Ocean-wide differences - part 1 : Timing & Leverage
Introduction
Ever wonder why there's a saying: "Follow the smart money"? If there's smart money, then who is the dumb money?? In this post we'll take a look at the differences in perspective between the two. "The ocean-wide mindset differences between Institutional and Retail investors".
Upside Down
If we are talking about the financial markets, lots of stuff are upside down. In the recent event of US reciprocal tariff where it slapped tariffs to countries all over the world, we can see a lot of case studies of these "upside-down" perspective.
Timing & Leverage
It's not unusual when Retail are buying hard and fast, on the other side of the trade Institutions are selling and vice-versa: when the baby's got thrown out with the bath water (absolute chaos and panic), Institutions are having a field day choosing whatever cheap assets they can get.
Below is a prime example of someone who is having a great day when the markets are collapsing:
The legend, the one and only!
Back to the topic on recent markets cratering, fear and panic took over the landscape. Lots and lots of selling both from Retail and (leveraged) Institutions. Note I specifically mention Leverage.
Take a look at these headlines:
- Q: So hedge funds were also part of the big sellers! What the fuck? I thought hedge funds / institutions are supposed to be the "smart money"??
- A: The differing factor is these institutions are highly leveraged / using margin accounts, and there are lots and lots of them. Yes it is called the human greed factor and this what makes these supposedly "smart people" to do dumb things.
Note: check this X thread if you want to read more on this hedge funds mass selloff.
- Q: So what does it mean to be Leveraged anyway?
- A: From 100% cash you allocated, via leverage you can acquire assets (stocks, bonds, options) in a much greater amount: 200% 300% 500% even more! So lets say you got $100k capital, you can buy $500k worth of assets with your capital. Isn't that great? Yeah leverage enables you to gain much higher profit when your investment direction is going to the right way. But when the direction's wrong, it could also stab you and do 5x damage to your financials.
For a 5x leverage, it only requires -20% drop in the wrong direction for all your capital to be wiped out...Gone! Nada! Zilch! And that is exactly what happened in the headlines shown previously. The term "margin call" is when your stock broker calls you and tell you to send more capital, otherwise it will trigger a "forced liquidiation" event on your investment account.
Conclusion
Avoid leveraged investment / trading practices. Even the most elite professionals in their field got shot in the foot in an overleveraged positions. You are smart, don't let your greed make you dumb!
Example: remember Archegos Capital meltdown back in 2021? A $35 billion fund exploded in a margin call forced liquidation event, how did this happen? Yes, exactly: overleverage! Archegos got 5x leverage when it blew up.
These people were indeed smart, but once greed enters the room, we are dealing with a whole different jungle.