To cover the extreme volatility in the markets and the recent outbreak of coronavirus , im creating this episode to discuss how we are livetradr been navigating through the turmoil.
As leverage has been around for a really long time but leverage has been change the culture just for a few hundred years and I think in these times in particular it’s worth understanding how leverage works and how we got here and what happens when it goes in the other direction back in the early days of corporations when colonialists wanted to put together shifts to go on long periods during this one methods that would be taking you life savings and buy one ship to go on a journey. If it works, you do well, if it doesn’t you’re completely wiped out but there is an alternative and the alternative is to borrow money.
To cover the extreme volatility in the markets and the recent outbreak of coronavirus , im creating this episode to discuss how we are livetradr been navigating through the turmoil.
As leverage has been around for a really long time but leverage has been change the culture just for a few hundred years and I think in these times in particular it’s worth understanding how leverage works and how we got here and what happens when it goes in the other direction back in the early days of corporations when colonialists wanted to put together shifts to go on long periods during this one methods that would be taking you life savings and buy one ship to go on a journey. If it works, you do well, if it doesn’t you’re completely wiped out but there is an alternative and the alternative is to borrow money.
To cover the extreme volatility in the markets and the recent outbreak of coronavirus , im creating this episode to discuss how we are livetradr been navigating through the turmoil.
Before we get started, we are sensitive to the fact that there are lot of people who have been adversely impacted by this outbreak and the markets downturn, the purpose of sharing our insights and wisdom is not to gloat about large gains , and we are also going to speak about a scenario for how we think the market could play over over the coming weeks and months.
When it comes to swing trading, we are not married to any one idea, we will quickly abandon our opinion when necessary or have limited downside risk protection when it is not working in our favor.
Please note that this is recorded on May 26th after the S&P closed at 2955 and the dow hones close at 24,465 and we are having a long holiday weekend with the memorial day holiday on Monday.
We’re recording this now when the coronavirus began spreading through China back in January and we bought put options to hedge the downside risk not because we had predicted the virus is going to cause a pandemic or did we have any foresight to imagine that what’s happening in China might spread globally and expose a much bigger problem the world is facing now. People have been caught with their pants down in what 2008 felt like so they never really seen a bull market because if you could recall the markets been going up every day, every single day and it’s giving returns like 10%, 50% , 100%. People keep questioning me like my ETF is down 35% , what should I d
I often said to them, did you think about it when it was up 25% ? So you don’t do anything right now or you should go and do something then you know that’s when I tell people, you see whats happening in the United States , it’s very strange because even when it was beginning to spread through China the market in the U.S and even in Asia , the markets was continuing to push on and to all-time highs, so I think the majority of people thought that it was going to be much better contained and as I mentioned it’s obviously caught a lot of people swimming naked and I think that’s partially the reason everyone was super bullish until a March the period is so much shorter and we have been regularly experiencing all-time highs just 60 days ago and so much trillion of dollars worth of stops has been triggered and people are discovering their long position is now worth 75% less or even 90% less.
You see, when panic sets in people are headed there along side with the wave of panic selling , traders are going to first sells stocks at crazy prices then followed by investors. I think today I felt day on March 25th 2020, was the first time I think we saw the markets at yet another crossroad that is going to diverge very soon.
We saw some buying activities last week that came in a little bit but by end the week it’s starting the fade. So the question you might have right now, is is this a false breakout? Or is this a bull trap?
Just rewind the tape to two months ago, there was a lot of panic and then some stocks were beaten so badly , they’re down like 2008 levels in anything that we have never seen before. You see, in 2008 we had the subprime mortgage crisis where over leveraged banks like Bear Sterns and Lehman Brother and a syndicate of other too big to fail banks selling shitty banking products like CDOs made it clear it was a financial meltdown.
So allow me to explain the way capitalism works not only in America but globally even in Asia. My hope is that I can create an awareness in our community is that we gonna start saving money for rainy days. Probably it’s like 75% of Americans live from paycheck to paycheck and we are caught in black swan situations like this because we underestimated that things like these won’t happen and won’t go as bad, but the fear is that, its going to be that bad, and in the markets, if you are an investor, people are going to sell everything and stay in cash and that’s what happened in 2008.
Don’t get me wrong, there will be good companies and stuff to buy eventually when the tide is over but I think we are not at the bottom now, and this is probably not a v shape recovery we are seeing.
