In my third installment of my investing series, I discuss the level of trading I deal with, including my recent dive into ForEx trading after the Brexit decision. I also run through the probability of extremely unlikely events and how humans have an inability to properly plan for these, “black swans”.
If you’re familiar with the first two installments of my stock series, then you’ll know I prefer to buy broad based indexes as part of each paycheck I receive. In this fashion, I am able to increase my tiny slice of global economic pie and I leave it at that.
The remaining 5-15% of my portfolio is what I refer to as my “play fund”.
Using the term, “play,” is deliberate as it overly emphasizes my understanding that this money could be lost at any time. Such are the dangers associated with trading in individual securities.
I can’t emphasize this last paragraph enough.
As a CPA (or maybe as a young millennial in Chicago), I have a lot of friends that range from “dabbling” in the market to actively making a living based on buying and selling securities.
One close friend of mine who has his CFA prefers to buy and sell options. His approach is to buy options to buy the market or an index at points that are drastically higher or lower than where it currently is.
These are essentially long shots. The probability of it happening are so low, the risk to reward ratio is very high.
This is a similar concept to what Nassim Taleb refers to in his book Black Swan.
In short, humans have an inability to predict uncommon events. We tend to be overly optimistic that the WORST CASE scenarios will NOT happen. These are events that you might consider outliers, but in reality, they happen more often that we would like to admit.
Of course, the book dives into decades of research and plenty of fascinating factors that drive this behavior, but this particular post is about how we can benefit from knowing this human blindspot.
When the price of the market experiences dramatic volatility, or price fluctuations, my friend stands to profit. His inexpensive options give him access to buying and selling at a massively discounted rate.
This year witnessed a rather volatile January & February which allowed my friend to essentially create enough profit in 2 months to last him for half the year. Similarly, he made enough money last August to last him 9 months.
The downside here of course is if the markets remain calm and flat, then his options will expire and he will run out of money. Again, there are risks involved here.
Recently, he had another successful month after UK voted to leave the EU.
I’m a big fan of Warren Buffett’s quote, “Be fearful when others are greedy and be greedy when others are fearful.”
I don’t believe my risk tolerance is high enough to rely on black swan events, but I wanted to be there to profit in the wake of them.
With the price of many UK based companies dropping dramatically, I wanted to take the opportunity to be greedy when others were fearful.
But, there was a gap.
Enter foreign exchange rates.
If you’re buying shares in a small foreign company, then the revenue that company makes will nearly be 100% denominated in that country’s currency.
If the company is larger, then they likely have more sales internationally and thus, denominated in various foreign markets.
What this means is if a small British company increases its sales and profit margins, but the value of the pound sterling decreases more, then from a foreign perspective, that company will be worth LESS.
As someone who just wrote that sentence, I, myself, am still having a hard time figuring it out.
What I do know is Sterling dropped massively after the UK exit.
As my buddy did before, I’m sure a lot of people put options in place and took advantage of such a large drop.
Given my recent curiosity with foreign exchange rates, I’ve been digging through some materials online.
Thankfully, the internet is filled with plenty of videos, tutorials, inexpensive programs, and other informational products on learning, well, basically anything.
One such resource I’ve used recently is here. In my opinion, anyone who takes the time to break down the fundamentals of ForEx to educate the public, is serving a benefit to society.
What I’m enjoying most about this process is that, after reading so many books on personal finance, I’m constantly realizing how much I don’t know.
Truth be told, I consider personal finance and investing to be two separate spheres that have maybe a 10% overlap. But, perhaps I can dive deeper into that comment on another post.
Another Buffett quote is, “The more you learn, the more you earn.” That’s what I’m banking on.
Do you consider yourself a trader? Have you dabbled in ForEx trading or investing in individual companies abroad? Are you more conservative than me and prefer to trade a small portion of your assets or none at all?