Recently, Mr. Cool and Mr. System Addict decide to get into a trade.
Yeah, surprise surprise, Mr. Cool is liquid again!
They’ve decided to trade Gold, and are pretty much in the money already. Their trades have come good first up. Both are leveraged 25:1, which is common with Gold derivatives. Mr. Addict has bet 5% of his networth on the trade, and Mr. Cool, true to his name, has matched Mr. Addict’s amount.
Gold prices jump, and Mr. Addict’s target is hit. He exits without thinking twice, and is pretty pleased upon doubling his trade amount within a week. He pickles 90% of the booty in fixed income schemes, and is planning a holiday for his girl-friend with the remaining amount. Instead of trading further, he decides to recuperate for a while.
Meanwhile, Mr. Cool rubs his hands in glee as the price of Gold shoots up further. His notional-profits now far exceed the actually booked profits of Mr. Addict. When’s he planning to exit? Not soon. He wants to make a killing, and once and for all prove to Mr. Addict and to the world, that he rules. He wants to bury Mr. Addict’s trade results below the mountain of his own king-sized profits. Gold soars further.
Mr Cool has trebled his money, and is still not booking any profits. He picks up his cell to call Mr. Addict. Wants to rub it in, you know.
Mr. Addict puts down his daiquiri by the poolside in his hotel in Ibiza. His girl-friend has at last started admiring him. They’ve been swimming all morning. “All right, all right, he’ll take this one call. Oh, it’s Mr. Cool, wonder what he’s up to?” Mr. Addict is one of the few people in the world who are able to switch off. He’s totally forgotten about Gold and his winning trade, and is really enjoying his holiday.
Mr. Cool tries to rub it in, but receives some unperturbed advice from the other end of the line. He’s being asked to be satisfied and to book profits right now. Of course he’s not going to do that. All right, fine, if he wants to play it by “let’s see how high this can go”, he needs to have a wide-gapped trailing stop in place, says Mr. Addict. Of course he’s got a wide-gapped trailing stop in place, says Mr. Cool. Mr. Addict wishes him luck, cuts the call, and forgets about the existence of Mr. Cool, dozing off into a well-deserved snooze.
As Gold moves higher, Cool starts to think about that wide-gapped trailing stop. Let alone having one in place, he doesn’t even know what it means. A quick call to the broker follows. The broker is ordered to install a trailing stop into Mr. Cool’s trade. Since Cool doesn’t know what “wide-gapped” means, he forgets to mention it. The broker doesn’t like Cool’s attitude and his proud tone. He installs a narrow-gapped trailing stop.
Circumstances change, and Gold starts to drop. It’s making big moves on the downside, falling a few percentage points in one shot. Cool’s narrow-gapped trailing stop gets fully jumped over; it doesn’t get a chance to become activated in the first place, because it is narrow-gapped and not wide-gapped. The price of the underlying just leaps over the narrow gap between trigger price and limit price. Happens. Cool does not install a new stop. Stupid.
Next morning, Cool’s jaw drops when he sees Gold down 15% overnight. On a 25:1 leverage, he’s just about to lose his margin. The phone rings. It’s the margin call. Cool panics. He answers the margin call. His next call is to Mr. Addict, asking what he should do. Mr. Addict is shocked to learn that Cool has answered the margin call. He asks him to cut the trade immediately.
Cool’s gone numb. Gold drops another 4%. Phone rings. Second margin call. Cool doesn’t have the money to answer it. In fact , he didn’t have the money to answer the first one. In the broker’s next statement, that amount will show up as a debit, growing at the rate of 18% per annum.
Mr. Cool’s not liquid anymore. Actually, he’s broke. No, worse that that. He’s in debt. Greed got him.