Steadfast FinancesWhat is the Fear Trade? - Steadfast Finances

What is the Fear Trade?

Filed in Investing 101 , Investor Psychology 11 comments

the fear trade (fear of swine flu, H1N1 flu virus) is way overdone.

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.

What is the “Fear Trade”?

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:

  1. Gold.  Anyone who is concerned about inflation or their national currency losing value will often flock to the world’s best reserve currency.  Most retail investors participate by buying gold bullion or gold coins, but can also buy the Gold ETF (NYSE: GLD).
  2. Oil.  Since the entire world is virtually held as a hostage to the price of black gold, anyone who holds, or owns a stake in, this critical commodity is in a position of powerful influence during times of global crisis.
  3. U.S. Treasury Bonds.  When in doubt, go to the world’s largest superpower and hope you can (at minimum) make a zero return on your money.  Typical yields for U.S. Treasuries are low single digits, but during the stock market crash of 2008, demand was so high that yields were actually slightly negative.

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.

Best Example of the Fear Trade in 2009?  Swine Flu!

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.

Attribution-ShareAlike Licensephoto by ZYG_ZAG

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Posted by CJ   @   30 April 2009 11 comments
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Apr 30, 2009
11:02 pm
#1 SJ :

If we buy into the efficient market theory, then it would fall into the ants/hive mind ideas.

A bunch of simple minded fools creating a semi efficient market =) Any views on that?

May 1, 2009
9:47 am
#2 Matt :

Well it’s really the smart ones that get in early and sell at the top while everyone else piles in hoping to make a buck on the momentum. Of course, getting in early is a very difficult thing to do since no one knows the future.

If I had to relate it any event in the real world or nature, I’d say it resembles a shark feeding frenzy. They all know it’s a cheap way to grab a free meal (money in this case).

Your opinion on efficient markets really depends on if you lost or made money on your trades. Funny how making money works that way. haha

Apr 24, 2013
7:22 pm
#3 Taren :

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