The Advantage of Asymmetric Risk/Reward
An asymmetric trade is when we have limited downside risk, but a lot more upside return potential. 😀
For example, earlier this year Great Britain held a referendum to decide whether or not it should leave the European Union. There was a 50/50 chance it could go either way. However most investors, traders and political pundits were pretty confident that the UK would vote to remain in the EU. So before the vote on June 23rd, the British financial markets were fully priced for a “stay” result. But when the votes were counted it turned out that they were wrong. So people panicked. Shortly after the vote, the British Pound dropped 15%, and the UK stock market also fell.
The UK referendum represented an asymmetric trading opportunity because if the people had voted to remain in the EU, then nothing much would have happened to the markets. But if they voted to exit, then there would be a large shakeup, which is what actually happened. 🙂
Parallel Opportunity in the United States
The U.S. presidential election on Tuesday this week represents another asymmetric event for the markets. Mainstream news sites and people on Wall St. are signally a 90% or greater chance that Hillary Clinton will win, and Donald Trump will lose. However, based on my own research on alternative news sites it appears to be more 50/50, so I expect the results to be pretty close. 🙂
What this means is the financial markets have already priced in a Hillary win. So there are two outcomes to the election and how it will affect investors over the short term. Below are possible examples of what could happen in each scenario.
- Hillary becomes president. No major movement in the stock market. Stocks won’t climb dramatically because almost everyone expected her to win, so it’s already priced in.
- Donald becomes president. Many people caught off guard. Sharp negative reaction in the financial markets. Gold goes up US $50/oz. Dow Jones stock index falls by 500 points. $USD loses 5% against $CAD.
To take advantage of this situation, one could short the US dollar or the US stock market, and buy the Canadian dollar or precious metals.
Personally I plan to buy some gold right before the U.S. election takes place. This decision has an asymmetric risk/reward nature because if Hillary wins, then I won’t lose much. But if Donald wins, then I stand to gain disproportionately more. 😉 I could then sell the gold at a profit to buy depressed stocks. But this type of trading behavior is very short term thinking so I don’t recommend anyone else to actually go do it. This strategy also assumes that gold will indeed go up in price if Donald wins, which is not guaranteed.
Anyway, October has been a solid month for my finances. Equities stayed pretty much flat, which is actually good news considering that historically speaking, October has often been a losing month for stocks. I purchased some new Fortis shares in my margin account, and now my Canadian portfolio stands at $126K. I deposited a check from my tenant, and will be contacting him shortly to work out the rent for next year.
Liquid’s Financial Update
*Side Incomes:
- Part-Time = $800
- Freelance = $700
- Dividends = $700
- Interest = $300
- Fun = $300
- Debt Interest = $1200
*Net Worth: (MoM)
- Assets: = $1,029,500 total (+17,100)
- Cash = $23,500 (+8,600)
- Stocks CAD =$125,900 (+3500)
- Stocks US = $76,400 (+1800)
- RRSP = $71,000 (-600)
- Mortgage Funds = $26,700 (+400)
- SolarShare Bonds = $10,000 (New!)
- Venture Capital = $0 (-6,600)
- Home = $263,000
- Farms = $433,000
- Debts: = $484,700 total (+9,800)
- Mortgage = $186,400 (-500)
- Farm Loans = $192,900 (-500)
- Margin Loans = $60,000 (+6000)
- TD Line of Credit = $18,700 (+4800)
- CIBC Line of Credit = $9,500
- HELOC = $17,400
*Total Net Worth = $544,800 (+$7,300 / +1.36%)
All numbers above are in $CDN. Conversion rate used: 1.00 CAD = 0.75 USD
I added SolarShare to my list of assets. This investment is worth $10,000 right now but will slowly decrease over time. I used a combination of margin debt and line of credit to fund my SolarShare investment, which means my liabilities increased this month. I continue to hold a lot of cash on hand because I plan to make a large investment in the upcoming weeks.
But unfortunately my $6,600 investment in the private company 8tracks fell through because they only take U.S. investors. They said they will send me back my money. So I plan to use this cash instead to buy some gold bullion from my local bank. In my post last week I mentioned that billionaire hedge fund manager Ray Dalio suggests holding 7.5% of one’s portfolio in gold. I think that’s a little excessive, but I would like to get my holdings up to around 3%. 🙂
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Random Useless Fact:
Some people can’t handle the truth.
Solid dividend total for October. Bottom line, It doesn’t matter what happens tomorrow. The market will rocket or fall off a cliff at the hint of any political, economic or international news. Think about what happened over the weekend. “Emails Warrant No New Action Against Hillary Clinton, F.B.I. Director Says,” and the world markets race to the moon. What does this have to do with the Fed, interest rates, national debt, corporate income, taxes, the ability of KO or PEP to sell one more drink? Nothing… Yet, the markets love to react on headlines, related to business or not. How can some stocks so hated a few days ago, like REITs, many health stocks, financial companies, etc. all rally today. The headlines were very negative with the S&P down nine consecutive days last week. What changed? Nothing. In other words, got a dollar, invest a dollar. Find the relative good value and put your money to work. Clearly, the stock market on a day to day, week to week and month to month basis is meaningless.
I totally agree. Short term market fluctuations are based on emotions and knee jerk reactions. For the purpose of providing a long, sustainable portfolio that we can count on in retirement we have to look at the long term fundamentals.
Looks like you had a great month all around Liquid. It’s interesting you’re buying gold. I’ve decided to up my gold allocation as well to about 1% of total net worth. I knew the US would be a circus either way, but DivHut it right, in the scheme of things the day to day gyrations of the market only offer opportunities for long term investors.
Let’s see how the election shakes out tonight!
1% is already more than what most people have. If nothing else, I see gold as an insurance policy incase something happens to the economy or our currency. A lot of successful investors hold at least some precious metals in their portfolios.
Looks like a good call!
Thanks. What a time to be alive.
Great job on gold! Financial stocks aren’t bad either. Financial ETF is up 7% YTD. I saw my account shot way up! I was anticipating a HUGE drop so I could buy more, but it didn’t happen. So I’m sitting on the sideline with $50K of cash.
Wells Fargo shares went 8% higher after the election. I think banks are anticipating reduced regulation from Trump.
This call was right on the money, even though the negative reaction in the marketplace was only temporary. Very good discussion of asymmetric risk and investment. Very good post.
Yes, too bad it didn’t last very long. Gold is now down again lol.
Who knew it would be: Trump wins, Sharp Positive reaction in the financial markets. Gold goes Down US $50/oz. Dow Jones stock index Jumps by 500 points. $USD Wins 5% against $CAD. 😛