How the Global Financial Crisis Happened
Since the Great Depression of the 1930s, no financial crisis in history has ever had such far-reaching consequences as the 2008 recession. This was probably because times are different, with greater media coverage and an inter-connected global economy, where every country’s economic affairs are affected by what happens across the world.
It has been more than ten years since September 15, 2008, when the investment bank Lehmann Brothers collapsed. America’s fourth largest bank, the kingpin of securitising sub-prime debt, declared bankruptcy. So high had been their risk-taking activities that the effects magnified to a global level. In the next three weeks, world leaders and financial regulators worked tirelessly to prevent a possible collapse of the world financial system. Despite their best efforts, the global recession occurred. According to a report published by the US GAO, the 2008 crisis caused the US alone $22 trillion.
How it All Began
While September 2008 was when the world sat up and took notice, the factors that contributed to this crisis came into play a long time back. Let us look at the causes and understand how things unfolded. Consider them the main actors in a full-fledged theatrical production (there are plenty of guest stars too!).
2006: Fall in Real-Estate Prices
The US housing market started to decline, but realtors believed that the market was just overheated and would soon return to sustainable levels. What they didn’t know was that too many home-owners had questionable credit scores.
The reason? The Gramm-Rudman Act 1987 allowed banks to trade in profitable derivatives, to be offered to customers. These mortgaged-based securities were supported by home-loan collaterals and created increasing demand for more mortgaged-based loans. Banks started letting people get loans at 100% or more of their home values. This was a time when years of lesser inflation and stable growth of the global economy had resulted in complacency and increased risk-taking by financial institutions. Irresponsible mortgage-lending started in the US, to “sub-prime” borrowers, who barely managed to repay them.
The big banks turned these risky-mortgages into low-risk securities and put a large number of them in pools. Risks related to each loan have to be un-correlated for pooling to work properly. But the big banks’ theory, that the housing markets in different American cities are unrelated to each other, proved false with the housing slump of 2006.
Now, these pooled mortgage-backed securities, known as collateralised debt obligations (CDOs), were divided into different categories, based on the level of exposure to default. Credit rating agencies, on the behest of big banks, gave them generous scores. Investors trusted these scores and these instruments, which provided them higher returns, compared to other products in the market.
Lower Interest Rates
The emerging economies around the world, like China, took a stance of “saving over investment” in their countries. Those savings found their way into safe US government bonds, driving down interest rates.
Economists often consider the prevalence of lower interest rates as a major contributor to the overall mess. Lower interest rates made investors go for riskier securities with higher returns, as did banks, hedge funds and other bodies. They went one step further by incentivising these borrowers, on hopes that returns would exceed the cost of borrowing. Investors put their money in longer-dated, higher-yielding securities.
A Chain Effect Starts
With the fall of the housing market in the US, a chain of reactions started in the money markets. Pooling didn’t provide protection to consumers and CDOs turned worthless, despite all the high ratings. So, many banks relied on short-term funding, using property assets as collateral, but now none of these assets had takers in the market. The “mark-to-market” accounting rules required banks to revalue their assets at current market prices. Losses that hadn’t yet taken place had to be put in the books. Capital reserves of major banks depleted.
AIG and Its Credit Default Swaps
Why did small pension funds invest in such risky assets? They believed that Credit Default Swaps protected them. The seller of such an instrument agrees to pay the buyer, in case the third-party defaults on loans. Here, it was AIG, a US insurance giant, who sold these swaps. As the derivatives failed, AIG realised that it didn’t have enough cash reserves to honour its swaps. The whole system was revealed as a major Ponzi scam. Banks had inflated their account statements, with not enough capital reserves to take in losses.
A Dangerous Cycle of Mistrust between Financial Institutions
As Lehman Brothers went bankrupt, panic set in the markets. Trust deficit prevented banks from lending. Companies worldwide froze their operations, unable to pay workers and suppliers. The global economy went down. Regulators had made the mistake of allowing Lehman Brothers to go bankrupt, thinking that it would solve issues and reduce government intervention. But things didn’t work out quite as planned.
