My Beginnings on Wall Street

Wednesday, October 14, 2009

I moved to New York City and started actively trading equities at a Wall Street firm over two years ago in August of 2007. Before which, I had been investing on a long-term timeframe for several years. Short-term trading was certainly a mentality switch and Wall Street was another world! My career began just two months before the top of the market. Everything seemed rosy and traders were doing well as volatility had just begun to pick up pace.

My entering group of traders started by focusing solely on Lehman Brothers and we were only allowed to go long the stock. How ironic! Needless to say, we weren't all that profitable in our first few months. I think the only time any of us made any money was when a rumor circulated that Warren Buffett was going to purchase a large stake in Bear Stearns and all the investment banks rallied sharply. That was a good day, and our first happy hour!

As the market topped and prices started dropping, we saw Jim Cramer go nuts on CNBC in a segment that I will never forget. He argued that this crisis was much worse than anyone was forecasting. The Fed opened the discount window to struggling banks and began cutting the Federal Funds Target Rate. I believed through much of this that the market was experiencing a temporary pull-back and it was a good time to buy long-term. As the situation worsened, I was continually surprised by the downside action.

I specifically remember watching a PBS interview in late 2007 where the guest stated that the end of this selling pressure would come with the bankruptcy of a major bank. I was amazed by that statement as it was the furthest thing from my mind. This guy was clearly on the extreme and stating something no one else was saying or even thinking at the time. It's rather amazing how naive I was at the time.

I started a fantasy stock market account on Facebook with a few trading buddies here at the office in early 2008. Our idea was to make some big bets on macro ideas with play money to compete with each other. I made my first trade on Friday, March 14, 2008. Bear Stearns dropped over 50% that day and I bought BSC with my entire account at the close of the day expecting a bounce on Monday. I bought $10 million somewhere around $33 per share, a stock that was trading at $150 not one year before. I remember walking over to a buddy I was competing with and telling him about my trade. He thought it was a great idea. I said I thought my only risk was a take-under if JP Morgan were to buy the bank over the weekend as was rumored. He thought that was highly unlikely. In an off-hand manner, I said that we have no idea what it's worth and they're only going to pay what it's worth. I didn't realize how correct that statement would be. But in the end, we both figured a take-under was fairly inconceivable.

Sunday night, I sat down to my computer and saw the headline: JP Morgan Buys Bear Stearns for $2. I was appalled. How could one of the largest investment banks in the world be essentially worthless? I wiped out my fantasy account the first day I made a trade because I did not even consider the possibility of bankruptcy. Good thing it wasn't real money! It was an incredible lesson to learn, luckily only having my pride hurt and not losing any capital.

Bear Stearns went bust and I once again jumped on the long bandwagon believing the worst was over. Hey, the guy on PBS said it would be over after this. Not until June 2008 did I begin to believe a lot more downside was possible. With the market trading back to the lows of the year, I started to fear a good deal more selling. The Dow was around 11,000 and I thought we could see prices in the lower 9,000s. Never in a million years did I imagine the Dow breaking 7,000.

The largest difficultly with the entire crisis was its opaqueness. The lack of transparency on bank balance sheets made it an incredibly difficult bear market to predict. We all knew the housing market was overvalued, and vastly overvalued in select parts of the country. We knew once the real estate market topped, the economy would experience some contraction. I did not forsee however, nor could have foreseen given my lack of knowledge, the huge leverage in the system and the fallout stalling prices would create.

October 2008 significantly changed my perspective of the world and I began to understand what was possible in a world I did not understand. Stocks can go to zero. Companies can go bankrupt, overnight even. There is no safety in the stock market during a vicious bear market, everything eventually gets hit. In less than a year, I went from thinking the bankruptcy of a major bank was a far-fetched idea to watching and trading the stocks of about 10 major financial companies that saw plummeting prices. I shorted Lehman on its road to zero, I shorted Merrill as it was the "next Lehman". I shorted Citi and Bank of America which eventually needed a government backstop to stay afloat. Fannie and Freddie were great shorts needing government takeovers. AIG, the largest insurer in the world, essentially failed by all reasonable metrics. Goldman and Morgan had to covert to regular banks to qualify for capital. We feared the collapse of the entire global financial system.

I rode the wave lower, making some money along the way but never really capitalizing fully on such a large and drastic move because I didn't have the wherewithal to foresee such incredible events. I shorted Lehman through levels but never thought it would literally go bankrupt. Likewise for the other financial stocks I traded day in and day out. Now a year later, I am determined not to fall victim to Taleb's "retrospective predictability". Retrospective predictability is defined as: "a happening that, after the fact, our human nature enables us to accept by concocting explanations that make it seem predictable." Traders are probably the worst culprits of this fallacy. If I am honest with myself, I never saw this coming.

Starting my career in trading just before a vicious bear market was one of the luckiest beginnings I think one could have in this career. I was in a position to profit from falling prices and saw firsthand, and participated in events that I never dreamed were possible. Everyone knows a major bank can go bankrupt in theory, but it's entirely different to know it's possible because I traded it. I believe the last two years will prove to be incredibly valuable on my path towards portfolio management. I now understand what John Maynard Keynes meant when he said, "There is nothing so dangerous as the pursuit of a rational investment policy in an irrational world." The educational lessons 2008 provided cannot be taught in a classroom. Yet, they were the most powerful and will stay with me for the rest of my life.


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