Watch Out: FOMO Trading Is Back

How to avoid following the herd off a cliff… [Morning Reckoning] October 24, 2023 [WEBSITE]( | [UNSUBSCRIBE]( Watch Out: FOMO Trading Is Back - Fear of missing out leads investors to make rash (and stupid) decisions… - Can the good times keep rolling? - Or will these trends run into some trouble? Baltimore, Maryland October 24, 2023 [Greg Guenthner] GREG GUENTHNER Good morning Reader, FOMO is finally back! Fear of missing out is one of the most powerful forces in the market. When conditions are just right, FOMO latches onto our lizard brains, leading to terrible investing decisions. We chase overbought stocks, fall for dubious stories and scoop up shares of some of the most risky, speculative garbage companies we can find. What could possibly go wrong? Well… everything, of course. To be fair, I’m not knocking stock market speculation. After all, I’m a trader. I have no trouble buying less-than-perfect stocks or flipping shares of fundamentally challenged companies. Different stocks and sectors fall in and out of favor all the time. And improving or deteriorating fundamentals have little to do with short-term performance. Market conditions and narratives are the main determinants of how a stock will perform over shorter time frames. Consider the broader market narratives and how they’ve evolved since late 2022… Many stocks — including mega-cap leaders Apple Inc. (AAPL) and Tesla Inc. (TSLA) — were in free-fall in December. Investors had endured a painful correction lasting the entire year. Not only were the averages in bear market territory — the popular Covid Bubble stocks had been decimated. Anyone heavily concentrated in these names was sitting on huge losses — far deeper than the 20% correction in the S&P and 30% drop in the Nasdaq Composite. It’s safe to say that most (if not all) investors were less than enthusiastic about stocks heading into 2023. Then, a funny thing happened. The market rallied. A few weeks later, stocks were still zooming off their lows. But no one believed it. We’ve talked about these early-stage bull moves before: the disbelief rallies. After a few failed relief rallies leave overeager buyers stuck in their trades, most folks simply give up. Then, when a rally does finally stick, the market’s cried wolf so many times that most investors simply don't trust the move. They sit on the sidelines and wait for the market to prove itself. This perfectly describes the market action during the first quarter. Most analysts, fund managers, and individual investors simply did not believe that the rally would last. Instead of buying stocks, they waited for the market to roll over. But the averages weathered their first meaningful pullback in February. They also survived a banking crisis the very next month — and even rallied into the second quarter. In fact, every single time the so-called experts said the market would roll over, we saw another rally. Now we’re finally seeing investors come around to the idea that the market has turned a corner. But not everyone is happy about it. [Urgent: Currency Wars Alert]( “Worst case scenario is almost inevitable” -Former Pentagon Insider [Click here to learn more]( In the 2011 book, Currency Wars, it was warned that the U.S. was engaged in a currency war. And that these wars: “Degenerate into sequential bouts of inflation, recession, retaliation and actual violence as the scramble for resources leads to invasion and war. ” Now with Putin invading Ukraine…Rising tensions with China… Inflation, recession, and supply chain issues all hitting the U.S. economy at the same time. It seems as if some of these worst fears have finally come true. [That’s why you need to watch this urgent video message.]( To update you on exactly what you need to be doing to protect yourself. Because if history is any indicator, this will not end well. [Click here to view this urgent video message.]( [LEARN MORE]( The Chase is On! “People will hate on a stock-market rally,” a recent Bloomberg Surveillance note begins, “They'll say it's fake, or just a handful of tech stocks making everything look better than it is. But the bottom line is, the S&P 500 and the Nasdaq — and especially the Nasdaq 100 — are up significantly, despite all the naysayers, and that alone is enough to drag cash in.” There’s that FOMO talking again… It’s not only retail investors getting “dragged in” to this rally. The pros are also getting sucked back into stocks. Fund managers who missed the earlier stages of the rally that began in January are significantly lagging their benchmarks. If you’re managing money and you’ve been twiddling your thumbs worrying about elevated valuations in this group, you might be in a bit of trouble here. The runaway performance of the big tech names has created a hold your nose and buy situation that’s powering this rally higher into the summer months. As Citigroup’s Stuart Kaiser explains in that very same Bloomberg piece, “We are reluctantly staying in the tech trade.” In other words, get onboard — or your