Hypo: What would you do if you were SURE of impending deline in markets

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Niam
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Hypo: What would you do if you were SURE of impending deline in markets

Post by Niam » Sun Jan 22, 2017 10:57 pm

I have more of an academic/theoretical question than an actual investing question I'd like to implement -- assume you generally had confidence in long-term markets but somehow knew that there would be a short-term correction or downward movement in the broad market, how would you invest and/or what would you do?

Note: This is not an invitation to talk about how no one can be sure what the market will do and its stupid to try to time the market. Yes, I get all that.

What I'm struggling with a bit -- at least at a theoretical level -- is that if I somehow knew that there would be a short-term (i.e., less than 90 day) correction in the market (based on some impending political event or something), I am not sure what one is supposed to do. Assume for a second that everyone in this thread is going to be fully aware of the risks associated with this hypothetical, what is the response if you know the broad stock market is almost assuredly going down in the short term? Let things ride because you don't know when the correct time to get back would be? Move a higher percentage to bonds? Assuming no adverse tax consequences, pull money out? Not change existing investments but try to short the market to balance the losses in your existing portfolio?

At a theoretical level, I am struggling with the concept that even if you were somehow sure that your investments were going to go down in value, you should leave your investments/investment plans as is. Suspend reality for a second and assume that you somehow know for sure that U.S. stocks are going to take a bit of a hit in the next 30-90 days. What, if anything, do you?

And I'd appreciate people trying to answer the hypo -- not just tell me I'm a moron because this requires suspending reality. Assume everything you know about the market currently is true, and assume you know nothing more than you do right now about long-term trends. The only thing you know is that there will be meaningful (but not catastrophic) short-term downward price movement in the broad stock market. What do you do?
Last edited by Niam on Sun Jan 22, 2017 11:02 pm, edited 1 time in total.

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Re: How would you invest if you were SURE of short-term deline in markets

Post by tetractys » Sun Jan 22, 2017 11:01 pm

Even if I was sure of a "short-term decline", as you say, I might not do anything at all. Often times one finds the time and trouble of reacting not worth the return. If it does eventually become worth it, my portfolio is set up to indicate that at the appropriate time, regardless of the prediction, forknowledge, or whatever.

And of course, sureness very often turns out to be delusion. -- Tet
Last edited by tetractys on Sun Jan 22, 2017 11:06 pm, edited 1 time in total.

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by radiowave » Sun Jan 22, 2017 11:06 pm

Well if you are looking at this from a long term lens, you can use an assumption that equity doubles every 10 years. E.g. see VG VTSAX total stock https://personal.vanguard.com/us/funds/ ... IntExt=INT. If you look at the little nooks and crannies later in the graph, I suppose you could buy on the downside with the anticipation you'll do well on the upside. Last year about this time there was a big dip in the market. I bought some total stock because I had that planned anyway and those lots are doing quite well. I didn't consider it market timing, just good fortune/luck. Something about past returns and the future :wink:
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Niam
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Re: How would you invest if you were SURE of short-term deline in markets

Post by Niam » Sun Jan 22, 2017 11:09 pm

tetractys wrote:Even if I was sure of a "short-term decline", as you say, I might not do anything at all. Often times one finds the time and trouble of reacting not worth the return. If it does eventually become worth it, my portfolio is set up to indicate that at the appropriate time, regardless of the prediction, forknowledge, or whatever.

And of course, sureness very often turns out to be delusion. -- Tet
Thanks. I assume many bogleheads will say something similar, so let me also posit a different hypothetical -- what would it take for you to deviate from that thinking?

I guess what I'm trying to do, among other things, is push the limit in my own mind about just how far the conventional wisdom on this board would go in terms of fidelity to the the well-accepted investment theory (which strongly discourages trying to make short-term investments, time the market, etc.). What is the limiting principle to that? What would it take to deviate from that? What if you lived in an alternate reality where you somehow knew certain short-term trends that would otherwise give you significant reason to chase short-term returns or minimize short-term risk? Still park your money in the broad index and forget it?

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by nedsaid » Sun Jan 22, 2017 11:12 pm

It is the old "right too early" problem. You might be 100% right but your timing might be wrong. It was clear in the late 1990's that something was wrong in the markets, euphoria and sky was the limit. The problem is that you cannot predict human emotion, in other words we don't know how long market euphoria or excessive market pessimism will last.

