Pain Trade

A A A

DEFINITION

The tendency of markets to deliver the maximum amount of punishment to the most investors from time to time. A pain trade occurs when a popular asset class or widely followed investing strategy takes an unexpected turn that catches most investors flat-footed. Under this definition, a sudden reversal in a niche sector or strategy would not qualify as a pain trade, since not many investors are likely to be in it. Pain trades sorely test the resolve of even the best traders and investors, since they must face the dilemma of whether to hold on in the hope that the trade will eventually work out, or take their losses before the situation worsens.

INVESTOPEDIA EXPLAINS



The periodic peaks and valleys in equity indices over the years provide a perfect example of pain trades at work. Consider the dot-com boom and bust of the late 1990s/early 2000s. As the Nasdaq soared over this period and reached a record high in March 2000, technology stocks accounted for a disproportionate part of portfolios held by most investors and mutual funds. The subsequent collapse in technology stocks and the Nasdaq led to a recession in the U.S. and a global bear market, wiping out trillions of dollars in market capitalization and household wealth. The pain trade here was being long technology stocks, as the subsequent collapse in the sector reverberated around the world and had an impact on the broad economy.

In 2008, the pain trade was being long equities in general. The U.S. and many major global equity indices had reached record highs in the fourth quarter of 2007, despite a simmering credit crisis that was rapidly coming to a boil. The collapse of global equity markets in 2008 made this the biggest pain trade by far in terms of the number of people affected and the amount of wealth destroyed. More than $35 trillion, or 60% of global market capitalization, was wiped out within 18 months, while the global economy suffered its deepest recession and biggest financial crisis since the Great Depression of the 1930s. In the U.S., plunging housing and stock prices led to the greatest destruction of household wealth in history, even as the recession threw millions of people out of work.

The strong recovery in global markets from 2009 onward proves that even pain trades can turn to gain over a period of time, with the Dow Jones Industrial Average and S&P 500 reaching new highs by 2013. However, rising yields in 2013 made the bond market the new pain trade for numerous investors in that year.


RELATED TERMS
  1. Dotcom Bubble

    An rapid rise in equity markets fueled by investments in internet-based companies. ...
  2. Stock Market Crash Of 1929

    A severe downturn in equity prices that occurred in October of 1929 in the United ...
  3. Stock Market Crash Of 1987

    A rapid and severe downturn in stock prices that occurred in late October of ...
  4. Herd Instinct

    A mentality characterized by a lack of individual decision-making or thoughtfulness, ...
  5. Max Pain

    The point at which options expire worthless. The term, max pain, stems from ...
  6. Bottom Fisher

    An investor who looks for bargains among stocks whose prices have recently dropped ...
  7. Distressed Sale

    When property, stocks or other assets are sold in an urgent manner, often at ...
  8. Market Disruption

    A situation where markets cease to function in a regular manner, typically characterized ...
  9. Market Psychology

    The overall sentiment or feeling that the market is experiencing at any particular ...
  10. Loss Psychology

    The emotional aspects associated with investing and the negative sentiment associated ...
Related Articles
  1. Pitfalls Of Copycat Investing
    Investing Basics

    Pitfalls Of Copycat Investing

  2. Follow The Herd In Trading The Capital ...
    Trading Strategies

    Follow The Herd In Trading The Capital ...

  3. Psychological Coping Strategies For ...
    Investing Basics

    Psychological Coping Strategies For ...

  4. Tips For Investors In Volatile Markets
    Investing

    Tips For Investors In Volatile Markets

  5. Industries Prone To Bubbles And Why
    Economics

    Industries Prone To Bubbles And Why

  6. How To Read The Market's Psychological ...
    Options & Futures

    How To Read The Market's Psychological ...

  7. The Fall Of The Market In The Fall Of ...
    Active Trading Fundamentals

    The Fall Of The Market In The Fall Of ...

  8. Taking The Bite Out Of A Bear Market
    Insurance

    Taking The Bite Out Of A Bear Market

  9. Fannie Mae, Freddie Mac And The Credit ...
    Insurance

    Fannie Mae, Freddie Mac And The Credit ...

  10. The Greatest Market Crashes
    Budgeting

    The Greatest Market Crashes

comments powered by Disqus
Hot Definitions
  1. Cash and Carry Transaction

    A type of transaction in the futures market in which the cash or spot price of a commodity is below the futures contract price. Cash and carry transactions are considered arbitrage transactions.
  2. Amplitude

    The difference in price from the midpoint of a trough to the midpoint of a peak of a security. Amplitude is positive when calculating a bullish retracement (when calculating from trough to peak) and negative when calculating a bearish retracement (when calculating from peak to trough).
  3. Ascending Triangle

    A bullish chart pattern used in technical analysis that is easily recognizable by the distinct shape created by two trendlines. In an ascending triangle, one trendline is drawn horizontally at a level that has historically prevented the price from heading higher, while the second trendline connects a series of increasing troughs.
  4. National Best Bid and Offer - NBBO

    A term applying to the SEC requirement that brokers must guarantee customers the best available ask price when they buy securities and the best available bid price when they sell securities.
  5. Maintenance Margin

    The minimum amount of equity that must be maintained in a margin account. In the context of the NYSE and FINRA, after an investor has bought securities on margin, the minimum required level of margin is 25% of the total market value of the securities in the margin account.
  6. Leased Bank Guarantee

    A bank guarantee that is leased to a third party for a specific fee. The issuing bank will conduct due diligence on the creditworthiness of the customer looking to secure a bank guarantee, then lease a guarantee to that customer for a set amount of money and over a set period of time, typically less than two years.
Trading Center