Everyone’s heard of “The Big Short”. We’ve Hollywood to thank for that, and thank them I will. After all, who didn’t love Margot Robbie explaining how it all worked? Even Mrs. Chris liked her.
Of course, our heroes correctly bet against these smoking piles of isht mortgage-backed securities and now they all drive Porsches and eat lobsters in their bathrobes.
Likewise, everyone’s heard of Jesse Livermore’s famous shorting of the 1907 and 1929 markets where he made a fortune — over a billion green ones in today’s money, actually.
Then there’s the legendary stories such as Paul Tudor Jones shorting into what was to become known as Black Monday in 1987, tripling his money.
Now, if you were to ask what defined these trades and made them different from any other, more often than not you’d be told that a lot of money was made in a very short period of time, which in itself is unusual.
True, but that doesn’t tell the whole story.
Dig further and ask what made it so, and you’d likely hear that the upside in the trades was high as opposed to say buying the Dow, taking a strong sedative, and waking up in 20 years.
All of these things are correct, but if you ask me this misses what is probably THE most important point that actually acts as a potential (note: I said potential, nothing is guaranteed) “tell” in any market. Bugger all downside risk. And this happens for very obvious reasons.
It actually comes back to what makes any market become over or undervalued in the extreme. In psychology, it’s known as the Dunning-Kruger effect or the cognitive bias in which individuals with low ability perceive themselves as having high ability. It is, in essence, overconfidence.
It was overconfidence that led Joe Sixpack to continue to buy real estate at prices which had become completely disconnected with the incomes that must support those prices, leading to the GFC.