I have been "sure" that interest rates were going up, particularly since the 2013 "taper tantrum." Rates went up and then back down again! With the recent elections, interest rates went up about 1% and have started to ease their way down again! The old saying holds true, predict early and often and sooner or later you will be right!
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Re: How would you invest if you were SURE of short-term deline in markets

Post by alex_686 » Sun Jan 22, 2017 11:25 pm

If I were 100% confident that the market would decline I would sell everything that I own, borrow as much as I could, and place a massive leverage bet using options. I think I could increase my wealth by a factor of 30.
Niam wrote:I guess what I'm trying to do, among other things, is push the limit in my own mind about just how far the conventional wisdom on this board would go in terms of fidelity to the the well-accepted investment theory (which strongly discourages trying to make short-term investments, time the market, etc.). What is the limiting principle to that? What would it take to deviate from that? What if you lived in an alternate reality where you somehow knew certain short-term trends that would otherwise give you significant reason to chase short-term returns or minimize short-term risk? Still park your money in the broad index and forget it?
I would recommend reading up on the "Wisdom of the Crowds". It states the conditions that make the market work. I think the markets can be beat but it requires skill, discipline, and a little luck. In short, it is hard to do so I leave it to the professionals. As a passive investor I reap the average returns of their hard work.

A more interesting line of thought is if you thought there was a 75% chance that there would be a steep decline in the market. Then what would you do? In this case I would point you to the Black Litterman model. It allows you to state your positions and combine them with market expectations to come up with a portfolio. The math is challenging.

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by White Coat Investor » Sun Jan 22, 2017 11:27 pm

Niam wrote:
At a theoretical level, I am struggling with the concept that even if you were somehow sure that your investments were going to go down in value, you should leave your investments/investment plans as is. Suspend reality for a second and assume that you somehow know for sure that U.S. stocks are going to take a bit of a hit in the next 30-90 days. What, if anything, do you?
Short the market. Preferably with a lot of leverage. Duh. The problem is it is very, very hard to be sure, and even when you are sure, you're wrong a lot!
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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by lack_ey » Sun Jan 22, 2017 11:28 pm

You need to define the parameters and limits of this knowledge. You know that it's going to go down within the next 90 days, but do you know how much? When it will recover? Are you saying that it will be down relative to today, or that there will be some drop over the period (that is, does 25% up, 18% down count as going down)?

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by whodidntante » Sun Jan 22, 2017 11:29 pm

Let's assume I can ignore taxes (which I can't, unfortunately) and that I know the S&P 500 is doomed to fall 10% in 90 days. Let's also assume I know when said doom occurs and has run its course.

I'm going to sell the doomed asset, and assets highly correlated to it, right away. I would then sell SPY short, at a broker that will not kill me on costs. I'm also going to borrow to increase my short position since we are talking about certainty. I want as much short exposure as I can carry profitably. When said doom has run its course, I'm going to close my short position, and resume my desired long-term asset allocation.

Making money is easy if you know the future.

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by MoonOrb » Sun Jan 22, 2017 11:41 pm

White Coat Investor wrote:
Niam wrote:
At a theoretical level, I am struggling with the concept that even if you were somehow sure that your investments were going to go down in value, you should leave your investments/investment plans as is. Suspend reality for a second and assume that you somehow know for sure that U.S. stocks are going to take a bit of a hit in the next 30-90 days. What, if anything, do you?
Short the market. Preferably with a lot of leverage. Duh. The problem is it is very, very hard to be sure, and even when you are sure, you're wrong a lot!
Yep. This.

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by patrick » Sun Jan 22, 2017 11:44 pm

If all you know is that the market will go down sometime within the next 90 days, there is no way to use that information. For the market to go 90 days without declining on any of the days would be unprecedented -- declining from time to time is the norm. The past long-term gains in the stock market have occurred over periods that were frequently punctuated with declines. Even if you knew that there would be a 10% declines sometime within the next 90 days, that wouldn't necessarily mean you should sell. Maybe the stock market will go up 20% and then go down 10% and then up another 20% -- you wouldn't want to have been out of the market just because you knew there would be a correction in there!

You'd have to know something more specific in order to be able to come up with any strategy to use your knowledge. If, for instance, you knew the stock market would be at least 20% lower than today's price in 90 days, then you could benefit. Selling your stocks now and then buying back in 90 days would be a start (the benefit likely outweighing any tax issues if the loss is going to be that large). This approach would not necessarily mean that you would sell at the top or buy at the bottom, but if you did know specifically that stocks would be lower in 90 days there would still be a significant benefit from avoiding those 90 days of 20% overall net losses. Plain short selling would not necessarily work, because the market could go way up (resulting in a margin call) before it comes down. Using inverse ETFs also might fail since their (usually daily) leverage resets cause them to do poorly when there is a lot of back and forth movement. However, you could use options to take a short position and make money safely.

That is, if one makes the extreme assumption that you could make such predictions reliably ...

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by avalpert » Sun Jan 22, 2017 11:47 pm

Of course the answer is you go short with as much leverage as you can get your hand on - assuming the reason your know for certain it is going down wouldn't result in insider trading.

