The Hard Lesson of a Stock Trader: No Pain, No Gain

One peril of investing – and especially stock trading – is an unexpected event.

Former US Defence Secretary Donald Rumsfeld would call it an ‘unknown unknown’.

Nassim Nicholas Taleb would call it a ‘Black Swan’ event.

And our in-house technical analyst, stock trader Murray Dawes would call it an ‘oh crap’ moment…or words similar.


The trouble is, the more that unexpected events happen, the more people expect them to happen. This tends to reduce their impact.

It’s why one stock trader is calm about the chances of another government or central bank stimulus boost. Which is surprising, seeing as four years ago the mother of all stimulus boosts cost him over a hundred grand, and a million-dollar payday…

European Union (EU) leaders are currently half way through a two-day meeting to try and fix the mess in Europe.

Leading up to the event, markets have risen and fallen depending on how confident investors are of the EU fixing the problem.

With the German DAX Index down 1.8% since last Friday’s close, it seems that for the most part, investors aren’t confident at all.

But that won’t stop the EU trying. Overnight, the leaders (or busy-bodies as we prefer to call them) released the first part of their cunning plan to spur growth.

Chief busy-body, EU President, Herman Van Rompuy told reporters, ‘The growth agenda is a sign of our unrelenting commitment.’

That’s good to know.

So, what is the first part of the EU’s plan?

According to Bloomberg News:

‘European Union leaders approved a 120 billion-euro ($149 billion) plan to promote growth in the 27-nation bloc that includes a capital boost for the European Investment Bank.

‘The government chiefs agreed on a 10 billion-euro capital increase for the EIB today as a centrepiece of the long-term growth plan, which includes infrastructure financing, tax-policy pledges and more focused use of EU funding. It also calls for project bonds and support of small and medium-sized businesses…

‘The Luxembourg-based EIB could use its capital infusion to increase its lending capacity by 60 billion euros and unlock 180 billion euros of additional investment, according to EU estimates.’

We won’t pretend to understand exactly how this new plan will work. But we already smell a rat. The EU will give the EIB 10 billion euros. This will ‘increase its lending capacity by 60 billion euros and unlock 180 billion euros of additional investment…’

Call us cynical, but it has all the hallmarks of a leveraged debt play. The same as the leveraged debt plays that have gotten Europe to where it is now. Borrowing from the future to pay for today’s growth.

Seen It All Before
 

That aside, let’s put the EU’s total 120 billion euro package in perspective. The plan is to spend or invest this money over three years from 2013 to 2015.

That works out as 40 billion euros a year…a lot of money. But not that much. Not when you consider that the GDP for the EU is 12.6 trillion euros.

In other words, it accounts for just 0.3% of annual GDP. Even if you include the leveraged position from the EIB, you’re still looking at the package contributing less than 1% of GDP.

So it means nothing.

That’s the problem with so-called ‘shock and awe’ tactics. They worked (in that they boosted the market, not that they were economically effective) in 2008 because they were a genuine ‘unknown unknown’, ‘Black Swan’ and ‘oh crap’ events.

But now, well, we’ve seen it all before.

The Million Dollar Miss of a Stock Market Trader
 

This brings us back to the stock trader who missed out on a million-dollar payday. His name is Murray Dawes, and he is our in-house technical trading guru.

For Murray, it’s a painful story. But even though he may not admit it, it’s one of those experiences any stock trader, sportsperson or entrepreneur needs if they want to taste real success.

A sportsman or woman can’t truly appreciate the joy of victory without first losing a championship game at the final whistle.

An entrepreneur can’t appreciate their billion-dollar idea without seeing other ideas crash and burn first.

And if a stock market trader wants to build a successful trading business, he or she needs to take a hit (a big hit) to the hip-pocket first.

That’s what happened to Murray in 2008. And the good news for Murray’s stock traders is that he has taken the pain on their behalf. They can learn the lessons Murray has learned without going through what he did in 2008…

He told everyone who attended the Markets and Money ‘Doomers’ Ball’ last November about it. But we asked Murray to (painfully) jot down the sequence of events for you to read this morning. Here’s how it panned out:

‘I was long 30 September 2008 emini S+P 500 1200 puts (Expiry on 19th September). Lehman collapsed on the 15th September.

‘On 17th September I bought 15 emini S+P 500 futures at 1160 to hedge my position. I.e. The whole position was US$60,000 in the money ($75,000 AUD – the exchange rate was about .80c then).

‘So I had locked in a little less than AUD$40,000 less the price of the options.

‘At 3am on the night before expiry, the market was getting hammered from the open and I thought the market could crash. So I exited my hedge (at a small loss of about 10-15 points) and let the whole 30 options run for the last night. When I went to bed the futures were trading below 1140 so I was up over AUD$100,000 at this point and thought I was home and hosed whatever happened from there.

‘While I was asleep the US government announced TARP 1 and the market opened the next day 14% higher than where it was when I went to bed. If I had kept the hedge on I would have been up over AUD$100,000 on the hedge alone. Instead my options expired worthless. Two months later when the S+P 500 fell to 741 the same position was worth USD$688,000 or over AUD$1,000,000 because the Aussie dollar had fallen to 64c by this stage.’

If you’re not into futures and options trading some of the jargon may be lost on you, but we didn’t want to change Murray’s words because the story he tells is one of experience.

Besides, if you’re in any doubt what this trade and the stimulus boost meant to him, just read the last two paragraphs…everything should be clear to you from that.

But that was 2008. The USD$700 billion TARP bailout was huge. It was unprecedented. No-one in their right mind could have predicted the size nor the impact it would have on the stock market.

It was an ‘unknown unknown’.

It was a ‘Black Swan’.

It was an ‘oh crap’ moment.

But with so many bailouts and stimulus programs over the past four years, each one has had less impact on the stock market.

As a Stock Trader or Investor You Must Take Risks
 

Last week, the US Federal Reserve announced an expansion of the ‘Operation Twist’ bond program. The impact on markets? Nothing. The US S&P 500 has barely changed since then.

And last night’s news of the EU forming a growth pact to spend 40 billion euros a year? No-one cares. The Australian stock market is down and US stock futures are virtually unchanged from the close.

It’s for this reason that Murray is happy to have a number of short trades on the Aussie market – eight at the last count, with a few long positions to hedge the portfolio if the market does go up.

Of course, there’s always the chance of a bolt out of the blue. That governments and central bankers will do something most rational people couldn’t possibly expect.

But that’s part of the risk when you invest. It’s about balancing probabilities and managing your risk. The alternative is to do nothing, which in itself is an investment strategy…just not a very good one.

With interest rates plunging to multi-decade lows, investors have no choice but to take risks. The only question is what risks should you take?

As it happens, our technical stock trading analyst Murray, has a few ideas on the subject here…

Cheers,
Kris.


Money Morning is Australia’s most outspoken financial news service. Your Money Morning editorial team are not afraid to tell it like it is. From calling out politicians to taking on the housing industry, our aim is to cut through the hype and BS to help you make sense of the stories that make a difference to your wealth. Whether you agree with us or not, you’ll find our common-sense, thought provoking arguments well worth a read. Money Morning Australia is published by Port Phillip Publishing, an independent financial publisher based in Melbourne, Australia. As an Australian financial services license holder we are subject to the regulations and laws of Corporations Act and Financial Services Act.


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