'Greatest Trade': How You Can Make $20 Billion

Discussion in 'Wall St. News' started by Optionpro007, Nov 15, 2009.

  1. 'Greatest Trade': How You Can Make $20 Billion


    Even as the financial system collapsed last year, and millions of investors lost billions of dollars, one unlikely investor was racking up historic profits: John Paulson, a hedge-fund manager in New York.

    His firm made $20 billion between 2007 and early 2009 by betting against the housing market and big financial companies. Mr. Paulson's personal cut would amount to nearly $4 billion, or more than $10 million a day. That was more than the 2007 earnings of J.K. Rowling, Oprah Winfrey and Tiger Woods combined.

    Adapted from "The Greatest Trade Ever: The Behind-the-Scenes Story of How John Paulson Defied Wall Street and Made Financial History," by Gregory Zuckerman. Broadway Books. Copyright © 2009 by Gregory Zuckerman.

    How did he do it? Believing that a housing-market collapse was coming, Mr. Paulson spent over $1 billion in 2006 to buy insurance on what he then saw as risky mortgage investments. When the housing market cracked and the mortgages tumbled, the value of Mr. Paulson's insurance soared. One of his funds rose more than 500% that year. Then in 2008, he shorted financial shares, or wagered that they would fall in price, profiting again when these companies collapsed.

    And are there any investing skills that average investors can learn from his success? Yes. There are no guarantees, of course, but the success of Mr. Paulson and a few other underdog investors lends encouragement to individuals trying to compete with Wall Street's pros.

    Here are eight investing lessons of Mr. Paulson's $20 billion gamble, the greatest trade in financial history:
    1 Don't Rely on the Experts

    Many investors lost big in 2007 and 2008 as housing crumbled and the stock market tumbled. But no one lost more than commercial and investment banks caught with toxic mortgage-related securities. These bankers were the very same ones who created these investments, and Wall Street's top analysts had vouched for their safety, even as Mr. Paulson and others bet against the investments.

    Lesson: When Wall Street is wheeling out its latest can't-miss product, be skeptical.
    2 Bubble Trouble

    Some academics argue that financial markets have become more efficient. But a rash of financial bubbles in recent years -- including housing, energy, technology and Asian currencies -- suggests that markets are becoming harder to navigate, and are more prone to overshooting. Today, investors of all sizes read the same articles, watch the same business-television programs and chase the same hot tips. They invariably head for the exits at the same time.

    Lesson: Have an exit strategy -- and cash to cushion any tumble.
    3 Focus on Debt Markets

    Most investors track the ups and downs of the stock market but have only a vague sense of moves in debt markets. That's a mistake. Early signs of trouble were seen in sophisticated markets that don't get much limelight, like the subprime-mortgage bond market. These problems eventually felled the housing and stock markets, and the overall economy, a set of falling dominos that Mr. Paulson and his team correctly anticipated.

    Lesson: Debt markets can do a better job predicting problems than stock markets.
    4 Master New Investments

    Mr. Paulson scored huge profits by buying credit-default swaps, a derivative investment that serves as insurance on debt. When risky mortgage bonds tumbled in value, Mr. Paulson's insurance soared. But many experts were flummoxed by CDS contracts or shied away from educating themselves about these relatively new investments.

    Mr. Paulson and his team had no experience with CDS contracts. But they put the time into learning about them.

    Lesson: Educate yourself about the range of exchange-traded funds being introduced, some of which can play a valuable role in a portfolio.
    5 Insurance Pays

    A number of investors worried about a bursting of the housing market, but few did much about it, even though insurance, such as CDS contracts, at the time were selling at dirt-cheap prices. Out-of-the-money put contracts -- options that pay off only if the market tumbles -- also were trading at reasonable levels. As cheap as this insurance was, many pros ignored it.

    Lesson: Don't underestimate the value of a safety net, such as put options.
    6 Experience Counts

    Some of the biggest winners in the meltdown were middle-aged investors dismissed by some as past their prime. But they had experienced past market downturns, while some of the bankers and analysts caught flat-footed knew only good times.

    Lesson: A historical perspective can be a valuable tool.
    7 Don't Fall in Love

    With an Investment

    In early 2009, Mr. Paulson became more bullish about the banks and financial companies that he had wagered against in 2008, after determining that these companies had improved their balance sheets. The moves resulted in profits this year.

    Lesson: Even the greatest trade doesn't last forever.
    8 Luck Helps

    In early 2006, Mr. Paulson determined that housing was in trouble and set out to profit from the impending fall. But some housing experts already had determined that real estate was overpriced; others had wagered against housing but could no longer stomach their losses. Just months after Mr. Paulson placed his historic trade, U.S. housing prices began to fall.

    Lesson: Don't risk too much in any one trade, even one that seems like a sure thing.

    Write to Gregory Zuckerman at gregory.zuckerman@wsj.com


  2. Don't let this article fool you.

    I bet against the housing market for 4 years prior to it's actual collapse and when it FINALLY did I just made a small profit after all the small losses I had before that.

    My advise is to wait till AFTER an event takes place then try and catch some of the move.

    Timing the market like that is extremely difficult and should be left to those with deep pockets and friends in the know.
  3. Thanks for the link.

    Paulson is deep into gold as well since spring and has already made hundreds of millions in a stock like Anglogold alone.

    Let's see if it continues and he becomes the biggest of them all.
  4. Unless you are 1000% percent sure the tide is turning, I agree, wait for momentum on big changes, sometimes it's better to lose out on some of the early big gains, rather than take and drag out actual losses.

    Most of us here don't have the rolodex that a Soros or Buffett has, our information is usually stale and secondhand.
  5. I don't see anything in this article about computer programming skills, backtests, and sitting at a screen watching moving averages on a chart. There is something to be learned in this article.
  6. Humpy


    Anyone know what this financial guru is betting on at present ? Besides gold which may have run out of steam a bit

    Hasn't got a brother called Hank has he ?
  7. I have absolutely no clue.
    #10     Nov 15, 2009