As Archimedes probably did say if you give me a lever that is long enough and place to stand I could move the entire Earth. The world we live in today gives you leverage. It gives you the chance to exert far more power than you would be able to on your own.
As leverage has been around for a really long time but leverage has been change the culture just for a few hundred years and I think in these times in particular it’s worth understanding how leverage works and how we got here and what happens when it goes in the other direction back in the early days of corporations when colonialists wanted to put together shifts to go on long periods during this one methods that would be taking you life savings and buy one ship to go on a journey. If it works, you do well, if it doesn’t you’re completely wiped out but there is an alternative and the alternative is to borrow money.
1.) How Leverage Works
When you borrow money you have to pay it back with interest but all the winnings belong to you so the easiest way to get rich for a very long time has been interesting if you consider even the real estate industry. Real estate prices are going up all the time. There are banks waiting in line to loan money to investors who want to buy real estate typically you could buy some real estate by putting 20% down of a piece of real estate that is for sale for $1,000,000.
In other words, you only need $200,000 in cash to buy in and the banks puts up $800,000. The bank is taking a small risk, because the risk is that you pay them back and if you don’t, they get the piece of property which assuming today is worth a million dollars. So they feel pretty secure for what happens with the value of the property goes up 20% and if the value of the property goes up just 20% to $1.2 Million you can pay back the bank $800,000 and you get to keep the rest, you essentially have doubled your money with a 20% increase in the value of that real estate that led to a 100% increase.
2.) How Businesses Are Getting Leverage
How much money you have that is called leverage and in Australia and the U.K they’re calling it gearing because you can can see the gears working turning in the direction and so anytime we have a chance to buy assets, that are known to be of value that we think are going to go up in value, leverage gearing gives us the change to multiply that which is a really productive way to think about this is that if you buy an asset. For example, you are surrounded by people who need to make pins for a living making a pin turns out to be a skilled craft and atypical pin maker could make a pin in 6 minutes.
Ten pins in an hour. Thus, you could buy a pin making machine if you could buy a pin machine, you could make 1,000 pins in an hour. If you make 1,000 pins in an hour. You can pay back what it cost to buy that pin making machine, so you could go to the bank again using leverage and say here's your $40,000 back and you’re telling the banker, “I’m going to be able to pay you back because it’s going to pay for itself. The bank takes the risk on loaning you the money by grabbing a guaranteed by your house and you go by that 1,000 pin making machine which pays for itself in five days so you can pay back the bank and the rest of the profit belongs to you
3.) A Culture of Over Leverage
Now, we have a machine to improve productivity only because of this leveraged transaction, it makes sense and it benefits all parties but what happens when we start speculating what actually caused the crash on Wall Street in 1929 and more recently the coronavirus pandemic.
It is generally accepted it would happen when people were over leveraged. If you weren’t sure that the stock market was going to go up with the day, you could take the stop you wanted to and use the money that you borrow to buy more stuff but on the flip side, when it turns around, you have a problem paying off the debt and the bank calls in the debt. Now the bank has a problem and the problem they have as they can pay back the people they need to pay back because of the leverage goes into the opposite direction.
Let’s examine how this has affected all of our culture and how the recent coronavirus pandemic just blew it wide open exposing vulnerable leveraged businesses with small profit margin like Airlines and the Cruise Industry. Like what Warren Buffett said : “You only find out who is swimming naked when the tides goes out.”
You see, since the last three decades, our obsession with leverage has created culture of competition and the race of obtain leverage. If you have competitors who start getting leverage you start to feel pressure to do so and it spreads to the media so it’s spread to every chain you’ve ever done business and to every industry that were aware of that.
Leverage works just the way for a solo entrepreneur wanted to make extra money and it becomes a cost of doing business. Imagine a community with two businesses. One of them has embraced leverage every chance they get, they borrow as much as they can. In sum, they use those borrowings to become ever more competitive and their competitor are the ones who is slowing down step-by-step and has no credit will start to discover that they are losing market share because they’re unable to compete with a highly leveraged competitor that is growing and they have no choice but to grow because they have to pay off the people that borrow the money from and so the less leveraged competitor faces a choice, to become smaller or borrow more to match up with your competitor.
