When he left physics, John Breit had the choice of a job in naval intelligence or on Wall Street. "My wife said I couldn't be a spy. She hates capitalism, but said to go to Wall Street," he told me recently. "And then I ended up running a spy network."

Calvin Trillin once attributed the financial collapse to the influx of smart people on Wall Street. The physicists, computer scientists and mathematicians displaced the slow-thinking country club types. With their incomprehensibly complex models, the smart guys' hubris brought our economy low.

Mr. Breit was part of that initial incursion. A Ph.D. in physics from Columbia, he was doing postdoctoral work when he realized that he could never be as good as his contemporary Edward Witten, who went on to pioneer string theory.

So in 1986, he joined Wall Street, moving not to the trading floor, like many of his fellow rocket scientists, but into risk management. In 1990, he took his skills to Merrill Lynch, rising to become the firm's head of market risk oversight. The physicist came to understand the limits of mathematical models. He learned that his job was really psychologist, confessor and detective. He became the financial version of a counterintelligence officer, searching for the missed clues and hidden dangers in the firm's trading strategies.

And:

Early in his career, Mr. Breit figured out that models for markets aren't like those for physics. They don't come from nature. It was necessary to know the math, if only so that he couldn't be intimidated by the quantitative analysts.

But the numbers more often disguise risk than reveal it. "I went down the statistical path," he said. He built one of the first value-at-risk models, or VaR, a mathematical formula that is supposed to distill how much risk a firm is running at any given point.

The only thing from capital markets math he came to embrace was this immutable law of nature: investors make money by taking risk. "If it's profitable and seems riskless, it's a business you don't understand," he told me.

Instead of fixating on models, risk managers need to develop what spies call humint - human intelligence from flesh and blood sources. They need to build networks of people who will trust them enough to report when things seem off, before they become spectacular problems. Mr. Breit, who attributes this approach to his mentor, Daniel Napoli, the former head of risk at Merrill Lynch, took people out drinking to get them to open up. He cultivated junior accountants.

"They see things first," he said. "Almost every trading debacle was sitting on some accountant's desk."
All the while, he was on the lookout for bad trades. Most traders who get into trouble, he thinks, aren't bad guys. The bad ones, who try to cover up improper trades, are relatively easy to detect. The real threat, he said, comes from the "crazy ones" who really believe they've found ways to spin flax into gold. They can blow up a firm with the best of intentions.

And:

He despises the concept of "risk-weighted assets," where banks put up capital based on the perceived riskiness of the assets. Inevitably, he argues, banks will "pile into" the same types of supposedly safe investments, creating bubbles that make the risks far more severe than the initial perceptions. Paradoxically, risk-weighting can leave banks setting aside the least capital to cover the biggest dangers.

David Fuller's view John Breit brought a very sensible, perceptive and behavioural approach to risk management, in my opinion. However, my guess is that very few firms use a similar approach. Instead, in my observation the regulatory divisions are more likely to use box tickers, if only to protect their backsides.

Many of the 'smart guys' who eventually find themselves under severe pressure due to trading positions gone wrong will resemble sweaty bingers. Criminals, such as Bernie Madoff, are smoother but often have some obsessional characteristics, although one is unlikely to spot these in a brief, largely social encounter.

In terms of our own personal trading and investments, most of us will recognise that ego is often a factor in our bigger mistakes. We may also become paranoid and combative, losing our objectivity in an effort to 'get our own back' in a battle with the markets.

Self awareness and introspection can help us to reduce these problems, as can a sense of humour. However, they will not remove them entirely because none of us are devoid of human foibles.

Price charts will help because they are a reality check in terms of where the money is flowing. The crowd will eventually be wrong because people and money are a volatile, emotional combination. We see the evidence in the speed and extent to which markets move, relative to changes in underlying fundamental data.

When trading with leveraged positions, or managing other people's money, it is dangerous to be on the wrong side of the trend before it loses momentum, even if we do know that it will eventually be proved wrong.