To curb panic and possible violence, government regulators worldwide went into a recovery mode, rescuing many companies from bankruptcy. From October 5 to 11, 2008, £90 billion was wiped off the value of Britain’s companies, a record since the Black Monday crash of 1987. As the credit crunch magnified, the IMF was sent requests for emergency loans by countries across the world.
Other Causes of the Meltdown
As we pointed out earlier, many factors came together to create this crisis. For example, the failure of the US Federal Reserve to see global current-account imbalances. Net capital inflows from Asian countries and the big capital inflows from European banks were overlooked too. All this created lenient or loose credit conditions in the US.
The ECB didn’t see the current account imbalances in the EU region, due to overheated housing markets in countries like Spain. They thought it irrelevant in a monetary union. But, bankers and regulators are not the only actors responsible for economies, political entities are too. They encouraged risk taking among consumers.
In short, excessive financial liberalisation in the latter half of 20th century, combined with a lack of regulations, can be said to be the cause of the 2008 recession. It left millions of people unemployed and homeless, which is why lessons need to be learnt from this debacle so that history doesn’t repeat itself.
If you open up a Forex trading platform you will probably see a set of tabs that look like M1, M5, M15, M30, H1, H4, D1, W1, and MN. What these tabs do is to set your trading window to a particular time frame ranging from 1 minute, all the way up to one month. For novice traders the concepts of multiple time frames can be very confusing. But once you learn how they work, you can decide how to best use the different trading chart time frames in your own trading strategies. There are a couple of simple concepts when trying to understand how the trading chart time frames work separately, yet together. If you click on the AUD/USD H4, then quickly switch to the AUD/USD M15, you are looking at the same trade at different points or moments in the movement of that trade. One way to think about this is like looking at something through a microscope. If someone puts a blood drop on a slide and looks at it under the lens they will see smaller particles within the blood that they couldn’t see with the naked eye. If they use the magnification lens on the microscope and turn it to 40X or 100X power, then they could see even more details of the individual cells within the blood. It doesn’t change the blood; it just gives you a more detailed look. Multiple time frames are like that too. The trade is the same on the M5 as on the H4 you can just see it with greater detail on the lower time frames. It is like a micro versus macro view point. The logical mind would then want to reason that if the trend is moving down on the H4, then it should be the same on the M5. When newbies shift around to the different times and see that they aren’t always the same, they get confused. If you were mapping out a road trip from Raleigh, North Carolina to Los Angeles, California you would notice your driving route will not go in a straight line. Roads leading from one place to another, especially if they are long trips, will not go in a straight line. There are obstacles like mountains, waterways, and cities that prevent a linear approach to a road trip. There will be times where you will have to drive northward or southward in order to end up west. It is the same with longer and shorter time frames. The D1 is your long-term destination and the shorter time frames are your individual roads. Although the daily trend may be down, there will be lots of up and down moves to get there. Understanding these concepts will help you to understand how the time frames work together and individually. Trading an hourly system like the Cornflower Blue, the long term destination is what the H1 shows. But you can use the M15 and the M5 to show you a better entry or exit point. Knowing how to read the different time frames will also help you decide the best trading plan and what kind of trader you are. Scalpers look for quick, small trades. They will not be trading on the M30 or H1 time frame because they create new candles or bars too slowly to know what is happening minute by minute. A scalper sticks to short time frames like the M5. An intraday trader will stick to the H1, or in some cases the H4 time frame, for their systems, because the moves are slower but bigger. Swing traders like the really big moves so they like to use the D1 or possibly the W1 time frame, depending on their trading strategy. Pros and Cons of the Different Time Frames: Short-term time frames Pros: More trade opportunities by only needing to hold a trade a short term. You also won’t be holding trades over night and have the fees and possible reverses when you are not watching. Cons: You can’t really employ a strategy as the moves happen too fast for analysis and set ups. The trades are small and more numerous, so your fees will be higher due to frequent trading. Moves