By Gabe Velazquez, Online Trading Academy E-minis Instructor
It's been approximately a year since the near collapse of the US financial system. The causation and blame for the crisis has been written about ad nauseam, and the debate ranges on as to what the solutions are. If you were long (owned stocks and/or mutual funds) as were the vast majority of people during that time, you probably shudder at the thought of reliving those terrible days. That was when 401k's, IRA's, and other investment accounts were literally melting away daily, and investors became either paralyzed with fear or angry about what was happening to their nest egg.
For the adept trader, however, those days were great as opportunities abounded. Because the market suffered massive declines then, one would think that most of the profits were realized by short selling. Indeed, betting on the downside did pay handsome rewards during that period, but going long was also a viable strategy as the violent swings occurring then were in both directions. The key was that there was plenty of movement for the active trader.
So what lessons can be drawn from this turbulent period? One perhaps, is to never discount any or all-possible scenarios. Back in the summer of 1987, when I was first starting out in the brokerage business, I was told by one of the brokers who had been in the business for many years, when it comes to the markets you must "never say never." I took what he said to heart as he was the top producer and was the only broker in the office that actually knew how to trade. In retrospect, that was a great bit of advice.
Think about it. If I had told you two years ago that Lehman Bros, a hundred and fifty year old venerable investment-banking firm was going to go out of business, you would have thought I was crazy. Or, how about if I had said to you, "AIG, Fannie Mae and General Motors (three of the bluest of blue chip companies) would all be traded for under a buck," you probably would have laughed at me. "Never say never."
Similarly, the Vix, the volatility or "fear" index, which in previous times of duress had gone as high as 45, (lower chart) shattered that earlier high-water mark by going twice as high, registering a reading of 89.53 on October 24th of last year.
Figure 1
Many folks were caught off-guard when they began buying stocks as the Vix index approached the previous apex of 45. The theory was that in the past, when volatility had reached these levels, the market usually bottomed. Unfortunately, for those folks, the S&P continued to crater, shedding half of its value before finally finding a floor. "Never say never."
The second lesson we can take away from last year's debacle is complacency. I recall that back in the early summer of last year, just before the mortgage meltdown sent the markets reeling, investors were either oblivious, in denial, or apathetic about what was going on around them. The aforementioned Vix index was registering readings in the teens (showing little fear) a mere two weeks before the first potential bank failure was announced. Moreover, the S&P had been essentially trending lower (shown on the chart below), since its all-time high was reached on October 11, 2007.
Figure 2
Anyone knowledgeable in Technical Analysis should have been aware of the major trend in place at the time, and been defensive on their long positions. It's uncanny how bad things usually happen when the trend is already heading south. Check out the trend going into all the market crashes this century. One hint: It wasn't going up.
Will history repeat itself? At some point, I'm sure it will. Regrettably, it takes drastic events such as the ones we experienced last fall to change people's behavior (at least temporarily). We've seen this first-hand here at Online Trading Academy with more and more people wanting to take control of their own financial destiny. From a broader prospective, people are saving at the highest rates in decades, which is long overdue. Some folks are also starting to adopt a "live within our means" type philosophy, which will help in shoring up their balance sheets. All in all, some good has come out of last year's near-calamity.
Lastly, the fact that these extraordinary events, some would say generational, have came to pass serves to reinforce the notion that (investors and traders alike) have to embrace, and thus prepare for the vicissitudes inherent in financial markets.
Until next time, I hope everyone has a profitable week.
If you have questions or comments, please email me at gvelazquez@tradingacademy.com
- Gabe Velazquez
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