How many people saw the financial crisis coming and profited from it?

2007 Christmas party at a dear Friend’s apartment in Azabu, Tokyo. He was the head of MacQuarie securities in Tokyo. Champagne was flowing and i was passably drunk. There was a bunch of Lehman, Morgan Stanley, Citi and other dudes, all smart articulate people.

They were talking about the current uncertainty saying it was an opportunity to buy on dips. I rolled in saying this would be the first time sh!t was about to flow uphill. All those delinquent loans would not end well. The two things that people buy on credit are homes and cars. If home loans turn delinquent, then the rest would follow, contagion. I happened to be tracking Japanese car manufacturers US car sales and watched them plummeting. They laughed at me and concluded that i was a drunken lunatic. Point taken…

1 year down the road, December 2008 same party, half the people. The Lehman dudes were gone or at Nomura. One of the guys ran up to me. I was about to duck and hit the floor as if chased by the police: “no

-“No i don’t do drugs anymore, no i did not do your wife, no i didn’t steal anything, you got the wrong guy” routine. He shook my hand and said:

-“You are the only one who saw it coming and had the courage to speak up. Whatever You say i do. What should i do now?”

-“Really?”, i said. “I don’t remember. I might have been seriously drunk”

-“You were a little more than tipsy, but you were funny and more importantly you were right”, he said

I had correctly predicted the crash, and was too drunk to even remember it. Sounds about right:

-“Hmm, Plausible”, i answered. “Alright, so buy when monetary authorities roll out the big guns”,  i said.

-“OK, but Buy what then?”

-“Come on, do i really look like i know? Seriously? Monetary authorities are panicking. They are about to roll out the mother of all monetary bazookas. So, it does not matter what you buy, everything will rally”

-“Yeah, right. You are drunk again” and he walked away

He did not buy and I should have followed my own advice. I gave back a lot of performance in the 2009 rally. I insisted on shorting cyclical stuff when i should have shorted defensives. I was stubborn. I stopped trying to make predictions shortly thereafter.

Now, the implicit question is probably: are we in the same situation now? I don’t know and frankly, it really does not matter. I looked at my forecasting accuracy stats and concluded i should not be in the forecasting business anymore. Not encouraging for the rest of the industry considering i foresaw the crash and the ensuing recovery.

These are the main lessons:


  1. predict the next crash: you will sell too early. It is as useful as forecasting when you are going to get sick. Only hypochondriacs check themselves in hospitals before they get sick. Don’t listen to those market hypochondriacs telling you the mother of all bear markets is around the corner.
  2. Focus on why: what matters more? Why you got cancer or how to cure it?
  3. Duration and depth: when it happened, sell-side “quants” rolled out average duration tables. On average bear markets last for xx months. If You are sick, what would you think of a doctor who would say You will have 39,8 C fever and you will heal in 3 weeks 2 days, 17 hours?


  1. Recognise when it is there: build a system that tells you now it is time to sell and go short. To identify the top, use my floor ceiling method. It works objectively after the fact. Laurent Bernut’s answer to What is the most precise way to draw support and resistance lines for forex trading?
  2. Recognise when it is gone: Everyone got terminally beared up at the end of the bear market. They all, me included, missed the rally. Those who said they bought in March 2009 are like descendants of the Mayflower: deluded liars. To identify the bottom, use my floor ceiling method. It works objectively after the fact
  3. Have a bear market plan: bear markets are notoriously stressful. Not the brightest idea to devise an emergency exit plan when the building is on fire

What are some of the best techniques for selecting stocks to short?

What are some of the best techniques for selecting stocks to short? by Laurent Bernut

Answer by Laurent Bernut:

Two parts: let’s start with stuff that does not work and end with stuff that works.

Part 1: stuff that does not work

High short interest:

Short interest and/or borrow utilisation is a function of supply and demand. Supply of stock available for borrow and demand from short sellers. So, when short interest rises, it means two things:

  1. Supply is drying up: institutional long holders liquidate their positions. Remember that whatever information that has led You to conclude something is a short is also available to long holders, who probably conclude it is not worth holding anymore
  2. Demand from short sellers is increasing: unlike going Long, going short is a finite universe. There is a limit to the amount of shares available for borrow. So, You will end up competing with short sellers and stable shareholders, those who never sell

Analysts downgrades:

Analysts are chronically late to the party. It is difficult for them to downgrade their ratings, especially when the whole investment banking food-chain depends on them rating stocks as Buy. Example: Enron was rated Buy days before its collapse.