happen so fast it can be easy to get stopped out by spikes and small reversals. The trading will be intense due to quick short moves and the need to have amazing timing. Median time frames Pros: You will be able to use solid trading methods and have time to analyze the trades. You will still have opportunities for multiple trades within a day. Moves are slower and you can usually see reversals or stalls and have time to react intelligently. Cons: You will still have more trading fees because of frequent transactions. Your entry and exits may not be as precise. Long-term time frames Pros: The chance to look at longer term trends and make larger amounts of pips. Less likely to get stopped out because of reversals or sudden market changes. You have more time to watch the trade and make wise, less emotionally driven decisions. Not as many trades made, so you will have less transaction costs. Cons: There will be less trading opportunities. Trades will be held overnight so you are subject to those fees. With less trading opportunities you need to make sure your system works really well on the longer time frame, as you will naturally get fewer setups while swing trading. There is no right or wrong, best or worst trading chart time frames to trade on. Like other smart trading decisions you use the time frame that best works with your trading style and system. But realize that just because you concentrate on one particular time, doesn’t mean the others won’t be of great benefit to you. Take the time to observe and understand how they all work together, so you can be as successful a trader as you aim to be.
Many of us trade well but due to the lack of some things in our trade almost all the time there are various negative effects as a result of the loss of trade. But if you trade with some important things or conditions, your trading power will be many times more than before and it will be positive, and if you can make it a regular habit, you will always trade better. Let's find out what are the things that will help you in good trading. 1. Create your own trading plan. 2. Take the help of 2-3 indicators in trading, there is no need to use many indicators. 3. Start trading through Money Management. 4. Trade by setting stop-loss with tech profit in each trade. 5. Take profit according to the duration of trading. Avoid closing profitable trades early and prolonging loss trades. 6. Do not increase the risk with success in a few trades. Do not trade excessively. 7. Do not change the trading plan in the middle of the trade. 8. Do not trade directly on the real account in the new strategy, first check the success rate in the demo. 9 Keep a record of both successful and unsuccessful trades, will be useful next time. 10. Do not trade with robots depending on different readymade auto trading tools. 11. Do not trade against the trend. Remember trend is your friend. 12. Don't take the total risk by getting angry after losing one or two trades. 13. Don't start trading without a fresh mind. 14. Share your trading experience and develop strategy all the time. 15. Trade a certain amount every day or at a certain profit target. When the target fails, finish the trade for 7 days. If the market volatility is not good, do not go to fill the target. 16. Don't trade emotionally, don't be greedy. 16. Do not trade in co-related currency pairs for one-way trades. For example, if you trade both EUR and GPB in a buy or sell order, the profit or loss result will be almost equal and the risk will increase if the market goes against you. 16. Trade with trading possibilities, you will never see any reason for your inexperience in losing trades. 19. In the case of trades, do not expect a profit per trade. 20 In case of short time trades, trade with an understanding of active time sessions
Trading is all about making informed decisions, keeping emotions at bay. And yet, despite much effort, sentiments do end up affecting not just a single trader’s decisions but also the way the markets move. Investor behaviour has a considerable impact on asset prices and demand for specific financial instruments. Behavioural economics says that investment decisions are highly influenced by risk, emotions and future cash flows. Trading sentiment refers to the overall attitude of traders towards a particular financial market, asset or instrument. For instance, rising prices usually leads to a bullish trading sentiment, while falling prices would result in bearish sentiments. These sentiments play a vital role for investors, especially those who like to take positions in the opposite direction of the current market trend. Indicators to Determine Trading Sentiments The good news is that there are ways to analyze the mood of the market and the direction the market sentiment is moving in, to help to identify potential opportunities. Here’s a look at some of the key indicators that can help a trader determine market sentiment. 1. Commitment of Traders (COT) This provides details about how the biggest traders, such as banks, corporations and hedge funds, are positioned and how committed they are to the current trend in the market. If these traders shift their positions, it indicates that the market is going to experience some movement. 