Vintage Andrea
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How to profit from bubbles.
The recent subprime crisis is not the first such calamity in the world's financial markets nor will it be the last. These delusional episodes occur at fairly regular intervals and are the product of deep, unchangeable aspects of human nature and crowd psychology. Think only of the great tulip bubble in Holland when the price of a tulip could be many times that of a luxury property, or the wonderful, boundless 'new economy' heralded in the NASDAQ folly of recent vintage.
At these times everybody begins to paint the same picture - the scenario. The elements of the scenario are repeated and rehearsed like a hypnotic mantra in the markets and the media. Watch out for repetitious key phrases like 'new paradigm', 'the markets have changed forever', 'risk is a thing of the past'. Look out for the telling harbinger of the pizza salesman or lavatory attendant turned billionaire overnight through the wonder-market.
The scenario painted in the run up to the subprime crisis had certain key features. A wonderful new piece of 'rocket science' called securitization could take big piles of increasingly dubious credit and repackage them in such a way that there was no risk anymore. Of course credit risk can never be made to vanish by any form of pseudomathematical magic. And, of course, there are never any free lunches - everyone here seemed to be enjoying a free lunch: the original borrower, the issuer of the securitization and the investor in the 'investment grade' paper spun off from the securitization. Another underlying scenario element was that property, especially in the USA would just rise and rise in value forever. This was often supported by various forms of Malthusian supply and demand argument about growing populations, growing wealth and limited real estate.
Look for the weakest link in the scenario or the one you can most easily exploit. Start off from the premise that the whole picture being painted is essentially false and follow through the consequences carefully. Wait patiently a while, even a year or more perhaps, until the hysteria reaches fever pitch then place your antiscenario trade which your careful analysis has identified as a logical consequence of the coming apocalypse. Use a strict stop loss and believe in the inevitability of the big scenario unwind. Be prepared to get knocked out many times and minimize your losses by following a rigidly disciplined stoploss philosophy. When the time comes use a trailing stop and expect big profits. It is wisest to use the trailing stop because unwinding bubbles are often partially reflated in emotional surges ('bear rallies') and you need to take your money off the table at the start of such psychotic relapses.
A deadly combination of mass delusion and greed fuels these recurrent episodes. Had I been in a position to I would have shorted securitization paper as a few hedge funds did and made huge profits. Nevertheless I personally made a lot of money in the latest debacle from the expectation that when the inevitable head-on collision with reality occurred the Yen carry trade would unwind. The media was awash with stories of Japanese housewives making gob-smacking fortunes by borrowing Yen and investing it in 'high-yielding' currencies. Institutions also put on huge bets of this form. It was foolproof and it could never end. But I was sure that any market shock would dry up the liquidity excesses underpinning this fool's paradise and cause the Dollar to plummet. It would be like a crowd of thousands trying to all exit through one turnstile. There would be and there was blood on the floor when the myth unraveled.
The Yen/Dollar future was easy for me to trade and I could get price updates on my mobile phone. I also studied all aspects of the seemingly endless 'carry trade' in the Yen and the movements and determinants of the Yen/Dollar pair. Globally, and especially in the good old USA, it became apparent to me that credit spreads were compressed in an unprecedented and unsustainable way. I felt that the crack would come in the seemingly unstoppable US housing bubble. When it did start to groan and rumble I had plenty of time to position myself and the unwinding carry trade paid me handsomely.
Study the markets in general carefully and be sure that you have an in-depth technical understanding of the particular market you intend to profit from. Make sure that you follow geopolitical events closely as these can often be the triggers for the big blowout (q.v. Nick Leeson and the Kobe Earthquake). Don't confuse antiscenario trading with simply being contrarian - a contrarian is always contrary - you are waiting patiently for a specific point of over zealousness and mass-insanity to be reached.
The puncturing of recurrent market bubbles can provide an opportunity for great profit.
Gregory Ovenden
http://personaltrading.yolasite.com
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