1. There are examples in history of similar strategies; the report explains why they failed and resulted in severe losses.
2. The report explains why such a strategy would lead to severe losses, over time.
3 . The report dissects the phenomenon for definitive answers on this question.
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Lately, we have seen a peculiar phenomenon: Musk tweets, and the value of certain, let’s say, ‘market opportunities,’ jumps. The only underlying cause being the mention, or as they say, “shoutout” by Elon Musk.
Is this a viable strategy? Can you, or should you, use this tactic to make profits? Should you use Elon Musk’s tweets to trade?
Analysis has been done by reputable examiners regarding this phenomenon. While this topic may warrant an event study, this report is a serious dissection of the fundamental proposition. Is Elon mostly, or usually, right? Can his wisdom be called ‘prophetic’? And should you trust these assertions as valid and back them up with your hard-earned money? These questions are addressed in this report.
Carry trade comes to mind on this subject. Carry trade is a basic trading strategy that involves borrowing money in low-interest-rate currencies and investing funds in high-interest-rate currencies. It was a strategy quite common in the past, when some traders, to exploit a form of interest rate arbitrage, borrow funds in, say GBP, and invest the same fund in, say Brazilian Real, or Argentine peso.
“Carry trade (carry is a market term for net interest earned on a trade). In the standard carry trade, an investor will borrow funds in a low-interest-rate currency and deposit them in a high-interest-rate one (Miles, Scott, Breedon, 2012).”
Did this strategy work? The answer is slightly complex, one that we need to understand thoroughly, to comprehend the fundamental point expounded in this report. The carry trade worked most of the time. However, it was analogized as picking pennies in front of a steamroller. Yes, most of the time, you’d be able to pick up a few pennies, but every once in a while, your fingers would be crushed! What is worth more, pennies or your fingers?
Technically, the carry trade should not be a profitable strategy long-term. This, of course, is because, in the long-term, the covered interest parity, or interest parity theory, should hold. For example, the currency with the lower interest rate should appreciate against the currency with the higher interest rate, neutralizing any interest gains, for the no-arbitrage condition to hold. Yet, it (carry trade) did work at times, due to a plethora of unsound reasons, such as risk premium, microstructures, etcetera; explanation of all causes is beyond the scope of this report. Suffice to say that most causes postulated were unsound, and over the long-term horizon, for example, 15+ years, interest parity did hold, usually (not always).
Why is a discussion of carry trade included in a report on Musk and a trading strategy based on tweets of Elon?
Carry trade strategy and trading based on Elon's tweets are very much the same. Both are like picking pennies in front of a steamroller; you are likely to pick up pennies often, but eventually, you’ll get your fingers crushed (explained in detail below).
If you examine the two, carry trade and trading on Musk’s advice, similarities are quite evident. Sound economic reasoning backing the two is absent; both are based on a phenomenon that, even assuming semi-strong form efficient markets, should not exist, yet here we are . . . Elon’s tweets do appear to increase the price of certain securities, and buying them exactly when he tweets positively about them, does seem, well . . . reasonable. But beware, the crows (big money, market movers, quantitative hedge funds) are observing too.
Let’s go back to the analogy of the steamroller. Picking pennies in front of a steamroller . . . can this be elaborated? We must understand the Pesos problem:
“Peso problems. If there is a small probability of a very large change, a small sample may not contain one of those changes. Peso problems: Even if the carry trade has made money for investors over many years, there is always a risk that it will make an enormous loss just at the worst time. Thus, even though it looks like it always makes money − one rare event could change that. (Figure 1 below shows) Argentinian peso against the US dollar and US and Argentinian interest rates. Prior to 2002, it looks like the Argentinian peso was a great carry trade − the currency never moved against the US dollar (they were in a currency board arrangement) and Argentinian interest rates were much higher than US rates offering a seemingly nice safe return. Then in 2002, the peso collapsed against the dollar falling more than 70% and completely wiped out any return’s investors holding the peso had made before then. (Miles, Scott, Breedon, 2012)”
The Argentinian peso, USD carry trade provided profits to traders for a few years, as the figure above displays; however, one big depreciation or crash wiped out all previous profits, and more. This means that, overall, those that continued to utilize this strategy lost more money than they gained, as the spot rate, USDARS, crashed around the end of 2001.
