Kauravas had not planned for this unknown unknown.

Abhimanyu, though a great hero, is worried that once he gets in, he will not be able to get out of the mess. His uncles Yudhistira, Bhima and others assure him that they will be close behind him. Once he breaches through the formation with his knowledge, they will drive in through the breach and protect him all the way. The idea is that once they are in, they can wreak havoc.

So begins the fateful day of the War. Abhimanyu makes the breach with a well laid out plan of defense. Unfortunately, before others can drive in through the breach, Jayadrata a Kaurava warrior effectively seals the breach and Abhimanyu is left to fight the battle all alone.

What follows is something that can only be described as epic. He destroys warriors after warriors as he plans his way out of the formation. He realises quickly that is only hope of survival is to drive all the way through and breach the formation on the other side. With this in mind, he drives deep down right to the centre. He fights epic battles and kills thousands. He even manages to fight one with Duryodhana, the Kaurava prince, who he bloodies but spares because his uncle Bhima has sworn to kill him. He kills his son and several other warriors leading to increasing consternation among the Kaurava ranks. There is now a very real chance that Abhimanyu will succeed in single handedly destroying this well thought out plan.

Finally as the day begins to end, Dronacharya realises that this great warrior cannot be killed by fair means. So begins the passage of time in the war which ends all rules of fair play with which the war was fought until then. Against all prevailing rules, the Kauravas gang together to fight Abhimanyu and kill his charioteer and his horses. They destroy his chariot and attack him simultaneously. His bow is cut from behind. Abhimanyu continues to fight with his sword. His sword is cut so he continues to fight with the broken chariot's wheel. Like a pack of hyenas, they surround the lion. Finally the incessant sniping and cutting is too much for the lion. A tired and weak Abhimanyu succumbs and the Kauravas manage to kill him.

A day which began as a day when the Kauravas would emerge victorious, ended as a day of unimaginable losses for them. One single warrior had slayed hundreds and thousands of their men. Instead of capturing Yudhistira they had only managed to kill one individual and that too through unfair means. The loss of morale in that one day was immense. They had planned for everything. Arjuna had been drawn away. The best formation had been laid. All that was left to do was to go in and pick up Yudhistira. Unfortunately their best plans were put to rest because of an Unknown unknown.

On the other hand, Abhimanyu, the great warrior was aware of his shortcomings. The fact that he did not know how to return back was a known unknown. Despite this, the plans of the Pandavas to mitigate the risk of the known unknown failed miserably.

So, on the thirteenth day of the Great War, both sides suffered because of the Unknowns. Kauravas due to the unknown unknown and Pandavas due to the known unknown. Similarly the investor/trader faces needs to be aware and wary of both these situations. The point is that while Unknown unknowns cannot be mitigated at all, the known unknowns can also lead to ruin if the plans to mitigate them do not succeed. For eg, if a trader tries to reduce risk and exposure to the market by shorting a set of stocks against his long position on another set of stocks, he could still be destroyed if the stocks he shorted went up and the long stocks went down. His risk mitigation efforts could only end up increasing risk.

The only way to reduce risk therefore is to not take it on in the first place. What is the point of going for so called low risk long-short portfolio strategies and then leveraging to ensure returns are decent? What is the point of doing a LTCM? If one indeed wants to take risk, then the best bet is to make it explicit. That is if one has both long and short positions in the portfolio then instead of netting out the positions to calculate exposure it is best to gross it out so that one is aware of ones real exposure to the market and to risk. It is one thing to fool the investor in a fund. It is disastrous to fool oneself!

If you notice, in my trading, I am either long or short. Never both long and short a set of stocks. I am currently long and will cut my long positions and go short below 5170.