As A New Retail Trader Age Rises, Heed Tales Of Past Manias

In spring 2020, the temporary closures of professional sports leagues during the initial coronavirus pandemic lockdown, coupled with the infusion of fresh capital into financial markets by the Federal Reserve and US Treasury, anointed a new class of retail traders in financial markets. This wave of new market participants brings with it a wave of liquidity that had been otherwise out of the reach of traditional financial markets.

While the past few months may have been exhilarating for retail traders it is a good time to look back into history for some informative cautionary tales from other retail manias in financial history. Here is a look at past events, emotions, and drama that led past traders to seek fortune from similar environments only to leave many struggling with the subsequent ruin.

OVERFLOWING WITH LIQUIDITY

In capital markets, liquidity will always find its own level. Financial capital will flow into the coffers of even the most insolvent companies when there is an abundance of liquidity. Consider the example of Hertz.

Bankruptcy at its core is a situation in which a company’s assets are worth nothing. If assets = liabilities + equity, then it must be the case that a company in bankruptcy has seen its equity wiped out, driven to zero value. And yet, retail traders continued to trade into Hertz, pushing the firm’s shares higher.

In a sense, this is what policymakers such as the Federal Reserve and the US government intended: shore up the economy against the scourge of the pandemic so that a recovery can take root. In turn, there is so much excess liquidity in capital markets, that businesses would be spared from illiquidity in the short-term and insolvency in the long-term. This can be summed in an analogy whereby despite ‘the holes in the bottom of the cup, the top would still overflow.’

LEARN FROM OTHERS’ MISTAKES

Another quote that carries weight with this introspection is one that my father would say to me when I was a child: “smart people learn from the mistakes of others.” The history of financial manias - not unlike the one we’ve witnessed since the start of March with the wave of new retail traders opening brokerage accounts - frequently involves retail traders who have enjoyed a brief period of success followed by sustained discomfort.

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