This is no different than Biff in Back to the Future 2. It really isn't an interesting hypothetical at all - if an individual had certainty in what the market would do then the general approach recommended on this board would not be appropriate.

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by Erwin » Sun Jan 22, 2017 11:50 pm

I know that it is not a matter of if, but when. And that is true at all times for some markets. Given that, from the very start I build a global equity portfolio hoping to soften the blow.
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Re: How would you invest if you were SURE of short-term deline in markets

Post by tetractys » Mon Jan 23, 2017 12:02 am

Niam wrote:
tetractys wrote:Even if I was sure of a "short-term decline", as you say, I might not do anything at all. Often times one finds the time and trouble of reacting not worth the return. If it does eventually become worth it, my portfolio is set up to indicate that at the appropriate time, regardless of the prediction, forknowledge, or whatever.

And of course, sureness very often turns out to be delusion. -- Tet
Thanks. I assume many bogleheads will say something similar, so let me also posit a different hypothetical -- what would it take for you to deviate from that thinking?

I guess what I'm trying to do, among other things, is push the limit in my own mind about just how far the conventional wisdom on this board would go in terms of fidelity to the the well-accepted investment theory (which strongly discourages trying to make short-term investments, time the market, etc.). What is the limiting principle to that? What would it take to deviate from that? What if you lived in an alternate reality where you somehow knew certain short-term trends that would otherwise give you significant reason to chase short-term returns or minimize short-term risk? Still park your money in the broad index and forget it?
Many people on this forum seem to chase cash back credit cards and such; but I don't myself, because I see that as an alternative reality. The other day a man was asking me what I regretted about my past, and what I wished it could have been. An intelligent person of character can't answer these types of questions of course, knowing simply that the outcomes are unknowable and could just as easily be negative as positive (and one's life would have to be relatively horribly negative for much chance of a positive outcome)--the ancient child's lesson of Aladdin and the Lamp. -- Tet
Last edited by tetractys on Mon Jan 23, 2017 12:04 am, edited 1 time in total.

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Re: How would you invest if you were SURE of short-term deline in markets

Post by whodidntante » Mon Jan 23, 2017 12:04 am

Niam wrote: I guess what I'm trying to do, among other things, is push the limit in my own mind about just how far the conventional wisdom on this board would go in terms of fidelity to the the well-accepted investment theory (which strongly discourages trying to make short-term investments, time the market, etc.). What is the limiting principle to that? What would it take to deviate from that? What if you lived in an alternate reality where you somehow knew certain short-term trends that would otherwise give you significant reason to chase short-term returns or minimize short-term risk? Still park your money in the broad index and forget it?
I time the market, so I guess I don't fit the convention you describe. I am a value investor at heart. I get excited about buying an asset that in my judgement is cheap and offers higher expected returns. This often works out fine, but it also makes me prone to catching a falling knife.

However, I do not dare to say I know anything about the future for certain. I read the hypothetical you posed in your OP as really about a trading strategy to benefit from a certain drop so that's how I answered it.

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by VaR » Mon Jan 23, 2017 12:05 am

What do you mean by "sure"? Do you mean that you are in possession of factual foreknowledge of the future? If so, then I agree with the peeps saying to use a leveraged short position - buying index puts is a good choice where you won't get knocked out by a short term upward movement.

OTOH, if by "sure" you mean "utterly convinced in my own mind", I would declare myself insane and check myself into the Boglehead Sanatorium until the feeling passed. I hear it's a lovely place. :)

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Re: How would you invest if you were SURE of short-term deline in markets

Post by long_gamma » Mon Jan 23, 2017 12:27 am

alex_686 wrote: A more interesting line of thought is if you thought there was a 75% chance that there would be a steep decline in the market. Then what would you do? In this case I would point you to the Black Litterman model. It allows you to state your positions and combine them with market expectations to come up with a portfolio. The math is challenging.
Exactly this. Though this model is applied for a portfolio consisting of multiple asset classes.

You can read up on this here.

https://corporate.morningstar.com/ib/do ... terman.pdf

https://faculty.fuqua.duke.edu/~charvey ... behind.pdf
Last edited by long_gamma on Mon Jan 23, 2017 12:33 am, edited 1 time in total.
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Re: How would you invest if you were SURE of short-term deline in markets

Post by avalpert » Mon Jan 23, 2017 12:29 am

tetractys wrote: Many people on this forum seem to chase cash back credit cards and such; but I don't myself, because I see that as an alternative reality.
What does that mean - 'alternative reality'? I don't see how reducing all my expenses by 2% because of the credit card I use is an alternative reality - I just see it as prudent financial management.

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by taguscove » Mon Jan 23, 2017 12:42 am

I would sell all my equity exposures, open an Interactive Brokers account, and try to short the largest possible position with S&P500 e-mini futures.
E-mini futures would allow me to take a 20x market exposure, so a 10% decline would net me a cool +200% return.

