In today’s Money Morning…just ask George Soros…reality has teeth…being slightly ahead of everyone else could shift your returns from good to great…and more…
It’s easy to adopt a set-and-forget approach to your investing. And this can certainly give you quite decent returns over the long run.
Ray Dalio — the founder of Bridgewater Associates — advocates for an all-weather portfolio with the aim of achieving steady returns in all market conditions.
There’s nothing wrong with this approach. It’ll suit some investors perfectly.
However, there’s lots of opportunity in catching the big market moves as they unfold. I know you have likely already heard countless reasons why you can’t time the market.
There’s a secret to catching these moves, though, and it’s actually pretty simple. I want to talk a bit about it today. You see, even catching part of a big shift can be huge for your returns.
I want to share this secret with you for you to ponder over the end of year break.
But first, we need to talk about why we should even try to catch these moves.
Let’s start with a story you might not have heard…
Just ask George Soros
Ryan mentioned George Soros yesterday as ‘the man who famously broke the Bank of England’.
I thought I’d expand on the story a little bit today. It’s a great story, and it fits well with what I want to talk about today.
In the early ‘90s, Britain participated in the European Exchange Rate Mechanism (ERM). This was a system to keep member currencies within tight exchange rate ranges. It was preparation for the euro — a single currency which is now used across much of Europe.
The thing with this system is that it had very stringent requirements on member countries. The British pound was facing high inflation pressures. The UK was in recession, and interest rates were too high for such a weak economy.
However, lowering interest rates would mean downward pressure on the currency. This would push it below the lower level of the ERM agreement, which was already dangerously close.
The Bank of England (BOE) tried to maintain the exchange rate by buying their own pounds.
George Soros, among other savvy investors, saw how unsustainable this was. He made a huge bet that the pound would fall. Other traders and investment banks piled into the trade.
This put so much pressure on the pound that the BOE raised interest rates by 5% in one day and continued buying their own currency.
The end result was that the pound was pushed out of the acceptable bounds of the ERM, and Britain was pushed out of the agreement. The pound fell hard. This day is referred to now as ‘Black Wednesday’.
George Soros famously pocketed over a billion US dollars for his conviction. The UK spent over 27 billion pounds.
He fought the Bank of England and he won.
That’s the thing about reality…
How to Limit Your Risks While Trading Volatile Stocks. Learn more.
Reality has teeth
Reality is real.
Reality has teeth.
We can deceive ourselves all we like, just like the BOE in the above example.
Sooner or later, reality will strike.
Right now, it seems to me like we’re in a similar situation with how the US Federal Reserve is dealing with inflation. They’re trying to pretend that inflation hasn’t gotten away from them.
I think they’re wrong.
Inflation and how central banks react to it is looking like a major theme for 2022. There are many different ways this situation could play out.
The important thing, firstly, is to see the situation for what it is and to start preparing for it.
This brings me to what I see as the key to catching these big market shifts.
It’s scenario planning.
You see, early in my trading career, my mentor gave me daily exercises to prepare for the day. One of these tasks was to map out 3–4 potential scenarios for the session.
So not having a pre-set idea about what is about to happen, more being open to what could happen. Of course, you have your own idea about which scenario is most likely. You can give your scenarios probability weightings or rank them in order of how likely they are.
But having the scenarios in mind before the session means you can plan for them. You can use this idea of scenario planning for a whole year, or to map out an event or theme.
It’s easy to look back in hindsight and say all you needed to do in 2021 was buy equities. But there were plenty thinking it would be a down year.
So create some scenarios for your own portfolio. What are your key support and resistance levels? Which markets are you watching for leads? What tells you that a scenario is playing out?
Which investments will prosper if inflation really does take off? How will central banks respond? I already talked last week about how I think the Fed will respond in the next downturn. This is just one possibility.
Scenario planning is an invaluable skill, and one I urge you to begin practising.
In the above story, Soros didn’t just enter a random trade to short the pound. He looked at what was happening, and he thought long and hard about how it could all play out.
He found one scenario that was highly likely, and he found a way to make the most out of it. As that scenario was confirmed, he took the required actions to see it through to his maximum benefit.
We can never know for sure what is just around the corner. But we can have several scenarios planned out, so that we know how to react as they unfold. Being slightly ahead of everyone else could shift your returns from good to great.
Until next week,
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Izaac Ronay,
Editor, Money Morning
PS: Izaac is also the co-editor of Exponential Stock Investor, a stock tipping newsletter that hunts for promising small-cap stocks. For information on how to subscribe and see what Izaac’s telling subscribers right now, please click here.
