Long term capital management spectacularly went bust in 1998 when Russia decided to default on its national debt.
The basic strategy of LTCM was selling options. The figured ( incorrectly ) that volatility had an upper limit.
Thus...if volatility is high, the price of an option will be high. In option terminology volatility is measured as risk or fear, and not as a mathematic value generated from standard deviations etc.
LTCM employed the following idea. If volatility is high then they wrote options, betting that the volatility would reduce ( as around 90-99% of the time during the life of the option they sold it would do) However there was no provision taken into account for events such as those encountered in 1998 where Boris Yeltzin decided to default on the Russian debt to the world.
This event increased volatility even further and pushed option prices up to levels never seen before. As LCTM was "shorting" options using leverage of around 33 times cash, they ran out of people to borrow from and went bust.
The twist to this story is that they received a bail-out package from the Federal reserve which was the first of its kind and was probably the first step to creating the society of irresponsible lending and trading that we see today. One can see that as many high profile names who were invested in LCTM's fund were faced with a total loss on investment that the bailout was a result of "helping out friends" at the expense of the US tax payer.
This trend has continued through 2008 to present day as has lead to the national debt of USA reaching an "official figure" of over $!6 trillion in March 2013 and the actual figure when including Fanny Mae, Freddy Mach and the un-funded liabilities of medicare and medicaid reaching a speculated estimated of over $30 trillion.
As a result of this profligacy the federal reserve is now printing $85 billion each month to pay for it all. The dollar collapse continues and hyper-inflation is now something which cannot be avoided.
London England news report on the day after the 1987 crash.
Monday 19th October 1987
This crash was the most memorable of the later part of the 20th century until being surpassed in the in the 21st century by the 911 crash on 2001, the sub-prime fuelled crash of 2008 and the flash crash of 2010.
Markets dropped around 22% in a single day. The crash was mainly blamed on electronic trading computers and the down movements were reinforced by more selling.
Interestingly here Ronald Reagan was asked for advice on what will happen! In times of crisis it is very sad to see how the little people run to the "big people" for help.
After this crash the rules were changed that short selling cannot be done unless doing into it into an up tick.
Circuit breakers were also added to cease trading on large declines.
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those with sufficient risk capital should consider trading. Past
performance is not necessarily indicative of future results.
Futures, Forex and Stock trading contain substantial risk and are not for every investor.
An investor could potentially lose all or more of the initial investment.
Risk capital is money that can be lost without jeopardizing ones financial security or lifestyle.
Only risk capital should be used for trading
Only those with sufficient risk capital should consider trading.
Past performance is not necessarily indicative of future results.
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One thing that we can learn from history is that crashes in the stock market are always going to be a sceptre of doom waiting to attack. The trend would seem to indicate that the speed of the crashes is becoming faster each time it happens.
Each crash we experience has a slightly different reason and a different feel and leaves a different imprint on our memory of those who observe it
The underlying mood on human emotions is however is always a constant. Fear is a always a stronger emotion that greed. Fear makes human act in ways the are often automatic and do not have conscious thoughts preceding the act of selling.
Here is a collection of high profile market crashes with some brief commentary.
Video on the Flash crash of May 17th 2010.
After several years of digging and research the sheer number of orders and trades done almost at light speed has still not been deciphered.
The conditions leading up to this event were a steady grind up of prices for an extended period of time...
Often in these high volatility events the markets exhibit a beautiful ebb and flow with incredible intra-day trends. Offering the trader with a sharp mind a chance to make a years profit in a single day.
Such markets are a dream for trend following systems that operate on a day trading basis because humans are operating on fear and greed only and most algorithmic systems get switched off.
The creation of the Black Scholes option formula, and how it lead to the trillion dollar bet which went wrong.
One thing that has always been clear to me is that academics do not make good traders.
Here we can see why.
Basis of historic volatility values, they assumed the following incorrect conclusions.
1. Markets will always move in gentle steps with good liquidity at each step.
2. Volatility has a pre-defined limit and will return to a mean value whenever this limit is reached.
3. Russia would pay its bills....
Result = catastrophic failure: See more below.