The story of Dave Portnoy and a warning to any new traders about overleveraging.

Welcome to Finance and Fury.

This episode is about the story of Dave Portnoy and a warning to any new traders of overleveraging – or even using leverage if you are relatively inexperienced

1. There are Millions of new investors are getting into the market- which is great – but being a new investor will come with growing pains
   1. I had plenty of growing pains for the first 5-10 years of investing – from 16 to 26 – learn a lot from mistakes
   2. But thankfully – all of those mistakes were isolated losses that were contained
2. Investing is important – but what is more important is to still be an investor in a decade and not end up losing all your investable assets or alternatively, being scarred for life when it comes to investing – and never re-entering the market
3. There are a lot of Online trading brokers that allow leverage – for any new investor that joins there platforms
   1. It depends on the market and the trading platform – but the amount of leverage a retail (which is what is considered amateur trader) can obtain is between a 2 to 1 leverage rate to 5 to 1
   2. Means that for every $1,000 that you have, you can get $2,000 of leverage to $5,000
4. Leverage itself – when done properly – can work very well – if it is done securely and when you do it in a way where you wont be forced to sell the assets
5. But when not – can leave you in a deep hole of debt – where you are left owing more than you might be able to afford
6. An important aspect in using leverage is understanding how to calculate the ratio of a loan to value ratio – or LVR – this is used to understand how exposed you are to downwards movements in the price of the assets when compared to how much you have invested
   1. The formula for leverage is: LVR = L/V – where L is leverage or loan size and V is the total value of the asset
   2. Very relevant for online trading accounts – as these are an effective margin loan
   3. multiplying the margin amount by the leverage ratio will give the asset size of a trader’s position
7. Risk and leverage trading – The most important thing to understand when talking about leverage is the risk involved – where it magnifies the risks
   1. Risk is inherent to any type of trading – if you buy a single share or even a basket of shares or index – you are exposed to downside risks or volatility risks
      1. Have both specific risk or systematic (market) risks – specific relates to the company (management, profits, etc.) – systematic is what we have recently seen – or in the GFC – when the whole market goes down
   2. That is where leverage will magnify these risks –leverage can cause both magnified profits and losses however – the risk of these potential losses are magnified depending on the assets that are purchased
   3. It is very important for any new investors to try to minimise how much risk they may face – and one way to do this is to try and minimise the amount of leverage they will use
   4. Don’t get me wrong – say you do take on a leveraged position – double your equity through taking a margin loan of $10,000 on your $10,000 equity – on a one-off basis you could massively benefit if it happen that this one-off trade goes your way
      1. But get it wrong and you could end up facing a massive loss – potentially more than you own in the share
      2. At this LVR – of 50% with a value of $20k and a loan of $10k – would take a 25% drop in the value of this asset before a margin call may be triggered

• If a margin call is triggered – you are either forced to pay down the loan, put more money into the share or if you don’t have any cash lying around – sell and cut your losses

8. The best way to reduce this risk is to distribute it across different investments and different markets – it is the concept of diversification – meaning you don’t put all of your eggs in the one basket
   1. If you are going to leverage on a portfolio like this – there is the need to calculate what your potential downside risks may be and to determine things like net asset value that the portfolio may drop to ensure that a margin call isn’t likely
9. However – With most margin lending – it is on one security and has one loan attached to it – especially with online brokers – looking at the Leverage on online trading –
   1. For some markets – especially for Forex – retail leverage rates can start at around 30:1 – compared to around 5:1 for shares
   2. However – leverage rates can also vary depending what type of trader you are, either retail of professional
      1. retail leverage rates for forex are around 30:1, they are around 500:1 for professional clients – professional clients must meet criteria in order to be eligible – however – in my experience – this is based around legally mitigating factors for the platform – not the individual – do a quiz, do enough trades, say you are a professional – then you are to them – even though you might not be – you have told the platform you are so the legal onus is on you
   3. I think it goes without say that the higher the level of leverage you can access – the greater risk you are at
      1. As an example – let’s say a trader has a maximum leverage of 10:1 and opens a position with that leverage on a $10,000 account – LVR of 90%
      2. The trader now has a position size with an asset value of $100,000. This means a price movement of 10% will wipe out your equity completely

This brings in the story of Dave Portnoy – You may or may not have heard of him – goes by el pres – founder of Barstool Sports