This observation, and the lessons that carry trade provides us, are very important in the current situation regarding trading based on Elon’s tweets, or tweets of other influential people, without any underlying economic logic.
What will happen if I continue to trade cryptocurrencies, such as Bitcoin, Doge coin, etcetera, on Elon Musk’s advice? Will I make money if I buy when Elon Musk tweets?
In the short run, you can make some profits when the market reacts positively to Elon Musk’s tweet. For example, you deploy this strategy and buy Bitcoin, every time Elon Musk tweets positively about crypto. This may provide you profits repeatedly (multiple times in a row). However, risk free profits are implausible in the financial markets, and a reality, similar to the USDARS crash, is almost certain to occur.
This, simplistically, means that while you may make profits multiple times, trading tweets of influential people, who, arguably, maybe marketing opportunities without fundamental economic logic supporting their views. Nonetheless, over time, i.e., if this approach is repeated enough times, you will suffer a crash, similar to the crash of the Argentinian peso, and this will result in losses that far exceed any gains that you may have made previously. The small profits one can make by ‘trading the tweets,’ if you will, are compensation for the risk taken in such an approach, similar to the risk/return relation of the carry trade.
Such a phenomenon is continually searched by the crows (big money, market movers, quantitative hedge funds), that scan the markets for persistent, predictable behavior, especially by smaller accounts. They do so to exploit a predictable behavior, so they can formulate a shorting strategy that calculatedly moves the market oppositely, so their short bet makes ‘flash profits.’ If the behavior of Elon’s devotees persists, remaining predictable, big money will make its move when the extractable profits are at the highest.
This, simply, means that if smaller investors and trading accounts continue to utilize this tactic, big money will bet and strike against these actors when they are most invested in their positions, and have the most to lose. Thus, it isn’t a tactic they’ll implement every time, because if they do, smaller investors will get ‘spooked,’ and overall, the expected behavior wouldn’t amount to high enough predictable positions that a flash crash of their engineering can meaningfully profit from.
They can utilize sophisticated systems and algorithms for making decisions, which an average Joe can never compete against. . . thus, their move should be swift, precise, and efficient, and smaller investors would, but of course, be like deer caught in the headlights.
Finally, another point worth mentioning here is the credibility of those that can make ‘predictions’ without any fundamental economic logic, with the assumption being they their intelligence or ability is so ‘piercing’ that sometimes they see things that they don’t even need to explain. And a simple tweet proclaiming ‘too the moon’ should suffice in terms of logic.
“Logic you demand? These are words of Elon Musk; how dare you question them!”
This condition demonstrates only one thing . . . the illogical nature of the market presently, and the inability of some market participants to make tactical choices based on strategies that actually work. . . . such as value acquisition or long-term portfolio construction.
Applying a strategy that lacks fundamental economic logic, i.e., adheres to strict principles of validity, is foolish, if I dare say . . . and, of course, “a fool and his money are soon parted.”
Finally, it is worth mentioning that no mere mortal can predict the future with absolute accuracy. When you make decisions based on the most prominent accomplishments of a human, forgetting or ignoring countless failures, essentially, you’re being influenced by a positive halo effect. Musk is no omniscient being . . . many of his ideas or assertions, in the past, didn’t play out as he claimed they would. For example, in the ‘90s, when he sold Zip2 to Compaq, he made millions, but Zip2 never became what he claimed it would.
“Whenever making financial decisions, always scrutinize the fundamentals you are making your decisions on. If they aren’t sound, or if none exist, abandon the proposition, it most certainly will lead to losses.”
CHAPTER 20: EXCHANGE RATE DETERMINATION: NOMINAL EXCHANGE RATES AND ASSET MARKETS D. Miles, A. Scott and F. Breedon, Macroeconomics: understanding the global economy (Wiley, 2012).
Cheung, Y.W., Chinn, D. and Marsh, I.W., How Do UK-Based Foreign Exchange Dealers Think Their Market Operates?, NBER Working Paper 7524 (2000).
Froot, K.A., Short Rates and Expected Asset Returns, NBER Working Paper 3247 (1990).
Flood, R.P. and Rose, A.K., ‘Understanding exchange rate volatility without the contrivance of macroeconomics’, The Economic Journal (1999), 109: F660−F672.