Of course, the premise is absurd. This whole forum is built around the idea that it's difficult to beat the market with an information edge.

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Re: How would you invest if you were SURE of short-term deline in markets

Post by Niam » Mon Jan 23, 2017 12:44 am

long_gamma wrote:
alex_686 wrote: A more interesting line of thought is if you thought there was a 75% chance that there would be a steep decline in the market. Then what would you do? In this case I would point you to the Black Litterman model. It allows you to state your positions and combine them with market expectations to come up with a portfolio. The math is challenging.
Exactly this. Though this model is applied for a portfolio consisting of multiple asset classes.

You can read up on this here.

https://corporate.morningstar.com/ib/do ... terman.pdf

https://faculty.fuqua.duke.edu/~charvey ... behind.pdf
Thanks, should be an interesting read and along lines of what i was looking for to further my understanding.

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by Tanelorn » Mon Jan 23, 2017 1:07 am

Certainly a prudent thing to do would be to sell all your stocks, barring tax issues (or hedge them if you don't want to sell). Sure the market might go up more than the 10% impending drop over the next 3 months, but certainly on average the market does not go up that much so the expected value of holding would be much lower than usually and very likely negative. I suppose this depends a bit on whether some perverse wish-granting genie gave you the tip and then arranged for just the wrong thing to happen when you try to make use of it, but it's what I would do for starters.
patrick wrote:If all you know is that the market will go down sometime within the next 90 days, there is no way to use that information. For the market to go 90 days without declining on any of the days would be unprecedented -- declining from time to time is the norm. The past long-term gains in the stock market have occurred over periods that were frequently punctuated with declines. Even if you knew that there would be a 10% declines sometime within the next 90 days, that wouldn't necessarily mean you should sell. Maybe the stock market will go up 20% and then go down 10% and then up another 20% -- you wouldn't want to have been out of the market just because you knew there would be a correction in there!
Long sufficiently long dated VIX futures or similarly positioned VIX ETFs would probably capture the upswing in volatility associated with a big drop even if the market rose by more than that first. You could also get cute and play games like wait for the first 60 days then buy 1 month options or something since now you "know" the drop is coming sooner.

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by letsgobobby » Mon Jan 23, 2017 1:35 am

Niam wrote:I have more of an academic/theoretical question than an actual investing question I'd like to implement -- assume you generally had confidence in long-term markets but somehow knew that there would be a short-term correction or downward movement in the broad market, how would you invest and/or what would you do?

Note: This is not an invitation to talk about how no one can be sure what the market will do and its stupid to try to time the market. Yes, I get all that.

What I'm struggling with a bit -- at least at a theoretical level -- is that if I somehow knew that there would be a short-term (i.e., less than 90 day) correction in the market (based on some impending political event or something), I am not sure what one is supposed to do. Assume for a second that everyone in this thread is going to be fully aware of the risks associated with this hypothetical, what is the response if you know the broad stock market is almost assuredly going down in the short term? Let things ride because you don't know when the correct time to get back would be? Move a higher percentage to bonds? Assuming no adverse tax consequences, pull money out? Not change existing investments but try to short the market to balance the losses in your existing portfolio?

At a theoretical level, I am struggling with the concept that even if you were somehow sure that your investments were going to go down in value, you should leave your investments/investment plans as is. Suspend reality for a second and assume that you somehow know for sure that U.S. stocks are going to take a bit of a hit in the next 30-90 days. What, if anything, do you?

And I'd appreciate people trying to answer the hypo -- not just tell me I'm a moron because this requires suspending reality. Assume everything you know about the market currently is true, and assume you know nothing more than you do right now about long-term trends. The only thing you know is that there will be meaningful (but not catastrophic) short-term downward price movement in the broad stock market. What do you do?
When the facts change, I change my mind. What do you do, sir?

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by UncleBen » Mon Jan 23, 2017 6:26 am

Write a book.

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by in_reality » Mon Jan 23, 2017 7:19 am

If I were 100% sure of an impending decline, I would turn over my investment accounts to someone more sensible than me.

It's a clear signal that cognitive decline has occurred. I will never be able to predict the future. Never.

Was that a trick question?

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by nisiprius » Mon Jan 23, 2017 7:20 am

(In_reality just beat me to it while I was writing this...)

If I were SURE of an impending decline in the markets, I would get some sleep, rest, re-read some investment books and remind myself why I shouldn't be SURE of any prediction, but especially not about the markets.

I would also remind myself as best I could (it's difficult because of the way we edit our memories), of times in the past when I was SURE about the markets or anything else, and what really happened.

And then, even harder, I would try to remember what advance feelings I had before big things really happened. For example, I would do my best to compare the feelings I had in fall of 2008, when the market was down about 15% from the start of the year, to feelings I had in fall of 2011, when the market was down about 15% from where it had been in the spring.