Bottom line, You don’t need analysts in Bull markets and You don’t want them in bear markets

Fundamental newsflow deterioration:

Many market participants wait for deterioration of fundamentals before putting on a short. Well, if You believe that markets are discounting mechanisms of future events, waiting for the confirmation of those events is by definition late. This is called confirmation bias.

On the short side, it often comes from painful experiences. Market participants often start with anticipation shorts: unsustainable valuations, momentum etc. They get carried out a few times. So, their next move is confirmation short: wait for fundamentals to really suck before putting on a trade. They then compete with other fundamental short sellers.

Vigilante short selling

Tourists short sellers often short stuff that does not make sense anymore. They go after crazy valuation, parabolic momentum etc. They may be right in theory, but they are invariably wrong in practice. One sane person versus an irrational mob is still an unfair fight.

Personally, i have no sympathy for those market participants. They put other people’s money in harm’s way. Their egos breach their fiduciary duty to their clients. Luckily, they don’t hang around for too long

Part II: stuff that works


Between the time a stock should go down because valuations & momentum are unsustainable and the time when a stock should go down because fundamentals are horrible, there is a long period of time when price actually DOES go down. Reality is the time between the “should”

Look for downward relative momentum first, then weave whatever rationale You want.

“Buy” for the long term investor

My favorite of all times is a blind spot of analysts. Within their coverage, there is always a buy rated stock that performs poorly. They call it “Buy for the long-term investor”, meaning short term it will go down and You have to be patient.

So, as a good acid test, thank the analysts for the info and ask them if they would like to be paid long-term commissions for those long-term ideas. If they grimace, then Short

Relative Shorts

Before Valeant (VRX), Wells Fargo, Deutsche Bank, Lehman Brothers, Enron drilled a hole in the earth’s crust in absolute, they underperformed their benchmark for some time.

Relative momentum (Absolute Price / Benchmark price) is by far the surest way to find good shorts. a good Long/Short portfolio is composed of Long book of outperformers and a Short book of underperformers.

Putting everything in relative terms will immediately increase the number of short ideas.

What are some of the best techniques for selecting stocks to short?

How do I get better at trading?

How do I get better at trading? by Laurent Bernut

Answer by Laurent Bernut:

Hope is a mistake”, Mad Max, post apocalyptic road poet.

3 declinations of the same principles: process

A. Trading edge is not a pretty story , trading edge is a number

Every strategy ever traded boils down to this formula:

Gain expectancy = Win% *AvgWin% – Loss%*AvgLoss%

Your survival only depends on how You can tilt the distribution. Regardless of the asset class, there are only two styles: mean reversion and trend following.

  • Open mindset: there is a nugget in everyone’s story
  1. Read the classics: Lefevre, Schwager, Covel, Van Tharp, Loeb
  2. Podcasts: Michael Covel, Andrew Swanscott, Barry Ritholtz
  3. Investment newsletters are to investment what mangas are to literature, Unsubscribe, no exception
  • Stock picking is vastly overrated
  1. Plain vanilla fundamentals is not enough: 3/4 of professional managers underperform; over 3/4 of them claim to be fundamental stock pickers
  2. 90% of market participants focus on stock picking and entry. 90% of market participants fail. Causality and correlation: unsubscribe from all newsletters
  3. never enter w/o an exit policy: Once in a position, there is 100% chance You will exit. W/o exit plan, 90% chance the market has sth nasty in store for You
  4. Money is made in the money management module. The single largest performance discriminant is bet size: process and math

B. Portfolio management process

  • Risk is not a story in China, Risk is a number

Risk is not a story. Risk is not a high Sharpe ratio or low VAR. Risk is how much You can afford to lose per trade and cumulatively. Whatever You think your risk budget is, divide it by two. By the time You have lost half your budget, You will be a different person, gripped in cortisol and CRH, paralysed by fear.

