Making right investment and trading decisions is about making right predictions, this is definitely right; however, I think some people define predictions too narrowly that they only think predictions are all about pointing out the correct state that will occur in the future among all the possible states. I view such investment or trading strategy not difference from gambling, especially when making some short-term decisions. Before an event exactly takes place, there is not any certainty that it is only right to say this event has a significantly high likelihood to take place than all the other events do. I think that there are other predictions that are also important and could bring us high returns from the financial markets. I am not good at disagreeing with others and being right at the same time, so I predict the returns of each possible state and borrow concepts from hedging to build up my portfolio. I have some successful examples and some failed cases. Today I want to compare one relatively successful case with one failed case to show the strength and the weakness of this investment strategy. Some people believe learning from successful stories is more useful and some argue learning from failure is more useful; albeit my opinion is only by comparing successful stories with failed stories in the same sector is more reliable to provide reasonable answers about what determines success and failure.
The two examples are my strategy for the Brexit referendum and my strategy for the US presidential election. These two cases share one important character that they only have two states: the Brexit referendum only had “leaving the EU” and “staying in the EU”, and the US presidential election only had “Trump” and “Hillary”. In addition, both cases happened in 2016, this was also important that as they took place in the same year, many market structures and characteristics were not very different in the two cases. In both cases, I used the same strategy. Firstly, I agreed with the “common public opinions”, which were represented by polls conducted by newspaper and other “reliable sources” at the time. I thought in the Brexit referendum people would choose to stay in the EU and in the US election, I thought Americans would choose Hillary. Secondly, I put a large weight on those assets which were in favour of my predicted state that I bought a pool of US listed multinational companies’ shares before the Brexit referendum and I bought solar shares before the US presidential election that multinational companies were the large supporters of the “staying in the EU” campaign and Hillary was supporting the renewable energy sector. Thirdly, I invested some, which was lower than my estimated return from my investment in my predicted state, to counter the situation when the other state happened. The instrument I chose for hedging was options, as options could limit my losses and lower the costs, and it could have some leverage functions as well. In both cases, I chose bank put options, the reason for the Brexit referendum was simple, it was because banks dislike the idea of Brexit and they would face increasing costs when Britain leaves the EU and the free trade deal. The reason for the US presidential election was because Hillary was marked as the candidate supported by the Wall Street and Trump had some very radical comments on the Wall Street bankers which made we believe he might place aggressive regulations on banks when he became the president.
It is very obvious that my strategy for the US presidential election was a disaster but my strategy for the Brexit referendum was a huge success. I would like to discuss my success first. My returns in the Brexit referendum came from two sides. The first part is the US dollar appreciation against GBP. The majority of my portfolio is American assets. As I live in Britain and spend GBP, I use GBP as my calculate unit for my account, if I use USD as the unit, the return rate could be lower. In addition, I chose to buy American multinational companies, large portions of their assets were in USD when GBP depreciated against USD, their asset values increase in GBP value. This prevented some losses as well. The second part came from the gains from the call options I bought. Their values were tripled and even quadrupled. This successful case is built on several good predictions: my prediction about Forex change, my prediction about the changes in the market if Brexit is chosen. These predictions were not correct (I underestimated the GBP depreciation), but they were very close to the reality and helped to gain profits. In addition, my success was also based on conservative strategies that I chose American multinational companies rather than British banks, as American multinational companies would face fewer losses than British banks from Brexit (they would still benefit from the free trade deal between Britain and the rest of the EU, since they are multinational businesses). However, one of my predictions might be a weakness in my strategy. I might overestimate the returns from the state of staying in the EU, if this was the case and the state actually happened, my portfolio could face a loss. But this loss is relatively limited and small, and given there is no arbitrary opportunity in the complete market, my strategy should still be considered as a success.
The US presidential election was a different story. The losses came from the sharp drop in the solar sector and the Trumpflation since Trump was elected. The sharp drop in the solar sector matched my prediction almost perfectly; however, the gains in the banking sector were not something I expected. Of course, cutting taxes was something banks like; however, his comments on the banking sector were not very friendly and his political ideology has some paradox and may create more confusion and uncertainties in the market, this is not good for the US economy and the banking sector. Based on such belief, I predicted the banking sector would lose if Trump is elected. I think my bad prediction is because of the complexity of politics; compared with the presidential election, the economic impacts behind the Brexit referendum are more immediate, simpler and clearer.
To conclude, from the two cases, firstly we can see politics seems the determinant of whether my prediction is good or bad. Politics is extremely complicated and changes individual behaviours that there are two totally different behaviours in the market to react the Trump presidency before and after the election. Therefore, such strategy and prediction might be only good in the cases of relatively pure economic events. Secondly, the instrument chosen to hedge against the unlikely event should be options of companies which are most directed to the core of the issue, as the price changes for such companies are the most volatile and options could provide a safety net and prevented extreme losses. Other instruments that have similar characteristics could be tried. Thirdly, it is worth mentioning in either case, it is impossible to judge the accuracy of the predicted returns from the unhappened state. Therefore, such strategy does not necessarily provide arbitrary opportunities.
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