Recently, I went to a local cash office. There were many customers there, and while I was waiting for my turn, a man asked me what I did for a living. I was happy to reply him that I’m a Forex trader and a market analyst. “Forex,” the man said, “ruined many people, including me, especially during the bear markets of the year 2008.” I immediately sensed that the man was ignorant of the realities of the markets. Since I was in a hurry and it was my turn to be attended to, I couldn’t explain anything to the man.
There are many wrong trading assumptions that are being nurtured and propagated by too many people. A few years ago, I wrote a series of articles covering 10 most widespread myths about online trading. This time around, the supposed crashes in the bear markets of the year 2008 were another myth that needs to be busted. How?
Contrary to what most novices think, there’s nothing like an everlasting trend. There’s no instrument or market that can go upwards forever, and therefore there must be some protracted bearish reversal and continuation. This is what ignorant people call a crash. The so called ‘crash’ is only a significant bearish market which can’t last forever, since it would give way to a bullish trend. When the markets go up, buyers gain and only sellers lose. When the markets go down, sellers gain and only buyers lose. If a professional trading risk manager was caught in wrong positions, she/he would simply cut the losses. That’s all.
Here are additional ideas about handling the bear markets that happened in the year 2008:
I’m not interested in the fundamentals that led to those bear markets. What I know is that bear markets must follow bull markets – though fundamentalists would always pinpoint reasons for that. Bearish trends give you great opportunities to make money by short-selling. Many great traders have made fortunes in bear markets. People like Jesse Livermore (the Great Bear of the Wall Street), John Paulson, Paul Tudor Jones, Robert Prechter, Tim Knight etc. accumulated great wealth from bear markets. There are individual traders who also make money in bear markets.
People lose in bear markets because they use big position sizes, they don’t use stops, and they decide to run their losers indefinitely. Little do people know that a bear market would continue to be bearish as long as people think it would soon end. However, as soon as most people think that the market will continue in a downtrend, then a northward reversal would happen. Likewise, a bull market would continue for as long as people are skeptical about it; it’ll reverse significantly only when almost all people show confidence in it.
In the year 2008, a competent trader who suffered initial losses would’ve exited when the losses were still small. Then she/he would see the new bearish signals and trade accordingly, thus recovering the initial losses and moving ahead. Sadly, there were certain traders who continued buying in that downtrend.
Based on my trading style and risk control parameters, what could I have done? Since I risk only 0.5% of my account per trade, I wouldn’t have lost more than that per trade if a trade went against me in that year. If I bought and was stopped out on a trade when the bearish biases began, I’d have taken the small loss (If I lost 6 trades in such a way, my drawdown would’ve been 3%) and started looking for new trades. So in the case of a bearish outlook on the markets, I’d have gone short or sold rallies in the context of the downtrend.
For instance, let’s look at the chart attached with this article. From August to early December, 2008, the GBPUSD fell by over 6000 pips! There are many currency market instruments that went bearish protractedly in that year, so the lessons below are also valid for them.
By looking at this chart, you’d agree with the lessons below:
- When trading on the GBPUSD during that period, if your position sizes were very small and you respected your stops, the losses on this trade would be negligible. But if you used big position sizes and/or refused to honor your stops, you’d sustain huge losses.
- With small position sizes, even huge losses can be sustained if you rode your losses in that kind of protracted bear markets.
- By running your winner, you could’ve made huge profit in that bear market.
- If you were initially caught on a wrong side and you were disciplined enough to cut your loss, you could’ve regained the loss and moved far ahead if you opened another trade and followed the trend.
Conclusion: Bearish and bullish biases are normal part of the markets. Sometimes, a bearish or bullish bias may last very long, and sometimes it may be short in duration. Nothing is wrong with the markets, for they’ll do what they’ll do, irrespective of what traders want. On the contrary, it’s our trading styles and approaches that bring us the results that we see. In the year 2008, the markets didn’t crash, only ignorant, undisciplined and greedy traders did. On the other hand, informed, disciplined and patient traders survive and made money. Can you see the difference?
The quote below concludes this piece:
“You will not continue to get better as a trader if you don’t track and measure what you are doing and how you are doing it.” – Dr. Woody Johnson
