Much like everyone else, Wall Street experiences the same basic emotions that all (or most) of us feel when news of an impending disaster (real or fearmongering) strikes.
Because there are real life human beings pushing the mouse buttons that execute the buy or sell orders during every minute of every trading day.
Try as they might, people falsely believe that Wall Street is some sort of cold calculating machine devoid of human emotions. When in fact, it’s just a collection of similarly minded people making real life decisions whether they should go long or sell everything at the drop of a hat.
Which means for all the delusions of grandeur that modern technology allows us, we’re still held captive to our own basic fears regardless of whether they are real, self induced, or an emotional contagion.
Unfortunately, a few Wall Street traders know this and will use it to their advantage.
A fear trade is really quite simple. The basic purpose is to make money from someone else’s fear (often a very large group) that some type of future event will negatively impact some aspect of their daily lives.
The basic examples of fear trades are the “flight to safety” trades, such as:
The fear trade is not just one sided transaction. It can actually involve buying, selling, or even shorting individual stocks, ETFs, derivatives and even basic commodities.
However, the one underlying characteristic of the fear trade is this: everyone will eventually want a piece of the (trading) action because fear, as well as greed, is continually pushing the market to buy or sell more of the stock as it gains momentum. This “mad” rush to buy can create such a psychological shift in the investment community that it can artificially create an investment bubble (e.g. gold bubble).
What makes the fear trade so interesting — and financially relevant for anyone who owns stocks — is that this response can be tracked by the sudden, often violent, move in an individual stock. Occasionally, it can even take place in a stock market index like the Dow Jones Industrial Average as we witnessed during the extreme volatility of intraday trading swings of 1000 points or more during the 2008 crash.
Occasionally, the fear trades can be so violent that moves will result in a stock’s value being cut in half in less than a few minutes or a stock that can double overnight.
My vote for the best fear trade of 2009 (thus far) is the swine flu trade.
What better than the fear of a global flu pandemic to scare the pants off the general population and get mainstream media mobilized for their nonstop fearmongering.
Traders took the news, and boy did they run with it!
Case in point, Novavax (Nasdaq: NVAX). A small biotech firm that produces flu vaccines.
As the details of swine flu story began disseminating slowly throughout the market on Friday morning (April 24,2009), you can see the stock slowly creeping up throughout the day. As the news hit mainstream media and polluted a substantial percentage of my incoming tweets (OK I fired off a few sarcastic tweets as well), this small flu vaccine manufacturer nearly reached $4 by early Monday morning.
That’s a 350% change in price overnight. Not suprisingly, Novavax began to sell off throughout the week as traders continued to take their profits.
Remember, this is a stock that traded below $1 and peaked near the $4 mark in two trading days. So we’re talking massive trading action and a few small fortunes were made from this one simple fear trade.
Such trading is considering extremely risky and unless you’ve got a sudden urge to lose half your money or you are a professional trader, messing around with such stocks during a news event like this should be avoided at all costs. However, if you are lucky enough to own a stock like Novavax and it suddenly spikes higher on news like this, it’s probably in your best interests to sell half of your shares to cash in on the short term volatility.
Disclaimer: I hold no stake in NVAX nor did I trade the stock during this time period. I use this chart as an example only.