Recently I read an article about the importance of pair trading (relative value). It got me thinking whether trading the market directionally is the best way to approach trading, especially in the current volatile environment.
Here are a few snippets from the article I read on the topic which highlights the dangers of directional trading as opposed to pair trading. It was written during the Credit Suisse fiasco but remains valid for any type of volatility.
Let me tell you what risks I see and why I think trading directional is a lot harder now.
- The CS fiasco may bring down other EU banks. First one that pops into my mind is DB.
- Many argue that CS will never be left to die because it is too big to fail European bank. I absolutely agree with this argument but would like to add that before a bail out happens there can be plenty more volatility to the downside, not just in the case of CS but other EU banks as well. Second the bail out may be conditional and nationalization may be in the cards which would automatically wipe out all equity holders and potentially hybrid holders. If that happens we have a monster drop in yields and rate hike expectations in Europe aka the squeeze continues.
- Alternatively, if you want to sell CS equity or debt because you are feeling bearish, you may get caught in the crossfire of news headlines. As you are aware SNB (Swiss National Bank) is providing a 50bn Swiss franc lifeline to CS which automatically means a huge squeeze of the shorts, not just in banks but in indices in general. There are so many ways to lose money in the current environment, if you are a directional trader, that I don’t think there are many cases in which it is worth doing it. Worst part of all? With directional risk you will be glued to the monitors day and night and wouldn’t be able to sleep at night.
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