  • Write strict investment guidelines: risk, exposures, objectives

“People live up to what they write down”, Robert Cialdini. Formalise your process in writing. Execute. Simplify. Running a portfolio w/o strict guidelines is like building a house w/o a plan

C. 90% of trading is mental, the other half is solid math

Above all else, any trading system is worthless w/o the right mindset: process over outcome

Examples of outcome vs process:

  1. Stop loss override: ego over process
  2. Close a position too early clear trading plan: outcome vs process mindset
  3. Too big/small bets: euphoria/depression over process
  4. Focus on performance instead of plan execution: outcome over process
  5. Mood swings depending on performance: outcome vs process

Being right is not being profitable (outcome). Being right is following the plan (process)


This is an “avant-gout” of the book to come. On the short side, the market does not cooperate. Open and process mindsets are the two keys to survival

How do I get better at trading?

Should naked short selling be illegal?

Should naked short selling be illegal? by Laurent Bernut

Answer by Laurent Bernut:

Let’s leave the adorable legal answers from “investors” aside for one minute and let’s think about what would happen if naked short selling was legal

A. Price discovery and price equilibrium

Many issues are un-shortable because there is no borrow available. It is a bit like artic ice. They slowly melt away until they liquify real precipitously.

The ability to short w/o having to source borrow first, would hasten price discovery. At some point, buyers would meet sellers, and there would be price equilibrium.

Short sellers facilitate price discovery

B. Transaction cost, volatility and market impact

In 2012, There was a landmark study on the impact of short selling done by the New York Fed. Long Buyers could only buy from a Long sellers. Bid/ask spread widened. The ban on short selling financial services materially increased transaction cost, volatility and reduced liquidity. Short selling has a net positive impact on transaction cost

Short sellers provide liquidity

C. Hedging

Not all short sellers want the underlying companies to bite the dust. In fact, only the emotional short sellers with a distorted sense of fairness do.

People sell short for all kinds of reasons. If You cannot sell short, you cannot hedge, Therefore, you cannot underwrite products such as options, futures, CBs. Now, there is a natural limitation coming from the borrow available. Put/cll parity goes out of whack for hard to borrow issues

Short selling provides better pricing on derivatives

D. What would happen if You sell sth You do not own?

Regardless of whether You sold naked or covered, you are still liable for the difference between the selling and the buying price. There is no way your broker will forgive your losses. So, what’s the problem here? the ability to drive prices into the ground, fairness, moral high ground,

In theory, if You do not need to own a stock, then You could short ad infinitum and potentially drive prices into the ground. Reality check: this happens … on the Long side. People do buy something they do not own yet. Does it drive prices to the moon? No, there is equilibrium between buyers and sellers

Now, naked short selling for the purpose of hedging other instruments such as derivatives is a different issue. Put underwriters delta hedge

As for fairness, put yourself in the shoes of a short seller for one second. More often than not, You are denied the ability to short an issue simply because there is no borrow. Borrow comes from LT large shareholders and institutions lending their shares. So, you are at the mercy of people who may decide not to lend or even recall their stock at anytime. Meanwhile, buyers are not at the mercy of anyone if they want to buy a stock. So, who is treated unfairly now?

The only two ways to live your life: Hero or victim

People who complain about short sellers are usually disgruntled righteous “stock pickers”. They get into some stock, which immediately proceeds to go Valeant on them. Then, they blame short sellers from driving prices down. One thing they need to know, borrow available is less than 10% of daily volume on average. So, yes someone is selling big time, but not the short sellers. Think about this next time You see a stock tanking: for every smart investor who has bought the stock, there is a smarter investor liquidating now. Just ask yourself Why

More importantly, there are two ways to live your life. Either You are the hero and triumph over adversity. Either You are the victim of circumstances, evil speculators, the system, the government. when people blame short sellers, they obviously take the role of the victim.

Now, if You were a pension asset allocator with money to deploy, who would You trust?

  1. someone who acts as a heroin and assumes responsibility for her mistakes or,
  2. someone who plays victim and blame everyone else for his lousy stock performance

Think about it next time You blame short sellers. Unlike underperforming “investors”, Short sellers do provide vallue

Should naked short selling be illegal?

Do you have any advice, analogies, or even abuse that you can give me so that I dont exit my winning positions too early?