If a time traveller appeared at my door with a copy of the Wall Street Journal for January 23rd, 2018, I would judge that the chances that someone had bothered to spend tens of thousands of dollars to prank or scam me--however infinitesimal they might be--were a billion times higher than the chances that this I was looking at a real time traveller with a real copy of the real Wall Street Journal.

Is this kind of fantasy, "if you were SURE of an impending decline in the markets," completely harmless? No, not completely, because it strengthens the pattern of thinking in terms of making short-term predictions and acting on them. The academics have told us amazing things about the prevalence of overconfidence and the difficulty of correcting for it even when you know it is there.

The devil of investing is not in being wrong, it's in staking too much. It's not in misjudging the market, it's in misjudging one's ability to judge.

If I were SURE I knew what the market would do, sure enough place a bet I couldn't afford to lose... and if I couldn't shake the feeling, I'd book an appointment with someone who could help me shake the feeling.
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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by Dottie57 » Mon Jan 23, 2017 7:36 am

+1

I am not even prescient about what I will have for dinner.

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by livesoft » Mon Jan 23, 2017 7:38 am

What one does in a 401(k) or IRA will be different than what one does in a taxable account.

Since one cannot use margin nor short equities nor do much in 401(k) or IRA, about the only thing to do there is to exchange everything to cash.

In a taxable account, one should make sure it is a margin account (not a cash account) and sign up for options trading which has a few levels of permissions. Generally, brokers may not give newbies all levels. Furthermore, with a margin account one has to have enough assets in the account to have the collateral to borrow money. If one is trying to use their equities as the collateral, then as markets decline, they may have margin calls.

So I suggest that one start practicing in their taxable account with options now in order to know what to do. :twisted:

Michael Lewis' book The Big Short describes what some people did in this not-so-hypothetical situation.
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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by sschullo » Mon Jan 23, 2017 7:58 am

With all due respect, your question means to me that you are learning about how to think about the investing process and trying to make it understandable. Your question deserves a response so you can fully understand what you are dealing with here. If anybody can predict a decline, then you can predict the recovery. If you can predict declines and revoveries, then you can predict which sectors, hedge funds, bitcoins, puts/options, gold, and individual stocks will go up and which will go down accurately.

If one can do all of this, then I refer you to a famous example illustrated below: you can start investing with a penny and within 30 days, you will have accumulated over $5 million with 100% return every day. If your investment only return 50% a day, it will take you bit (no pun intended) longer to be wealthier than WB.

Day 1: $.01
Day 2: $.02
Day 3: $.04
Day 4: $.08
Day 5: $.16
Day 6: $.32
Day 7: $.64
Day 8: $1.28
Day 9: $2.56
Day 10: $5.12
Day 11: $10.24
Day 12: $20.48
Day 13: $40.96
Day 14: $81.92
Day 15: $163.84
Day 16: $327.68
Day 17: $655.36
Day 18: $1,310.72
Day 19: $2,621.44
Day 20: $5,242.88
Day 21: $10,485.76
Day 22: $20,971.52
Day 23: $41,943.04
Day 24: $83,886.08
Day 25: $167,772.16
Day 26: $335,544.32
Day 27: $671,088.64
Day 28: $1,342,177.28
Day 29: $2,684,354.56
Day 30: $5,368,709.12
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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by Jack FFR1846 » Mon Jan 23, 2017 8:24 am

My intuitions are nearly 100% wrong, so if I was really, really sure that the market was going to drop, I guess I should buy lots of equity and sell all my bonds. What I would do in reality is nothing.
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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by random_walker_77 » Mon Jan 23, 2017 9:35 am

Assuming the purely hypothetical and answering the question at face value: Do you know how much things will decline? Assuming I just got my time machine working (and not nisiprius' potentially-lying time traveller), but only know the price and date for a future short term decline, I'd sell everything I had (houses/cars/investments) and borrow as much money as I could. Then, instead of shorting stocks (which opens one up to margin calls), I'd buy as many put options as I could afford. If a stock is trading at $110, it's usually just a few pennies to buy the right to sell the stock for $100. If I knew the stock was soon going to be at $80, that could allow for a 400x (40,000%) return (i.e. $20 / 0.05). By buying options, rather than writing them, there's no risk of a margin call. If you don't exercise the option,then it simply expires, so you can't lose more than what you spent to buy the option.

Still, even if you had this working time machine, a large move like this would probably invite an SEC review looking for insider trading, so it's better to take multiple trips to the future to scope out multiple smaller bets.

edited to add reference: http://www.investopedia.com/ask/answers ... tvsput.asp

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by Index Fan » Mon Jan 23, 2017 9:51 am

For several years, many prognosticators were sure bonds had 'nowhere to go but down'. They were wrong for several years.

