I Know EXACTLY How Your Index Fund Will Crash

Boris Schlossberg

Ah, the glory days of passive investing. Has there ever been a time when it paid so handsomely to be dumb money? While Wall Street Masters of the Universe close up shop and day traders fight to the death for every single basis point, Mom and Pop investors continue to grow rich with every passing day by blindly buying their Vanguard funds on a regular basis.

Hell, even Hedge Funds have stopped fighting the trend and joined the party. Business Insider recently reported that “Hedge funds are crushing it with a trade that anyone can replicate” noting that the best and the smartest are now basically buying up the emerging market ETFs (EEM, VWO) owing more than 12.4% of all outstanding shares.

It’s easy to believe that easy money will continue to flow. After all, the single decision bet of buying a cheap well-diversified ETF has been the most profitable investment idea of the past decade. No worries about risk control, commission costs or even selection bias. It’s done for you. Just set it and forget it as Ron Popeil used to say.

But mark my words this will end very badly for most investors and I know exactly how.

This week FT reported about the “Tech Tantrum” last Friday when many of the best known and biggest companies suddenly tumbled without a reason. What happened? As FT explains, an increasing number of institutional investors now use “factors” to allocate their money. Factors such as “growth” or “value” are the basic building blocks of market performance, and investors can try to cheaply and passively beat their benchmarks by tilting towards some that have shown to produce benchmark-beating returns over time.

“Indeed, the correlation of the “FAAMG” stocks – Facebook, Apple, Amazon, Microsoft and Google – to the growth, volatility and momentum factors are in the 92nd, 90th and 96th percentile respectively, Goldman Sachs noted on Friday. Tech has this year been even less volatile than utilities.

When tech began to buckle, reversing both their momentum and low-volatility factors, systematic funds would begin to sell, with nervous traditional mutual and hedge funds – which have piled into the sector this year – adding to the pressures.”

If all of this sounds familiar then you must be old, because I have only one word for you -- 1987.

Yes if you are old enough to remember 1987 then you know how 25% of your whole net worth can be wiped out in a single market afternoon. At that time, the new fangled “program trading” system managed to create the biggest crash in market history.

Robots have no feelings and at a time when only 10% of all trades are proprietary, the soothing, vol dampening aspect of algorithmic trading which has created so much complacency in the market over the past 8 years can quickly morph into a death-defying momentum crush of the machines.

Almost no one believes that US equities could fall by 50% in one day which is precisely why it can and will happen. Because machines have no limits and will pound an asset down to zero if the algo rules suggest that to be the highest probability in the next hour.

So active traders, don’t despair. Your hard work and knowledge of risk control may protect you yet because in life passive never pays in the end.

The Greatest Rally of All Time? The Day of 1987 Crash

Boris Schlossberg

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Howard Marks, the famed investor who runs more that 100 Billion at Oaktree Capital, tells a story of a phone call that changed his life. He had a conversation with Michael Milken who was just starting out as the king of junk bonds at the time. Milken told him that, “If you buy AAA or AA bonds they only have direction. If you buy single B bonds, and they survive, all the surprise will be on the upside.”

Out of that brief encounter Marks took away the lesson that all investments are about price. As he tells Business Insider, “There’s no such thing as a good investment idea, until you’ve discussed price.

Investing well is not a matter of buying good things, it’s about buying things well. And people have to understand the difference. And if you don’t understand the difference you are in big trouble.”

Mark’s observation made me think about the great stock market crash of 1987. I am embarrassed to admit that I am old enough to remember it. And ironically enough I was at Drexel Burnham Lambert, the very firm that Milken made infamous, when the crash occurred.

What very few people realize is that the 1987 crash was also the day of one of the greatest stock market rallies of all time. At around noon, after a vicious sell-off in the morning, stock staged a massive rally that brought the indices almost to breakeven. All in all, the move from the bottom to its apex was more that 200 Dow points or greater than 10% gain in matter or hours. Trader who bought the bottom and exited midday made a fortune. Of course, equities then faded into the afternoon and ended up down more than 500 points on the day or more than a 22% drop -- still the biggest one-day decline in US stock market history. But if you were a trader, there was almost as much money to be made from the long side as there was from the short side. All of which leads me to conclude that in trading just as in investing price entry is everything.

So as traders, we should banish the concept of oversold or overbought. We should stop worrying if we are aligned with trend or not. The only real question to ask whenever you make a trade is -- did I get a good entry or not? The answer to that query will determine your chance of success far more than any strategy you use.

Five Things to Learn from the Cable Flash Crash

Boris Schlossberg

What can we learn from the cable flash crash?

  1. That if you really want to move prices -- early Asia is as good a time as any.
  2. That bad news rarely ends when you think it will and buying dips in a downtrend is generally a suckers game.
  3. That human traders will always underestimate how modern day computerized markets will amplify the magnitude and the speed of the move.
  4. That markets always work worst when you need them the most.

But most importantly the main thing that we can learn from from the cable crash is to
always
always
always
attach a stop to every trade.

Is EUR/USD About to Crash?

Is EUR/USD About to Crash?

Chart Of The Day

After a few tumultuous weeks during which the pair turned in one of the most vicious short squeezes ever in the history of the currency market, the euro is back to trading on fundamentals and has resumed its downtrend against the buck.

As we noted earlier today, “It is ironic that the dollar has actually strengthened against the euro in the wake of a decidedly dovish FOMC presser last week, but it may very well be the market’s judgement that the Fed was simply delaying the normalization policy until the December meeting.

We have argued that the Fed may have simply decided to wait until the budget negotiations in Washington conclude and did not want to tighten monetary conditions ahead of what could turn out to be a tough fiscal negotiation that could roil the markets.”

The market appears to be convinced that the greenback rally will resume and today’s price action is confirming the new leg of a downtrend in the EUR/USD. The pairs has lost more than nearly 300 points in just 2 days and looks top be headed towards the 1.1100 figure. A break below would confirm the Head and Shoulders formation and could send the pair towards recent swing lows near the 1.0850 level