Do you have any advice, analogies, or even abuse that you can give me so that I dont exit my winn… by Laurent Bernut

Answer by Laurent Bernut:

Now, that is an excellent question. You have the right approach to solve it. Change your beliefs and your reality changes. The reason you cut your profits is because you have been burnt with losses and wan to protect some profit. The reason you procrastinate on stop losses is your ego taking over. Awesome question, let’s have fun

Tiger Moms math aptitude

Among the numerous studies on the “Tiger Mom” effect, one of the funniest and most interesting ones happened when they decided to test the mothers’ math aptitude. One university assembled a team of Asian mothers. They gave them a mathematical test. They were primed with dis-empowering stereotypes on females, mothers: “ladies, You may not like math. You probably don’t do a lot of calculus, algebra and trigonometry these days. Sorry about this…”. One month later, they gathered the same moms, administered the same level of test. This time, they primed them with empowering Asian stereotypes, emphasis on education“You are Asians, right? Asians are supposed to be good at math”. Voila, with simple priming, average score jumped 20%. Congratulations, Way to go Ladies!!!

Morales of the story:

  1. if You want to solve the Fermat theorem, something that has eluded mathematicians for centuries, round up a bunch of Tiger Moms. Remind them that if wasn’t for them balancing the family budget, looking after the education of kids, making sure future generations will be financially well off, they would all live under bridges and tunnels, courtesy of their drinking, gambling husbands. In addition, tell them that solving that simple problem will guaranty entrance to top schools for their children. Leave a stack of application forms to Harvard for inspiration and motivation. Come back before it is time to pick up the kids for their piano, math, and karate/ballet lessons. Problem solved. Anything else?
  2. Change your beliefs, they will change your reality. Impact goes as far as muscular mass and oxygen retention in muscles

You are facing a common problem: Cut your winners, ride your losers. (BTW, have You considered a position in the mutual fund industry? Popular skill set You have here)

How to reverse it? Re-parent the orphan

First, You need to know that abuse will not work. Part of your problem is ego fighting back. Ego, in the Jungian archetypes, is the orphan. In your brain, this is the amygdala, one of the most primitive defense mechanisms. Any attack will push the orphan deeper. Not a good idea. Forgive yourself for your mistakes. This will soothe the amygdala

Metaphors work

Have You ever wondered why we memorize stories instead of abstract concepts? So, using metaphors will definitely help You.

Time asymmetry

In a world where You want to ride your winners and cut your losers, the latter will come quicker than the former. That means your account will drop before it rises. This time difference is a feature You must accept. That is part of the game. It takes time for good trades to mature.

Exit plan and the geography of divorce

Exit is like divorce. No-one wants to but roughly half of the population divorces anyways. So, if You don’t think about it before getting married, it may get a lot more expensive than You think. There is a reason “divorced Barbie” is so much more expensive than all the other Barbie dolls out there. She comes with Ken’s house, cars, boats.

The point is You need to have a clear uniform exit plan. There is no such thing as customised exit plan for that particular stock or that particular case. This nonsense will confuse your inner idiot. Complexity is a form of laziness.

Switch from outcome to process orientation

May i suggest You read this piece on the psychology of stop loss. The psychology of stop loss: how You can be 100% right despite 60% failed trades by Laurent Bernut on Alpha Secure. Look at Bill Ackman and Valeant for a great counter-example. Ego took over and clouded his judgement. No-one is immune.

Your new metaphors must emphasize process over outcome

The way i did it: trap price in a box

I remember the day when i moved from semi-discretionary to 100% systematic. I remember it because the next day i was not stressing about all open positions.

That day, i made a commitment that until stop loss, partial exit, time exit were triggered i had nothing to do. After entry, there are only 3 ways stock can go: up, down or nowhere (x-axis: time). Price is boxed.

Of course, things did not always look good. But i thought of those exits as booby traps. until one of them gets tripped, no need for premature action.

I remember that day, because in the afternoon i started watching Shaolin flicks on Youtube to cut the boredom. While my colleagues waiting for announcement, my computer made some awesome Bruce Lee sounds. I was at peace following the exit plan.

Peaceful exit

Once you decide on an exit plan, commit to doing nothing until one of those booby traps gets triggered. It will bring immense peace.

Stock market is a highly competitive sport. Every hundredth of percentage point counts. If you put every single position in a their individual exit box, they will be no need to stress over them. The right exit will show up. This will save terabytes of mental bandwidth

Do you have any advice, analogies, or even abuse that you can give me so that I dont exit my winning positions too early?