job might be in jeopardy. Now, we have the strongest stocks attracting even more attention. Mega-cap tech, semiconductors and artificial intelligence names are rolling as summer approaches. Can the good times keep rolling? Or will these trends run into some trouble as the summer heat approaches? Buying Into the Summer Doldrums Now that the herd is backing up the truck and pushing many market leading stocks to new 52-week highs, we should take a moment to see how the S&P fares during a typical pre-election year. Don’t get too hung up on the S&P’s performance perfectly mirroring the pre-election year composite. The trend is what counts. And so far this year, it’s closely followed a typical pre-election cycle. Next, take a look at how the composite behaves at the end of the second quarter. In a pre-election year, the S&P typically tops out at the end of June and remains in a range until an end-of-year push in November - December. Will the market follow the blueprint this year? I doubt it will match up perfectly. But the composite does give us a general idea of what we could expect as this rally matures. The market loves to get everyone bulled up at the wrong time. No one wanted anything to do with stocks when they were ripping in January. Now, they’re buying with both hands into a potential short-term top. Best, [Greg Guenthner] Greg Guenthner Contributing Editor, Morning Reckoning feedback@dailyreckoning.com [Nvidia Helps Spark $100 Billion Sales Surge For A.I. Supplier?]( Nvidia’s little-known supplier is set for a [$100 BILLLION sales explosion]( …and it’s thanks in part to this mysterious device you see here: [Click here to learn more]( According to our research… This $100 billion sales boom could even turn this little-known supplier… …into the [the next trillion-dollar stock](. To see how to take advantage of this little-known supplier – before it’s $100 billion sales surge —— [go here now.]( [LEARN MORE]( In Case You Missed It… There Once Was a Boy From Watford Sean Ring, Editor [Sean Ring] SEAN RING Dear Reader, I was looking through my old files and remembered that I hadn’t told you this story yet. When people ask me why I’m so against shorting options, this is what I tell them. I’ll elaborate on what can happen — though admittedly very rarely does - when you’re short volatility and you don’t know what you’re doing. The Rogue Trader Nick Leeson was an ordinary boy from the ordinary London suburb of Watford. He was going to live an ordinary life until he got the opportunity to work in The City. That’s The City of London, where serious international banking gets done. It’s the British bastion of capitalism, whose profits pay for the folly of the British Welfare State. But Nick didn’t have the right background or proper accent to succeed there. So, when he was given the opportunity to move to Singapore, he jumped at the chance. As a side note, when mediocre bankers are sent from London to Hong Kong, they’re pejoratively called FILTH — Failed In London, Try Hong Kong. Hint, hint… Nick got on a plane and went to Singapore, where he was simultaneously named a floor trader and Head of Settlements. In the early 90s, that nonsense could happen. Let me confirm: it means he was responsible for checking his trades. And yes, you’re right; it was a recipe for disaster. Without overegging the pudding, let me get straight to the trades that brought down Barings Bank, HM The Queen’s Bank, in 1995. Much of this is by memory, as my edition of Rogue Trader, Leeson’s autobiography, was lost in one of my many moves. Thus, any errors are my own. Straddle This! I’m going to proceed in a plain English manner, not making it too geeky or Greeky. If you’re a pro, please forgive me for the oversimplification. First, let’s get long. [chart] This is the payoff profile of a long call position at expiry. It’s a bullish trade. In this case, the call buyer pays $5 per share for the right to buy 100 shares later at $225. Therefore, the breakeven point is $5 + $225 = $230. The buyer can only lose his premium, no more. That’s still 100%, to be sure, but it’s not as much as he may lose holding the shares. The upside is unlimited. Think TSLA call buyers and how much they made in the recent past! Next is a long put option. [chart] A put option is where the buyer has the right to sell shares at a specific price in the future. In this case, the buyer paid $6 for the right to sell these shares for $225. This is a bearish trade, as the buyer must think the price will decrease. The breakeven point is $225 - $6 = $219. That is also the maximum gain, as it’s not unlimited (though it’ll feel almost as good)! So, a long call and a long put, separately, are directional trades. But what happens when we put them together? Remember, these calls and puts will have the same underlying, strike price, and expiry. [chart] Et voila! You’ve got a volatility trade! That is, you’re long volatility. (I always write the “volatility” next to the payoff profile to make it easier for grads to remember.) Looking at that payoff