Risk On, Risk On

Trading Places 2

I like risk. I’ve spent the greater part of my adult life taking risk. I stood in the futures pits of the COMEX and NYMEX for almost 14 years. Must be something about risk that kept me coming back…Oh yeah, the reward part of the saying. Risk/Reward. It seems simple. But it’s difficult to comprehend sometimes what real risk can feel like at any given moment. The government and the brokerage houses have a great deal to rules to address this. Certain instruments are only available to specific investor classes deemed able to accept it.

There are a few ways to become able to trade or invest in these instruments and methods. One is to be rich. When you’re rich, or at least rich as deemed by a government guideline, you can pretty much do whatever you want. And that seems fair. First of all, chances are you can afford to lose some money. Also, there’s a good chance you’ve done something or some things in an intelligent enough manner, financially speaking, to understand the downside. Or maybe you were lucky enough to be born rich, and we figure somewhere along the line it was all explained by the elder generation.

You can take tests. Series this, series that, CFA, etc. There are lots of industry tests. And passing these tests implies at least that you have an understanding of what can go right, and more importantly what can go wrong with different investment vehicles. So once you pass a test saying you can help others to make money in your chosen discipline, it’s often ‘assumed’ that you understand it for your own purposes as well.

Experience. The more experience you have with financial investing and trading, the more the portfolio of allowable products may grow. If you survived one level, you get to play, I mean move on to the next level. Seems logical. Not all of these approaches open every door. But they all open some, as far as what you can buy and sell, or invest in. We generally start out with basic equities, move on to margin trading, options, from simple strategies to being given a longer leash and being able to try more risky strategies. Maybe this is how video games were designed. Games following life, but with no real risk involved, just the risk of some silly music playing as your character is killed.

I’ve mentioned my background as a futures trader in the COMEX and NYMEX pits. It was funny when I applied for a stock account after trading futures for my own account for a couple of years. I was told I was approved for everything. I guess the risk of the pit, every single day, gives you some ‘street cred’, as it were. So for me, risk is fine. In fact, I have often referred to the fixed income part of our industry as akin to watching paint dry due to less risk…for the most part. But that’s just for me. And fixed income has made a lot of people a lot of money. So I’m not knocking the profit side of the equation on that one. It just isn’t the same as the world of futures and the leverage afforded those participating in that part of the industry.

So this thing the government has about bringing us along at a reasonable rate to work our way up the risk ladder is probably one of the more logical things they’ve passed rules about. The Political Science major in me often says that one of the primary roles of government is to protect people from themselves. We don’t want to have constant bailouts for every person that didn’t understand the risk involved in getting short natural gas futures when there’s a hurricane on its way. Or any other similar trade.

Then I read this article. The SEC on Tuesday approved a request to trade quadruple leveraged exchange-traded funds, ETF’s. Those initially approved seek to make four times the daily performance of the S&P 500, either up or down. And the symbols? Up and Down, of course. Cute. Trading is many things, cute is not supposed to be one of them. But that’s marketing. And speaking of marketing, how are ETF’s listed and marketed? As equities. And since ETF’s are equities, just past that first video game level is using margin on equities. We just increased the leverage. So when I saw the article yesterday, it was a “Wait…What?” moment of sizeable proportion.

As a kid we were all told at some point, “Sure it’s fun, until someone gets an eye poked out,” or at least a similar phrase. And that’s how I feel about these new ETF’s. They’re going to be fun for people while the market trades with some semblance of normalcy. It will go up. It will go down. People will get addicted to the comparatively outsized returns available with that type of leverage. Until…

Now this isn’t to say that the market is going to crash anytime soon. But with that kind of leverage it doesn’t have to when you’re wrong. We can short them too…this is really starting to sound a bit more risky than buying shares of McDonalds. But that’s ok. Go ahead. What could happen? Everyone understands the risk involved. Oh wait, we’ve already decided that many of the people trading equities don’t fully comprehend the level of risk involved in many types other of trading. We actually learned that when the NASDAQ bubble burst.

What if the market does crash? It’s happened. More than once. And I know that one of the toughest things for a trader or investor is to admit they’re wrong and get out. Remember the blog about finding your nearest exit? That’s what I’m worried about. Crashes happen to the degree they do because they feed on themselves. No one wants to get out…until everyone wants to get out. But I’m a fan of risk, though maybe I should say understood risk. And I’m even a fan of giving people access to taking a shot on things beyond basic corporate ownership in the form of shares. But in this case, I’m not sure the government is really doing a good enough job of protecting people from themselves.

For the professionals, there are futures contracts on the S&P. Plenty of risk for those qualified. There are single and double and even triple levered ETF’s to trade the indexes. Seems like we’ve got to be far enough down the road by this point. Do we really need to narrow the gap between the most and least risky instruments that much? Does everybody have to have access to outsized risk? Like so many other things in the world of investment instruments, I believe we should be careful what we ask for. Before we get it.


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