Instant Sage on Wall Street

It can be confusing to lose all your money on the stock market, and we’re here with Instant Sage on Wall Street to explain to you the terminology of your loss. That always helps.

Pacing up and down, fidgeting and the inability to sit still are all signs of restlessness and in medicine can indicate that a patient’s condition is about to deteriorate. The word ‘restless’, however, is unsuitable for use in financial trading due to ease of understanding. Thus, volatility is used instead. As with humans, increased volatility is often a sign of impending deterioration, usually in price. Currency is always traded in pairs, from one to another, so currency volatility has the added joy of guessing which of the two might become worth less. Some emerging market currencies don’t need that space between ‘worth’ and ‘less’.

Volatility brings risk, a combination of precariousness, likelihood and importance. We hardly notice when a leaf falls from a tree. The leaf was precarious, but it wasn’t important. We don’t worry that a skyscraper will topple over as we walk past. Toppling skyscrapers are important but (formerly) unlikely. Risk then is the estimation of how likely and how bad. If I stand on a low wall in a strong wind it’s not important. If I stand on a high wall on a calm day I’m taking a small risk and, if I stand on a high wall in a storm I’m an idiot. So too for financial products. Risk is the combination of how much you might lose and how likely you are to lose it. Owning US Treasuries or T-Bills is the ultimate low risk and owning Bitcoin isn’t.

The loss, greater loss, and catastrophic loss of your money will follow stock market cycles. Good times ebb and flow like the seasons: value, price, activity and trade go up and down. In 2000, 2007 and 2018 prices were high (the summer) and everyone was a talented investor. In 2002 and 2009 prices were low (the winter) and for god’s sake somebody should have warned us.

Waves are closely related to cycles. Imagine sitting on a sandy beach watching the waves roll in. Each wave starts as a small bump on the sea. At some point the top rises up and keeps rising until it gets too high to be supported by the water underneath. It rolls over, crashing in a cloud of froth and spray. Every seventh wave is a big wave. There’s a pattern we can see when we’ve tuned in. In financial trading, wave theory is the notion that market cycles are not random but follow certain patterns. That’s important for traders because if they analyse correctly it helps them predict the future and make more money.

Hedging can be your friend and is akin to betting on both horses in a two horse race. Wall Street traders have lots of products that go up when something they’ve paired it with goes down or vice versa. The idea with hedging is to mitigate risk, if the main deal goes south the hedge goes north and minimises any loss. Just like insurance.

What are bid, offer & spread?  Tourist currency exchangers buy their Dollars, Yen and Pounds from bigger banks or from tourists and they need to make a profit. So, they sell for more than they pay, just like a grocer who might buy raisins at €1 a packet and sell them at €1.20. If our grocer had ambitions to be a financial broker they’d need to use auction terminology. They’d offer something for sale and they’d bid to try and buy what the wholesaler has. Our raisins would have a bid price of €1.00 and an offer price of €1.20 at the grocers.

Spread is simply the difference between the buy price and the sell price, so our raisin spread (yuk!) is 20c or the sell price of €1.20 minus the buy price of €1.00. Spread is a measure of how much profit margin the trader is taking which is why it’s important. If we can find raisin spread at 10c instead of 20c we’ll have more money instead of the grocer.

You probably won’t be doing any quantitative easing yourself, but others will, and it will affect you. Affectionately known as QE, quantitative easing is a national cure for excessive debt by encouraging more borrowing to boost asset prices. QE is carried out by central banks who lower interest rates and buy bonds. Buying bonds in bulk boosts bond prices thus lowers yields (aka interest rate paid by the bondholder). To the uninitiated, using more debt to fix the problems of excessive debt may seem illogical, but central bankers have many PhD’s and sometimes even practical experience so obviously they know best.

So there we are. With any luck, your stock market loss hasn’t yet occurred, so when the waves run out, the cycle turns, and, with rising volatility, you realise too late you’re not hedged, these useful investing concepts will be conducive to a more informed sense of woe.

May the trend of the graphs be with you.

 

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