This is a guest post from Bill Provenzano who is a 20‐year veteran commodity trader of the CME. He is also the founder of Upside Breakout, a biblically based coaching and mentoring program for Christian stock and commodity traders. Find out more at ChristianTradingCoach.com.
Trading Traps
I couldn’t help but think today about the devastation that the housing crisis has brought upon our economy. As I gave it more thought, I realized that a Trading Trap that many traders fall into was one of the issues at the core of the housing bubble. Trading Traps are those behaviors that sabotage a trader’s profits. One of those traps is the fear of missing out. This manifests itself when a trader fails to act on a trading signal and then watches helplessly as the trade he should have executed goes in his favor. He is left to stare at his screen watching the opportunity continue to move away from him as the position he should have executed goes in the direction he thought. He feels sick to his stomach as he mentally adds up the profits he missed out on. Finally, he can’t take it anymore! He enters the trade at a point far too high to have enough upside potential to balance his downside risk.
Mr. and Mrs. Hopeful
The same thing happened to many ordinary folks who watched housing prices climb higher and higher. So many people felt like they were missing out on one of the greatest trading opportunities of their lifetime. It seemed that all of the family and friends around them flipped a rehab, built a spec house, upgraded to a 3,000 square foot home, or bought a vacation home that skyrocketed in value. Not wanting to miss out, Mr. and Mrs. Hopeful took the plunge. They made the trade with the help of an eager mortgage broker, friendly appraiser and a bank willing to wear blinders (yes, everyone is to blame).
Know well the condition of your flocks
As it relates to both trading and investing, one of my favorite verses is Proverbs 27:23 which says, “Be sure to know the conditions of your flocks, and give careful attention to your herds.” Flocks and herds were the investment accounts of that day. This proverb advises us to know what we are invested in and to understand the factors that impact our investments.
In 2005, aside from my primary residence, I owned 6 other investment properties. I was preparing to purchase another investment property but had a keen eye on the extreme nature of the housing market. It seemed that the price appreciation would never end, but I knew that could not be true. As part of my “knowing well the conditions of my flocks”, I paid close attention to any speech given by Alan Greenspan, the then Chairman of the Federal Reserve. The Federal Reserve sets the course for interest rates and, therefore, has a very real impact on the housing market.
In a speech given to Congress in 2005, given in typical “Green‐speak”, the “you‐have‐to‐guess‐what‐I‐am‐saying” language that Mr. Greenspan spoke in, the Fed Chairman made some statements that made me sit up in attention. After reading and rereading a transcript of the speech, it was clear that Mr. Greenspan was about to set upon a path of steadily raising interest rates to let the air out of the housing bubble. In fact, he was far clearer about his plans than in any of the previous speeches that I had read. I still remember how shocked I was to read that Greenspan was not only unusually clear about his intentions, but that the housing party was about to come to an end.
The bubble burst
Now, to be clear, the severity of the downturn would have been far less if the housing bubble were allowed to slowly leak rather than burst. Slowly raising interest rates should have been the slow leak. But because of extremely loose lending standards, even modest declines in home prices accelerated mortgage defaults which accelerated the rate of depreciation which in turn increased the rate of defaults….you get the picture. Because I had taken the time to pay close attention to the housing market and to keep myself aware of what the arguably most powerful man on earth was saying about interest rates, not only did I not buy the investment property I had my eye on, but I also I sold four of the homes I was invested in over the course of 2006. I kept two investment homes, which I plan to keep for many years to come.
In hindsight I look like a genius. But in reality, this is the kind of thing that we all can experience when we apply God’s word to our trading and investing. When we execute our trades, we must be aware of the factors that impact the stock or commodity we are trading. We must “know well the conditions of our flocks”. And as we keep self‐aware of Trading Traps like fear of missing out, we can side‐step the devastation of that behavior.