Don't fall for the guessing game.
"Optimum est pati quod emendare non possis." | -Seneca

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by livesoft » Mon Jan 23, 2017 9:55 am

random_walker_77 wrote:..., I'd buy as many put options as I could afford.
Many brokers would not allow this for those inexperienced with options trading.
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Calais
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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by Calais » Mon Jan 23, 2017 9:59 am

I would sell all my equities, raise my overall level of anxiety, and underperform the market for the next year and a half.

...wait, that's not hypothetical.... :wink: I'm still confident in my decision, but not my prediction, for what that's worth...
viewtopic.php?t=173073

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JamesSFO
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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by JamesSFO » Mon Jan 23, 2017 10:10 am

The challenge is that even if sure, when would you get back in? Missing the best days is just as problematic as avoiding the worst days.

See, e.g. http://www.marketwatch.com/story/how-mi ... 2016-01-25

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by long_gamma » Mon Jan 23, 2017 10:12 am

livesoft wrote:
random_walker_77 wrote:..., I'd buy as many put options as I could afford.
Many brokers would not allow this for those inexperienced with options trading.
are you sure? I know there are restrictions for selling puts, not for buying puts atleast for index puts. There could be restrictions on certain stocks or markets if short selling is restricted or banned.
"Everyone has a plan 'till they get punched in the mouth." --Mike Tyson

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by Tamarind » Mon Jan 23, 2017 10:26 am

It depends on if you know how much as well as when the drop will begin and when it will end. If you know there will be a x% drop over y period of time, you might reconsider your AA, or stockpile dry powder to purchase at what you know will be the bottom.

If you don't have all three pieces of information you're better off doing nothing.

Of course as you point out a time machine would be required to do it right.

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by pkcrafter » Mon Jan 23, 2017 10:41 am

Niam, if I take your hypo literally -
The only thing you know is that there will be meaningful (but not catastrophic) short-term downward price movement in the broad stock market. What do you do?
You have defined the problem as short-term downward movement, so under that scenario I would do nothing because there is no risk there. You have to understand the difference between normal volatility and risk of actually losing money.

If I were close to needing the money, I would have already tempered volatility risk by reducing equity exposure.

In the real world, we will definitely experience times as you describe, we just don't know when they will occur. Smart investors do not flinch on news and noise about short term market fluctuations.

Paul
When times are good, investors tend to forget about risk and focus on opportunity. When times are bad, investors tend to forget about opportunity and focus on risk.

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by msk » Mon Jan 23, 2017 10:48 am

Depending on how much confidence I have about the impending fall, for a $100k account:

So-so confidence, like for many people currently: Invest 100% in SPY, $100k. Sell one-year covered Calls on SPY. I collect money up front, about $5300 (today's prices for Call options), but I could still end up with a net loss if the drop is more than, say, 5% within the year. No drop? I make $5300+$2000 in dividends. $7300, 7+%, not bad for such low risk.

Moderate confidence: Invest 50%, $50k, in SPY, sell covered Calls on that half. Make $3650, as above. Use the cash $53650 to buy 3700 Puts on SPY. And wait for the fall...

Supreme confidence: sell everything and buy 6900 one-year Puts on SPY. If the drop exceeds 5% within the year I sing with joy. No drop at all and I am out of $100k... This can get to be serious money. A 25% drop within the year and I net $300k.

The so-so confidence scenario above is very tempting. I have used it repeatedly in the past couple of years (on a million$ SPY) whenever SPY approached or surpassed 220 and I have netted some $100k just from the options play, since it always fell back within a few months. It's only recently that SPY seems to possibly break out of the sideways movement. Am tempted to play it again if SPY reaches 230 (SP500 2300) :confused

691175002
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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by 691175002 » Mon Jan 23, 2017 11:06 am

Niam wrote:Suspend reality for a second and assume that you somehow know for sure that U.S. stocks are going to take a bit of a hit in the next 30-90 days. What, if anything, do you?
The answer to your question is considerably more complicated than people have assumed. The obvious answer is to make a leveraged short bet (probably via leverage or margin) but the information you have is not sufficient to guarentee that strategy will be successful.

Lets say I know with 100% certainty that at some point between 30-90 days from now, the market will be at least 10% lower than its current price. That does not make it safe to implement a leveraged short right now. Twenty days from now the market could be 20% higher and the position might get called before the crash occurs.



The optimal strategy for a retail investor with knowledge of the future is further complicated by tax and brokerage constraints. If the account has many years of capital gains then you would probably leave it invested and run derivatives on the side, but accessing margin and sneaking the whole transaction through the tax system might be impossible without investment banking connections.