3.) Six Months of Cash to Six Weeks of Cash
So we end up with companies that have six months worth of cash in the bank to six weeks or six days because what we ended up with today are institutions that are betting that tomorrow is going to be just like today. But more profitable and don’t have the resilience to weather an interruption and then it hits the media companies. The media companies are the ones that might be willing to say because we publish this magazine for 30 years, and we’re going to publish it for 50 more years and we don’t have to worry about clickbait, we don’t have to worry about maximizing today’s profit because we don’t have to pay off investors and we don’t have to please the stock markets. We’re running something we are proud of and not running a machine that has to maximize return everyday. Well, if that media company has a competitor and that competitor has to borrow money with leverage to grow and needs to grow in order to pay off the money they have borrowed, they will do a different sort of media
A media that maximizes attention or panic. A media company that is focused on how much money did we make today and what shortcuts can we take in the way we treat our people because next year doesn’t matter if we can’t make this week’s work.
4.) Why Leverage is Contagious
This is the number one reason leverage spreads and it spreads because if you have a competitor who is leveraged, you feel the need to be leveraged. Sometimes the market demands that you act like a company that is leveraged and number to leverage works in both directions.
On the positive side, the gearing works beautifully when things are going up because more leverage makes things go up just a little but faster and because the share in the winning the person who collects it, the entrepreneur, the capitalist, or the person in the center who gets to keep the key prizes until it goes in the other direction. And when it goes in the other direction in a cascading effect, and that cascade effect says we lost a little now but we owe a lot more and the bank or the person who gave you the leverage says “wait a minute, this is going in the wrong direction, I am withdrawing this debt and then companies struggle to get new debt and if you’ve ever seen a machine where the gears start going in the wrong direction, the thing to worry about is sometimes the teeth fall of. Sometimes things don’t go as elegantly backwards as they go forward.
5.) How the Rich and the Poor uses Leverage
So what to do about all of this fo the first thing is to ‘see’ the leverage and the second thing is for the powers-that-be and for us the voices that influence the powers-that-be to speak up and to slow things down because if we can slow down the reverse and turn off the gears, it is possible for the wind to come back into our sales.
To mix the metaphors here and maybe just maybe we can make the gears go forward again after this lockdown is over and business resume and it will never be the same again because of what I've outlined here.
But going forward as individuals we have the chance to load up on credit card debt as individuals by the chance to borrow to buy a new car or borrow to buy something else that goes down in value.
Look, school won't teach you about leverage. And like what Robert Kiyosaki mentioned in his book Rich Dad Poor Dad, the Rich knows how to use leverage to increase their wealth and financial intelligence while the poor is busy looking for ways to upgrade their lifestyles using leverage to buy things that go down in value.
6.) How Think Hard about Leverage and Use it in Your Favor
We need to think hard about whether we as humans want to be leveraged and people who engaged with the culture and engage with corporations we need to think about the fact that if it is our choice to do business with someone who is lowly leveraged or not. And that part of it means to buy local.
Part of it means to engage with people we can look in the eye that we are making a choice to head toward a culture and an economy that is looking farther down the road in the next week of the next quarter or that part of the Tulip Mania.
Wall Street often believes that the purpose of culture is to enable capitalism when the opposite of that is true and that being big too often embraces a cycle of destruction because that is where the leverage pays off turn the years in one direction and then switch to the next project, But we are not projects for people and this is our culture and what is possible to do is build for resilience.
So in a world when there is great uncertainty, a lot of people have to unwind their positions because this is the worst case scenario. People are gonna be stick big time and that’s millions, billions and trillions of my passive money invested, and investors are starting to realize they got to just unload it now which could cause a 2nd wave of meltdown.
Also, when I say I kept buying buying buying, it sounded boring, when I say my trading plans is novel and eventually a bottom is formed but that’s not how the stock markets is being treated right now, and I still have a view that it’s a time to start scaling in on longs and capitalize on this decade long opportunity and this is not the time.
Maybe they’ll be a better price and I don’t want be early in this market catching a falling knife because I mean, think about this, cash is king right now. If you look at tech companies like Microsoft who have like 150-200 billion dollars sitting with them and they can be like the gods of market right now.
I get it when it comes to extreme downturn markets, it sure comes down to preparedness and what are you doing to prepare prior to the open each day and not have these preconceived notions that the markets will act a certain way like it did before.