2. High/Low Sentiment Ratio This is one of the easiest ways to determine trading sentiment. It involves calculating the average and comparing assets heading to 52 weeks of highs to stocks heading to 52 weeks of lows. If the average direction of the market is close to the highs, then its bullish, and if the average direction of the market is closer to the lows, it is bearish. 3. Put/Call Ratio In this indicator, the number of put options is divided by the number of call options. If the ratio is above 1, it indicates that more investors believe that the market is going to be bearish. If the ratio is below 1, it indicates that more investors believe the market is going to experience a bullish trend. Factors Affecting Trading Sentiment · Macro-Economic Factors Macro-economic factors, such as interest rates, inflation and strength of the overall economy, influence investor behaviour. Studies have proven that inflation and money growth have significant impact on the returns generated from the stock market. · Herd Behaviour This refers to traders following a common path. If any seasoned trader invests in a particular asset, then others might follow the established trader’s lead and make similar investments. Herding can be based on the inclination of investors towards the same source of information, analysing indicators in similar ways and, therefore, increasing the chances of similar trading decisions. Small markets with low liquidity can also lead to herding, since it isn’t possible to execute trades without following other investors, due to a lack of options. · Risk and Cost Factor This depends on two features of investor attitude, stability of the market and high risk leading to high returns, if the trade is successful. Investor decisions are also affected by stability and good governance, and the belief that risks and returns are directly proportional. Impact of Trading Sentiment · Ambiguity Aversion This is a situation where an investor prefers to choose known risks over unknown ones. This behaviour was explained through the “Elisberg Paradox,” where people preferred to bet their money on the outcome of an urn with 50 blue and 50 red balls, instead of betting on the outcome of the urn with 100 balls but unspecified number of blue and red balls in it. · Familiarity Bias Here, people prefer investing in familiar portfolios from their own region, state and company. Some investors will avoid foreign or international assets, investing in domestic or local assets due to the bias, despite the return on investment. · Active Trading This trading strategy involves taking advantage of short-term price movements. It focuses mainly on financial instruments in high demand, such as stocks, currencies and derivatives. It could be focused on a specific industry as well. This type of trading involves continuous analysis of and speculation regarding market movements. Tips to Control Your Sentiments while Trading 1. Treat Trading as a Business Design a trading strategy, with specific, realistic goals and daily activities, to keep your sentiments in check. Stick to your plan despite the market conditions. This will help you prevent sentiments from colouring your trading decisions. 2. Use Candlestick Sharts Often, early entry and misinterpreted indicators lead to unnecessary losses. So, analyse candlestick charts to fully form before making any trading decisions. Mid-candle decisions tend to be impulsive. This will not only help you control your emotions but will also improve your performance as a trader. 3. Research before Investing Do not completely depend on trading sentiment, do your own research too. It might help you explore new opportunities for trading, while ensuring that your decisions are information based. 4. Paper Trade Use demo accounts and dummy trading tools to test new strategies, new indicators and new ideas before investing real money in the live markets. Focus on your strategies and work them through to figure out any loopholes. Use new strategies or try new assets only after you gain confidence through practice. 5. Educate Yourself There is always something new in the market to broaden the horizon of your trading. Learn about some new indicators, instruments, strategies or some advanced trading tools. With advancements in technology and internet penetration, today, you can easily access books, coaching academies, webinars, etc. This will help you assess and improve your current trading plan. The financial markets are influenced by emotions, providing trading opportunities. Understanding trading sentiment is key to making informed trading decisions. Analysing trading sentiment as part of your trading plan is only useful if you can utilise it to gain an edge in the market and take positions at the right time. How the market feels about the current scenario and how it feels about the future provide potential opportunities for traders. So, make sure you learn how to assess and analyse market sentiment and your own emotions to fine tune your trading decisions.