Online Trading : Published Trading Articles
Fear and panic in the markets
The recent and ongoing crisis in the financial markets has probably confirmed to many, that trading and investing in these markets is probably no better or safer than gambling.
As a currency trader I can confirm that whilst there are similarities between playing poker and trading certain markets, the blame for this particular crisis lies firmly at the door of the banks, with the market makers taking full advantage of the situation.
Reckless lending to the sub prime end of the market (that is to people with a poor credit record) as well as to over leveraged hedge funds and private equity companies, could not be sustained once interest rates started to rise. In addition it isn’t just a question of bad debt that the banks are suffering from, more importantly, it’s what has been done with this debt which is causing so many problems. By parcelling up the debts and converting them into tradable assets, the risks have been so compounded that no one knows who is now holding the original debts, nor the extent of the debt. As Warren Buffet once said:” It’s only when the tide goes out that you see who has been swimming naked”!!!
As a consequence we must now all suffer, as the effect of this credit crunch spills over into the wider financial community. Not only will this uncertainty make it more difficult to borrow money as lending restrictions are tightened, but the market makers have used the news as an excuse for a massive sell off of shares.
Signals that all was not well appeared earlier this year with falls in the Shanghai index. This was put down to over exuberance on the part of the Chinese investor! However, alarm bells rang as far back as May and June when the VIX, a particular indicator of volatility started to rise. My own personal currency blogs of the 11th May, and 17th June warned of difficult times ahead. In fact the major falls started on 27th July (www.making-bread.co.uk/myblog/)
The VIX is often referred to as the indicator of “fear” – it starts to rise only during periods of volatility (i.e. sell off and panic!) and is low when everything is quiet and prices are rising. During the past few weeks it has risen to readings over 30 – imminent financial meltdown.
If the professionals can get things so wrong what hope is there for the small, retail investor and trader to stay safe and make money. I firmly believe that whilst it is not easy, it is in fact remarkably straightforward.
Just as a good poker player will have a strategy, understand “odds” and know when to “fold”, good traders and investors too must start with a clear strategy and trading plan. There can be many elements to a trading plan, but at the very least it must include sound money management and an understanding of risk. Good money management will always ensure that any losses will be kept to a minimum. As has been repeated many times, preservation of capital is the key to success, and the number one priority. If you lose all your money you are out of the game. In trading, a simple stop loss is the first line of your defence. Naturally, as traders and investors become more proficient and sophisticated, hedging strategies and correlation will add further layers of protection.
In summary, the turmoil of the past few weeks has demonstrated that the professionals have clearly forgotten simple, basic rules and have allowed themselves to take bigger, unquantifiable risks. What is also very strange is the fact that the so called professional players, only seem to have been trading one side of the market – i.e. prices going up. This again is very odd since hedge funds are supposed to hedge risk, by trading all sides of the market. Complacency (remember the VIX) and eternal optimism have ruled the markets for the last four years in the latest bull run. When everything is going up – shares, gold, and commodities, everyone buys with the herd mentality and it is all too easy to forget that the market has two sides. By all means ride the run, catch the wave but always be aware that nothing lasts forever.
Understanding market mood is crucial to successful trading and investing. You don’t have to be an economist or analyst, just keeping a close eye on the VIX, the relationship between price and volume (I’ll cover this in my next article), and the Chinese is a good start.
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