In short, information about the future is not as profitable as one might assume. You need very precise knowledge about the timing of the event and price movements that surround it to safely take on leverage. If you are locked in by large capgain taxes and need to set up a new margin/options account (with compliance/risk management breathing down your neck) you might have trouble making more than 5-10% risk free.

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by inbox788 » Mon Jan 23, 2017 11:34 am

White Coat Investor wrote:
Niam wrote:
At a theoretical level, I am struggling with the concept that even if you were somehow sure that your investments were going to go down in value, you should leave your investments/investment plans as is. Suspend reality for a second and assume that you somehow know for sure that U.S. stocks are going to take a bit of a hit in the next 30-90 days. What, if anything, do you?
Short the market. Preferably with a lot of leverage. Duh. The problem is it is very, very hard to be sure, and even when you are sure, you're wrong a lot!
One of the best ways to achieve this is using options. With their expiration dates, they're by definition market timing. Pick the time frame and the strike price you predict this will occur, say 3 months out and 10% or 20% drop and if you're 99% sure, you should buy lots of puts (you could lose 20% of your investment very quickly). If you're 100% sure as you suggest, then sell naked calls! (not just 100% loss, but unlimited liability theoretically - practically, you have margin limits, but folks have figured out ways to bypass them, some not legal or via accounting tricks/off the books accounting) These are very levered strategies and you'll face margin issues, but should yield the highest return if you nail the numbers. Practically, the Put strategy might extend you the most potential margin, so might be even better.

With SPY near 225 now going down to 200 in 3 months, you can do any of these. Buy 225 Put for $5, make $25. Sell 200 Calls for $25, make $25.

200.00 SPY170421C00200000 27.81 27.60 27.76 0.00 0.00% 10 59 23.63%
225.00 SPY170421P00225000 5.02 5.12 5.17 0.23 4.80% 278 8,897 12.58%

http://finance.yahoo.com/quote/SPY/opti ... 1492732800

Now everyday, someone is buying and selling these options, but at different dates and strikes. Watch the volume spike at times when some folks are more sure. And if you're really confident you can win the trifecta (date, strike, stock), pick a specific stock that will decrease the most in the declining market.

FCX
http://video.cnbc.com/gallery/?video=3000582674

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by alex_686 » Mon Jan 23, 2017 11:45 am

long_gamma wrote:
livesoft wrote:
random_walker_77 wrote:..., I'd buy as many put options as I could afford.
Many brokers would not allow this for those inexperienced with options trading.
are you sure? I know there are restrictions for selling puts, not for buying puts atleast for index puts. There could be restrictions on certain stocks or markets if short selling is restricted or banned.
There are. One would need "Level 2" authorization. Level 1 is for covered calls, Level 4 is for going naked. Trading long options is speculative, is open to abuse, and has burned many inexperience investors. Brokers, even discount ones, are expected to protect their clients from themselves - if even by a little bit.

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by nisiprius » Mon Jan 23, 2017 11:49 am

inbox788 wrote:...One of the best ways to achieve this is using options. With their expiration dates, they're by definition market timing. Pick the time frame and the strike price you predict this will occur, say 3 months out and 10% or 20% drop and if you're 99% sure, you should buy lots of puts (you could lose 20% of your investment very quickly). If you're 100% sure as you suggest, then sell naked calls!...
If I were SURE of an impending decline in markets, the next question is: what is the source of that certainty?

If everyone is SURE, then nobody is going to be willing to sell me that option.

So, the options are only available if I think I know something that not everybody knows.

Shouldn't I be worried that the person willing to sell me the option knows something that I don't know?

In the world I personally live in, asymmetrical information is not usually on my side.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by cadreamer2015 » Mon Jan 23, 2017 11:59 am

Since no one can be sure of anything except death and taxes (apologies to Benjamin Franklin), and even there the timing is at least somewhat uncertain, how is this actionable?
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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by greg24 » Mon Jan 23, 2017 12:00 pm

I guess if you throw out the hypothetical that I am SURE of sporting even outcomes, I'd bet on them.

Since that is impossible, I generally don't bet.

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by Toons » Mon Jan 23, 2017 12:01 pm

What would you do if you were SURE of impending deline in markets


Buy More. :happy
"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by random_walker_77 » Mon Jan 23, 2017 12:04 pm

alex_686 wrote:
long_gamma wrote:
livesoft wrote:
random_walker_77 wrote:..., I'd buy as many put options as I could afford.
Many brokers would not allow this for those inexperienced with options trading.
are you sure? I know there are restrictions for selling puts, not for buying puts atleast for index puts. There could be restrictions on certain stocks or markets if short selling is restricted or banned.
There are. One would need "Level 2" authorization. Level 1 is for covered calls, Level 4 is for going naked. Trading long options is speculative, is open to abuse, and has burned many inexperience investors. Brokers, even discount ones, are expected to protect their clients from themselves - if even by a little bit.
Thanks, I've now learned something new today :D

Looks like it requires additional paperwork to convince the brokerage that you understand you're a speculator and understand what you're getting yourself into.
http://investorplace.com/2009/03/option ... IY3MBsrJhE
https://www.tdameritrade.com/retail-en_ ... DA2334.pdf

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by random_walker_77 » Mon Jan 23, 2017 12:21 pm

Niam wrote: At a theoretical level, I am struggling with the concept that even if you were somehow sure that your investments were going to go down in value, you should leave your investments/investment plans as is. Suspend reality for a second and assume that you somehow know for sure that U.S. stocks are going to take a bit of a hit in the next 30-90 days. What, if anything, do you?
That is a hard concept. Maybe even *the* hardest.

