I’m sure by now, most of you have seen The Big Short. If you haven’t make sure you do so this weekend.
As a trader, you will love it.
If you traded through the housing collapse and suffered big losses, maybe it will hit a bit close to home.
It is certain to go down as a trading favorite alongside Wall Street, Rogue Trader and Trading Places.
The Big Short follows the story of a group of renegade traders who predicted the housing crash and booked enormous profits as a result.
Initially the trades slowly lost money as the traders waited and waited for their prediction to come true.
Right at the point when their hedge fund was about to go under, prices finally started tanking.
Source: Bloomberg TV
While the movie did take time to explain credit default swaps and collateralized debt obligations, I did have to pause it a few times to explain what was going on to my wife.
Even those explanations were greeted with blank stares, but as a trader, you will have no trouble following along.
One of my favorite scenes is where Selena Gomez is playing blackjack while other players make larger and larger side bets on her hand. This is a great metaphor for what happened in the synthetic CDO market where those increasingly larger side bets had a domino effect once they lost.
Here are some of the key lessons to take away from the movie:
You can be right, but if your timing is off you can be stuck with big losses
Christian Bale plays the character of Michael Burry who comes under incredible scrutiny from his investors when his predication of a housing market crash fail to come true.
Investors berate him and ask for their money back as the poor performance of his hedge fund continues month after month.
Luckily for him, he was able to hold on long enough for his trades to work. Still, he was lucky, and had big balls to stick with it when everyone was telling him he was wrong.
Burry has been back making headlines recently saying that the next bubble is in passive investing. Time will tell if he is right.
The efficient market hypothesis is dead
If securities are fairly priced based on all available information in the market, then why did the cost of Credit Default Swaps not spike when default rates started spiking in 2007?
Because the market was rigged. Banks refused to mark the CDS at the correct prices (because this would result in massive losses for them).
It’s amazing more fraud charges weren’t laid as a result of what happened.
Banks will always throw retail traders under the bus if they can improve their bottom line
Don’t ever think that banks are there to help you. They are there to serve themselves and their bottom line.
If they can throw you under the bus in order to make a bit of profit, they won’t hesitate.
Don’t be afraid to question what you are being told
Just because someone tells you something is a good investment, make sure you do your own research and ask for a second opinion.
Not everything that glitters is made of gold.
If it seems too good to be true, it probably is
If it was easy to get rich, then everyone would be rich. Building long term wealth requires hard-work, dedication and smart investment decisions.
Stay away from get rich quick schemes and never take on too much leverage.
Beware of conflicts of interest
If someone has an incentive to sell a product, with no recourse if that product doesn’t perform well, be very wary.
The system was flawed and in one amusing yet depressing scene, we have two mortgage brokers who had no idea what they were selling bragging about how much cash they were making.
Every industry has shady characters, but the finance industry seems to be one of the worst
Unfortunately, there are a lot of people attracted to the finance industry through greed, and they don’t mind profiting at someone else’s expense.
Every year there are big stories of insider trading, Ponzi schemes and the like that hit the newswires.
These are just the ones that get caught. And some of the minor offenses wouldn’t even hit the papers, so the general public only hears about a small portion of them.
Recently, Karen the Supertrader, who made herself out the be the darling of retail traders, was accused of fraud by the SEC.
Don’t invest in something you don’t understand
If you don’t understand what you are buying, it’s not investing, it’s gambling.
Stay away from illiquid markets
Your trading strategy may turn out to be correct, but if there is no one to sell the security to, have you really made a profit?
At best, you are going to take a big haircut to find a willing buyer.
Overall, the Big Short is a fantastic movie and well worth the watch, but gee it does leave you feeling a bit depressed at the end.
Let’s just hope nothing like this ever happens again, but somehow, I think it will eventually.
Trade safe!
Disclaimer: The information above is for educational purposes only and should not be treated as investment advice. The strategy presented would not be suitable for investors who are not familiar with exchange traded options. Any readers interested in this strategy should do their own research and seek advice from a licensed financial adviser.
