A month before the fed raised the rates, a Bloomberg article stated that if the If
Stocks Don't Fall, the Fed Needs to Force Them. That was a red line that
immature investors should have taken seriously, but people made so much money with meme stocks
that it seemed like they would never fall. When everything is rising, making money is easy!
Whatever you buy is going to be the right bet. You will make money no matter what stock you buy.
Of course, it’s great, but it's very dangerous
in the long run. You will start thinking that reading financial statements and
analyzing their long strategy isn't important when deciding which stock to buy.
Here you go! You made money without even having a clue on how to analyze financial statements!
Your confidence wouldn’t be based on solid grounds but is going to be flawed.
That’s why most meme stock investors lost fortunes when everything crashed
the moment the fed raised rates by half a percentage point on the 4th of May.
Once these meme traders see their portfolios down by over 50 percent, they will most likely
move to something else and stop trading or investing until the next boom. The only
problem is that the next boom doesn’t seem to be around the corner.
Inflation has gone out of control to the extent that it's now the fed's top priority.
Experts at The Economist Intelligence Unit expect the Fed to raise rates
seven times in 2022, reaching 2.9% in early 2023.
On top of that, the fed plans to dramatically shrink its 9 trillion dollar asset portfolio
that it acquired during the pandemic. Beginning of June, the fed intends to shrink the balance
sheet at a maximum monthly pace of $60 billion in Treasuries and $35 billion
in mortgage-backed securities after an initial few months at a slower pace.
This might not sound like a big deal,
but it was one of the main reasons why the market reacted so harshly.
One of the primary ways the fed injects money into the economy is by buying bonds.
When bonds mature, the fed often replaces them or uses the interest from these bonds
to purchase more bonds. But now it's just not going to renew them,
which means no more cheap money in the economy. Of course, it ain’t going to happen overnight but
gradually in order not to cause any immediate economic crashes, but it already did since
that sent a clear message to investors that the age of cheap money has ended.
That’s why stocks and crypto crashed to rock bottom, but that raises the question:
how to profit from a crash? Is there a way to earn money when the market is crashing?
We will answer all of these questions and many more but before we do that,
give this video a thumbs up, and here is a little disclaimer: this is not financial
advice and everything thats said in this video is for educational and entertainment purposes.
When we talk about a crash, it’s usually a negative thing. Emotions get in the way,
and you start selling your positions that are falling faster than a crashing plane. It gets
even worse when these investments represent your entire savings.
Just go back to the case of GameStop when people got ever excited and threw
everything they had into that opportunity. Unfortunately, things went south. People
panicked and sold their stocks at negative 80 percent after the hedge fund’s manipulation.
If they had been a little more patient, they wouldn't have lost as much as they did. Of course,
it's easy to say how things should have been after everything has already happened. But the reality
is that that's the nature of the market. We can go back and say the exact
same thing about the 2020 crash. The moral of the story, not letting emotions
get in the way of your investing decisions is the best thing you can do to your investments.
Each time the market overreacted and fell dramatically, it recovered
shortly afterward. Those investors who panicked and sold out found themselves
regretting their decision, while patient investors were rewarded.
After the Japanese attack on Pearl Harbor, the S&P 500 index fell more than 4%
and continued to drop another 14% over the next few months. However, After that, and through
the end of the war in 1945, the stock market returned more than 25% per year on average.
The moral of the story is - when everyone is panicking and selling, that's the time to buy.
Once everyone calms down and realizes that life goes on, no matter what happens,
people will start investing again, which will bring back the market to its pre-crash level.
Another way investors or traders, to be more accurate, monetize a crash
is through put or call options.
Let’s go back to April 2022. The markets were doing not bad. The only problem was that
most people were unsure if the fed would raise rates in May
and, most importantly, how the market would react.
If you were a hundred percent confident, you could have shorted the market, but if you are not, you
have an option. A put option. An option to sell the stock at a specific price for a small fee.
Let’s say stock A cost $100, and you think that if the fed raises rates, it could fall by over %50.
You buy a put option that costs 5 dollars to sell stock A for 100 dollars that expire in a month.
You have 30 days to exercise the option. If the stock doesn't crash,
maximum that you can lose is the 5 dollars you put up.
However, if the market crashes after the fed raises rates and stock A drops by 50 percent as
you predicted to 50 dollars. You can buy the stock for 50 dollars and sell it for
100 dollars since you have purchased the right to do so. And boom, you just earned 50 dollars.
After deducting the cost of your put options which was 5 dollars, you are left with a profit of $45.
That’s one of the main ways how traders earn fortunes during crashes and minimize their risk.
But let’s say the market has crashed, and you don’t know whether it will recover or not, so
you don’t want to risk your money buying stocks. Is there a way to still profit out of this crash?
Of course.
That’s why we have call options. A call option works exactly like a put option,
but in this case, you have the right to buy the stock at a specific price.
Let’s say company B has crashed from 80 dollars to 50 dollars, but you think that it’s a temporary
crash and the company has all the basis to return back to 80 dollars, but you are not sure!
We might face a recession, and the stock might keep declining. So instead,
you buy a call option, a right to buy the stock at 50 dollars for, let's say, 5 dollars.
2 weeks later, the stock bounces back to 80 dollars. You exercise your right to buy
the stock at 50 dollars and then sell it in an open market for 80 dollars.
After deducting the cost of the call option ($5), you made 25 dollars on this deal.
So when there is a market crash, not everyone suffers. Some people thrive during crashes.
And some people are even willing to take an infinite risk by shorting the market.
That’s why we have news such as this - Tesla short-sellers have made
$8.2 billion betting against Elon Musk's company this year as tech stocks crashed.
Instead of buying put options, you can borrow the stock from your broker and sell it in the
open market for, let's say, 1k dollars and then buy it back once the price drops to let's say,
700 dollars and return it back to your broker, pocketing the 300 dollar difference.
The only downside to this strategy is that, theoretically,
the stock price can rise infinitely, so theoretically, your losses can be infinite.
That's exactly what went wrong with hedge funds that shorted Gamestop.
Good for them that they somehow survived the catastrophe,
but it could have gotten much worse, bankrupting entire hedge funds. But as the latest news shows
that traders haven’t stopped shorting. In fact, even prominent names such as Bill Gates
are using this strategy. Gates was even lately criticized for trying to tackle climate change
but at the same time shorting Tesla, that's trying to make electric cars more affordable.