Not even close. Soros “only” made $1 billion on that trade. It was considered the biggest trade of all time until recently.
Back in 2006, he realized that the housing market was in some serious trouble. But to the rest of the world, the housing market could do no wrong.
Being an outsider to the world of real estate and mortgages, people discredited Paulson, saying that he didn’t know what he was talking about. Everyone from big banks to private investors kept on buying bad mortgages, not stopping to realize that the housing market could not go up forever and lenders were giving loans to anyone who could fog a mirror.
Although this seems like common sense now, at the time people were just too caught in the hysteria. Basically the same thing that happened during Tulip Mania, the South Sea Bubble and the Dot Com Bubble.
So what did I learn from this (audio) book?
1. Common Sense Is Not So Common
Even though Paulson and other investors around the country knew that real estate had to fail eventually, so-called experts and CEOs of investment firms were in a state of euphoria about the market. These otherwise very intelligent and astute investors were caught up in one of the biggest flaws in human nature.
It just goes to show that you should get educated, trust your research and trade your plan. You can listen to the opinions of others, but do not mistake them for fact. Even the best are wrong sometimes.
2. It Made Me Evaluate My Trading Skills
While I was listening to this book, a thought occurred to me. I got into stocks during the tech boom in the late ’90s. Never made a dime. I also got into real estate shortly thereafter but actually lost money.
What was the common reason? I thought about it for awhile and I figured out that I was listening too much to other people at the time.
If I thought for myself, I would have been able to make a ton of money. Now I know…
3. I Was Caught Up In the Euphoria Too
At the time when Paulson was putting on this trade, I was investing in real estate. Yes, actual real estate.
What was I thinking?
The basic economics of real estate at this time did not work. People were getting loans for houses that there is no way they could afford. Although this gave me an advantage as an investor because I could get better deals, it left a lot of downside risk.
I was working at a hedge fund that had a CDO trading desk and I should have learned all I could and figured out a way to get short when I realized that real estate could no longer sustain the move up. I didn’t have to invest in CDS contracts (and probably couldn’t have anyway).
But I could have bought puts on stocks of companies that held risky mortgage investments. It would have been a lot cleaner and easier to manage than real estate.
So as tempting a real estate looked at the time, I was caught up in irrational market too. This taught me that I have to check my own judgement at times and figure out if I am going with the herd or making my own decisions.
4. Being Right At The Wrong Time Can Be Expensive
You can be completely right about something and end up completely broke. I learned that you should ease into these types of fundamental trades. Put on a little at a time.
Then when things are really starting to go your way, you can load the boat. If you shoot your load too early, the market may still have a one last irrational run left in it that can clean you out.
They say that hindsight is 20/20. But in this case, foresight was also 20/20. There would be a market correction at some point. Basic economics would eventually prevail.
The devil was in the timing. This is why proper risk management and avoiding the all-in mentality is so important.
5. Sometimes You Have To Structure Your Own Trade
When Paulson wanted to short mortgages, there wasn’t really a way to do it. So he worked on a way to buy CDS contracts, which were insurance policies on certain grades of debt backed by risky mortgage pools.
This is what allowed him to build such a huge position against mortgages because these contracts were so cheap. Sometimes the answer is not so obvious, you may have to put in some work to make it happen.
In Forex trading, trades are pretty straightforward. You buy and sell. You don’t need to create obscure contracts, the trading vehicle is already there.
But sometimes, you might need to get a little creative and possibly use hedging, options or scaling. Learning about how Paulson constructed the trade helped me consider the alternative trading strategies that I could use in different situations.
Overall, I thought the book was very interesting, from a historical point of view. The writing was a little dry though and told rather matter-of-factly. The narrator was not the most exciting either and there was a lot of technical jargon.
If you don’t understand these types of investments, it may be a bit of a difficult read. However, in my opinion, this book is totally worth getting just to learn how he pulled it off. It is an inspiring story for any trader.
Oh, and by the way, do you know how much Paulson’s company made?
$15 billion…and then some because he also reversed the trade after the crash. This dwarfed Soros’ trade and will forever be remembered as one of the greatest trades ever.
If you aren’t into reading, you can also listen to the audio version.
So what will be the next bubble? Leave a comment below and let me know what you think.
This trade was actually the inspiration for our Bubble Trading Course. It teaches you how to take advantage of Micro Bubbles that happen in the markets every day. You don’t need to trade these huge risky bubbles, there can be a better way.
Disclaimer: I get a commission if you purchase some of the products listed in this post, but it goes towards supporting this blog and a portion is donated to my charity partner.