What is 'Pain Trade'

Pain trade is 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.

BREAKING DOWN 'Pain Trade'

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 and early 2000s. As the Nasdaq soared 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 percent 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.

A Long-Term Strategy May Neutralize Pain Trade

The strong recovery in global markets from 2009 onward has proven 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. Recession

    A recession is a significant decline in activity across the economy ...
  2. Economic Collapse

    An economic collapse is a prolonged breakdown of a country's ...
  3. Recession Rich

    Recession rich refers to a person who manages to do well financially, ...
  4. Global Recession

    A global recession is an extended period of economic decline ...
  5. Growth Recession

    Growth recession describes an economy that is growing at such ...
  6. Financial Crisis

    A financial crisis is a situation where the value of assets drop ...
Related Articles
  1. Investing

    The Painful Truth About Leveraged ETFs

    Unfortunately, the growing popularity of leveraged ETFs is coming at a painful price.
  2. Managing Wealth

    Investing In Crisis, A High Risk-High Reward Strategy

    The financial crisis of 2008 and the great recession that followed is still fresh in the memories of many investors.
  3. Investing

    Nektar Pharma Opioid Drug Shows Promise In Phase 3

    Nektar Therapeutics' opioid drug NKTR-181 reported positive results in a late-stage study.
  4. Personal Finance

    Components Of The 2008 Bubble

    The 2008 financial crisis proved that no two recessions are the same.
  5. Investing

    Recro Pharma Pain Drug Does Well In Study (REPH)

    The on-track progress enables Recro to file for FDA approval by mid-2017.
  6. Investing

    Teva's Pain Drug Gets Approved By The FDA

    Shares of Teva are up slightly today after the company announced the FDA approved its pain management drug.
  7. Investing

    Traps That Lead to Market Underperformance Part II

    There is a vicious investing cycle that impacts many young and first-time investors.
  8. Investing

    The Bond Market is Trying to Warn Us of Trouble

    Are central banks to blame if the bond market collapses?
RELATED FAQS
  1. How does the performance of the stock market affect individual businesses?

    Learn how stock markets affect individual businesses by influencing consumer spending levels and affecting the way companies ... Read Answer >>
  2. What causes a recession?

    A recession is a significant decline in economic activity lasting more than a few months, normally visible in real GDP, income ... Read Answer >>
Trading Center