profile, you see something obvious: it doesn’t matter which direction the underlying goes, as long as it goes far. So, you’ve got the unlimited gain potential from the call. And you’ve got the limited but substantial potential gain from the put. Thus, there are two breakeven points. This will be the strike price plus and minus the combined premiums. The upside breakeven point is $225 + $11 = $236. The downside breakeven point is $225 - $11 = $214. As long as the underlying either goes up beyond $236 or down below $214, you will make money. Of course, the pros will manage these trades minute to minute and adjust accordingly. However, this is something retail investors, who have other jobs, will find exceedingly difficult to do. But for now, know that a long straddle is a long volatility trade. Derivatives Are a Zero-Sum Game Derivatives are a zero-sum game. That means no wealth is created or destroyed by trading them. Of course, there are winners, and there are losers. It’s capitalism at its very finest. But overall, nothing is lost. That means if you can buy a straddle, then someone must have sold it to you. Someone like, say, Nick Leeson. To illustrate, let’s take the long straddle we just looked at and flip it upside down. [chart] It’s the exact same trade but from the seller’s perspective. Let me ask you this: what’s the best thing that can happen to the seller? Answer: nothing. Literally. If the straddle expires at $225, the seller will keep the $11 per share premium. Anywhere else, he doesn’t maximize his gain. Below $214 and above $236, he loses money. Again, if a pro entered this trade, he’d keep his eye on it and manage it accordingly. He can use stop-loss orders, close out a side, or turn the straddle into an iron butterfly. Don’t worry about these things right now. Because if your name is in God’s book on a particular day, he will get you no matter what. And that happened to Nick Leeson. How Straddles Killed Nick Leeson and Barings Bank Leeson was already down. He was supposed to be running an arbitrage operation, taking no risk. But he couldn’t help himself. Leeson already racked up millions in losses. Moreover, he was losing nearly from his first day in the office in 1992. It just turned 1995, and he was running out of options - no pun intended. So how could he get that money back without incurring much more risk? Boom! He could sell straddles! That would let him take in the premium from both the calls and puts. The markets are quiet anyway, so it’s a sure thing. The date was January 16, 1995. Leeson sold a bunch of straddles on the Nikkei Index. He probably went to Harry’s Bar on Boat Quay after work, thinking all was well. Incidentally, Harry’s is next to my favorite SG watering hole, The Penny Black. Harry’s used to have a plaque on the bar that read, “Here sat Nick Leeson.” I saw it myself! Then, in the early hours of January 17, 1995, the unthinkable happened. The Kobe Earthquake struck. [chart] Leeson, already down GBP 208 million, was crushed. The Nikkei gapped down on the open. Of course, the call options would expire worthless, but he was now short deeply in-the-money puts. To counteract this, Leeson bought futures as the market “couldn’t go down anymore.” But, of course, it did — much, much more. Nick Leeson’s losses totaled GBP 827 million, about $1.4 billion. That doesn’t sound like much now, but it was enough to wipe Barings, The Queen’s Bank, from the map. A friend once told me of an event he held in Singapore. A member of the Royal Family was present to open the event. My friend pointed out the window onto Raffles Place and said, “That’s where Barings office used to be.” The reply was, “My family lost a lot of money that day.” That is the story of Nick Leeson, told as plainly and as “Greeklessly” as I can. It’s a great cautionary tale to retail options traders and professionals alike. Heck, it can be said that Leeson inadvertently wrote today’s derivatives regulatory structure. The upshot is there are far better, less risky and less stressful ways to participate in the market than by shorting options. Have a great day today! All the best, [Sean Ring] Sean Ring Contributing Editor, The Morning Reckoning feedback@dailyreckoning.com X (formerly Twitter): [@seaniechaos]( Thank you for reading The Morning Reckoning! We greatly value your questions and comments. Please send all feedback to [feedback@dailyreckoning.com.](mailto:dr@dailyreckoning.com) [Greg Guenthner] [Greg Guenthner, CMT,]( is chief strategist at Forge Research Group. He has spent the better part of the past two decades developing long-term and short-term strategies with a single goal in mind: to help everyday investors generate outstanding returns and control their financial futures. Greg’s charts, analysis, and insights have appeared in Marketwatch, Forbes, Yahoo Finance, and many other financial publications. [Paradigm]( ☰ ⊗ [ARCHIVE]( [ABOUT]( [Contact Us]( © 2023 Paradigm Press, LLC. 808 Saint Paul Street, Baltimore MD 21202. 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