I believe that the market is incredibly efficient with information. That it's not only a means to buy/sell portions of companies, but also a remarkably good way to integrate information and predictions, because people are voting with their dollars. (see wisdom of the crowd / prediction markets https://en.wikipedia.org/wiki/Wisdom_of_the_crowd, https://en.wikipedia.org/wiki/Prediction_market)

I believe that, of the millions of other investors out there, anything I know someone else probably also knows. So it's already priced into the market.

I believe that, if I were to actively sell, I wouldn't be able to optimally pick the right time to buy back in. Given that a lot of the market gains happen in a very small number of really good days, I believe that on average I'd do a lot worse by trying to time my way out and back into the market.

I know that there are a lot of really smart, highly experienced, and heavily resourced people trying to beat the market. I don't think I can beat them.

Finally, there's a lot of research showing that it's really hard to beat the market. Most pro's don't, especially after deducting their fees. I don't think I can beat the market and am happy with merely matching the market, using low cost passive index funds. To do that, I have to stay in the market, lest I miss one of those surprising run-ups.

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by long_gamma » Mon Jan 23, 2017 12:24 pm

alex_686 wrote:
long_gamma wrote:
livesoft wrote:
random_walker_77 wrote:..., I'd buy as many put options as I could afford.
Many brokers would not allow this for those inexperienced with options trading.
are you sure? I know there are restrictions for selling puts, not for buying puts atleast for index puts. There could be restrictions on certain stocks or markets if short selling is restricted or banned.
There are. One would need "Level 2" authorization. Level 1 is for covered calls, Level 4 is for going naked. Trading long options is speculative, is open to abuse, and has burned many inexperience investors. Brokers, even discount ones, are expected to protect their clients from themselves - if even by a little bit.
Thanks.
I have traded options more than a decade both at IB and TOS. Not sure what forms did i filled those days :D .

I just checked IB, their requirements are vague.
https://www.interactivebrokers.com/en/i ... quirements

"Limited option trading is also available with ANY Investment Objective. Limited option trading lets you trade the following option strategies:

Long Call or Put
Covered Calls
Short Naked Put: Only if covered by cash
Call Spread: Only European-style cash-settled
Put Spread: Only European-style cash-settled
Long Butterfly: Only European-style cash settled
Iron Condor: Only European-style cash settled
Long Call and Put


As someone pointed out TOS has Level 2 requirements. What i don't understand is the risk for brokers, if they buy cash-secured puts or calls? They have money to purchase the stock, if it is put to them. If it is on margin, i can see liquidation problems for the stocks. There should be no issue with the cash settled index puts. Anyway this is a side issue, not related to OP.
Last edited by long_gamma on Mon Jan 23, 2017 12:38 pm, edited 1 time in total.
"Everyone has a plan 'till they get punched in the mouth." --Mike Tyson

MathWizard
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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by MathWizard » Mon Jan 23, 2017 12:33 pm

Nothing.

The only way I could be sure was if I had inside information.
Trading on such would not compromise my ethics, but could land me in jail.

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Re: Hypo: What would you do if you were SURE of impending deline in markets

Post by alex_686 » Mon Jan 23, 2017 12:57 pm

long_gamma wrote:As someone pointed out TOS has Level 2 requirements. What i don't understand is the risk for brokers, if they buy cash-secured puts or calls? They have money to purchase the stock, if it is put to them. If it is on margin, i can see liquidation problems for the stocks.
The risk is that will be sued. When I was in compliance I was trained never to let little old ladies do options. Even if they had a MBA in Finance they would win a jury trail by playing the unsophisticated granny card. It was a bit of a joke but....

Since the 1940s there have been rules on the books that brokers need to look after the interest of their clients. They may be been weak but they were there. Option and future trading has a long and storied history of abuse. Like fire, novices always get burned the first few times they use it. The protection that brokers offer is rule based, pretty flimsy, and protects the broker more than the client. You must be sufficient wealth to withstand the inevitable fumble. Plus some experience.
Last edited by alex_686 on Mon Jan 23, 2017 1:09 pm, edited 1 time in total.

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