You have to remain flexible and nimble in environments like these because we have seen part of 2008 when easy money was available in the markets but the markets spent another 9 months dropping to new lows. Remember, we have seen a drop that we have never seen since the great depression and for example, the S&P opening down 6.35% triggering the circuit breaker because the something was halted and it haunted all of Wall Street and it was a liquidity problem in the market and even algorithms could not work during a circuit breaker.
People were selling their investments really quickly when panic selling sets in, but on the fop side, you can buy reversal trading that snap back as shorts are restricted. Understand that if the markets drop with 10% , you can be sure conditions are going to be abnormal and it’s time fo you to dial back on the risk and then there’s another mindset which is this is a very rare opportunity right now and it doesn’t come around very often and putting on risk is actually justified during periods like this.
It doesn’t mean you go and be stupid and do a calculated risk right is you see something that you like and you think you can surely make good money because in this market, we are right as much as missing good trading opporunities in a hugely depressed market like 2 months go ago, I was up about 7,500 on our put option I’m like yeah my day is done today while listening to CNBC and Bloomberg reporters contemplating what has happened and I finished the month about 600 times my money which is very rare in my trading career.
When you are a professional trader, you’re not worried about being down to come back when there’s not a positive week that’s even harder when you try to emulate the same thing what others are doing. When it comes to an increasing volatile markets like this you have to ask yourself more specifically, are you actually managing risk thought this. Are there any rules that you are forcing upon yourself and at the same time you have to cut losses or in our case buying insurance using options to mitigate the downside risk which is the important ingredient in trading professionally.
Recalling this movie when I got hit pretty badly during the Trump-China trade war back in 2018, I thought the markets have been acting so crazy and I haven’t seen crazy panic gap down or the panic flash crash in 2019.
When its a rainy day, with so much volatility right now, how do you determine where to focus your attention in situations that are unique. And then if a trade if working in your facor, how do you add to your positions more and believe in yourself and all the money that comes along just start working like clockwork is when you can do things right and show how for me it’s like if I'm positive, it’s because I’m doing things right and I’m in the flow.
But on a negative day of the week because I changed my mind so it’s good to know yourself and not try to overanalyze because we don’t know for certain what’s going to happen in the next few weeks or months, what what you can control right now is your risk, how you skew the odds in your favor, your trading plan and getting into the flow.
There is so much uncertainty and Trump tweeting in press conferences the number of cases is ever-increasing every day. Will there be a 2nd wave of mutated virus, will there be another lockdown in San Francisco, or New York, because of what happened. I mean you’ll just have to have risk control in place and if a trade is working in your favor, how do you move on or let the profits build-up.
So the next question I’m getting from my readers of Wall Street Secrets is : I just wanted to ask, you’ve down very well during this downturn, ultimately, if you can put up on a summarized notepad, what skills and abilities have enabled you to make a large game when it comes to serious risk and reward trade.
I’ve always said that honestly, the experience is a big factor in this, it’s about gaining putting in that 10,000 hours of work, meaning live trades not paper trades over the course of 10 years, and there is no shortcut to it. Most traders give up when faced with a string of losses like I mentioned in my last episode of Wall Street Secrets, the average attrition rate of a live account is just 3 months.
With experience, you will see situations and you are going to behave like a professional trader but at the same time detached from the emotional side of it, I’m still communicating with other traders around me and I’ll see what they are seeing, what they don’t like and sometimes it annoy you should you just talk to a trader that has different viewpoint because there is always one side of the markets when someone is buying someone is selling and you know there’s always someone on the other end with bigger capital waiting to swoop in and eat your lunch any day.
As I get older, I’m forgoing the need to be right all the time when it comes to trading the markets because I think ultimately waking up early, having a clear mind, a good nights sleep, taking care of my health which is no.1 priority now and it’s all interlinked to the decision you make as a trader.
On the contrary, if I’m not sleeping well, eating junk food and not working out, I’m just like rotting away, and even though if I’m making money from the markets I don’t know how to enjoy this situation. I love to win and that’s the most important thing, I think that trading is just like any other sports, you have to be in top-notch shape mentally and physically because every decision counts, and the most important thing is that I think if you love trading and you love being in front of the markets having skin in the game, and you do it consistently playing that long game, one day, you will notice that you have already built up so much unconscious competence in the game of trading.