1. Bit of an internet celebrity – personally think he is pretty funny – his rivalry with Roger Goodell – the commissioner for the NFL is pretty funny
2. But Portnoy is not exactly an investor – In fact, prior to the quarantine, he had bought just one share in his life
   1. Not to say he isn’t a good business man – sold a large stake of 36% in Barstool Sports to Penn National Gaming for $450m
3. El Pres loves a punt – a pretty big gambler – putting hundreds of thousands on the line in bets on the NFL, boxing, the NHL, really any sport
4. But with the country shut down in recent months, meaning no sports and no betting, Portnoy was bored. So, he turned to the stock market, saying “with the volatility, it is kind of like watching a sports game.”
   1. He started trading – but using large amounts of leverage – so he now day trades, live-streaming his account as “Davey Day Trader Global.”
5. Portnoy is also a tad less-than-humble about his alleged success. A week ago or so – he made a pretty interesting tweet: I’m sure Warren Buffett is a great guy but when it comes to stocks he’s washed up. I’m the captain now.
   1. The irony here is that Buffett’s rules for investing goes as follows – Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1. – seems like good advice – protecting your downside is very important –
   2. However – Portnoy has just two rules: 1. Stocks only go up. 2. When in doubt whether to buy or sell, see rule 1 – interesting juxtaposition on Buffett’s rules
6. Portnoy has a large following – around 1.8m followers – and many of them were following his advice – even though he claims he isn’t an investment adviser – he is sure giving a lot of advice on what to invest in and that if anyone loses money in the markets – they are idiots or loser –
   1. At the moment – with so many online brokerage accounts – this creates a situation where market infrastructure could be amplifying feedback loops. Most of the brokers popular with retail investors earn fees from selling order flows. Cheap or free retail trades are possible in part because transactions are routed through securities groups like Citadel Securities – so they don’t need to charge brokerage
   2. And in the US – with many stimulus check or PPP loan going into the market – as has been recently discovered by the Treasury – there are a lot of other people in the markets – mostly new investors further fuelling the feedback loop
7. El pres was doing well – however – The US stock market started to lose ground – especially as technology shares started to lose steam
   1. A lot of Robinhood traders tried to buy the initial dip in the market but were hammered over the next few days – especially those who were leveraged
   2. The short-lived rally before the further decline trapped a lot of newer investors into believing a “V” shaped rebound was imminent – especially on shares like tesla
   3. With the E mini Nasdaq down nearly 2% at around 11,181 level (at the end of the day) – Portnoy told thousands of his viewers on his live Twitter stream he’s “over-leveraged again” and that, if he doesn’t sell by the close, his broker will force him to “write checks”- his exact words were “I’m overleveraged, so something’s gotta be sold,”
      1. About 5 minutes to the U.S. cash close, Portnoy told viewers that he lost “$150,000” 
      2. However – in total – he lost around $4m in total value – about $700k of it was his own money
   4. For him – not a massive deal – he has a lot of spare cash – but it shows the power of leverage to either be your best friend – or worst enemy when misused
8. Leverage that is done smart can work –
   1. Leverage that you can afford – LVR has to be within reason – and sell diverse
      1. Look for portfolios of shares and diversified across
   2. Leverage that doesn’t use your shares as collateral – such as what margin loans do
      1. Through taking out other forms of equity like on a home can help to reduce the risks of being forced to sell a position – but again – relates to the portfolio itself – you could take out $200k against your home a put it into a speculative microcap share – but the chance you will just be left with a huge debt is high – when compares to taking a DCA approach for a diversified portfolio of assets of thousands of shares across different asset classes
   3. However – Leverage out of greed can undo you – take too much risk in debt – and invest out of hope – your wealth accumulation strategy can be massively set back
9. So – And maybe stocks don’t “always go up” as Portnoy suggested – Especially in the short term – volatility in the markets are real –
   1. Dave is right in general with the market overall – when looking over long timeframes – those of the decade – markets will historically be up over a decades timeframe – but in the short term – it is anyone’s guess if they will be up today or tomorrow
   2. The position you need to be in is one that can survive this
10. A few factors could be taken into consideration when determining what amount of leverage to apply to a portfolio
    1. how much risk you are willing to take on – by examining this via percentages – if you look at this through a maximum loss potential – or how much a declining market would be required to wipe out your capital – the higher the probably that this doesn’t happen the better
    2. What your investment timeframe is – if you are investing for the short term – leverage may not be appropriate
       1. Leveraging should be seen as a long term strategy – not a short term gamble on the market
    3. Where the leverage is coming from – margin loans which has additional risks or from investment loans from a properties equity
    4. What the investment is in – one single share or a portfolio of assets – in managed funds or ETFs
       1. Try to reduce the risk involved with single asset volatility

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