the spring and early summer. Finally, on July 11, 2008, oil peaked at $148 a barrel. Now under extreme pressure from the public, President George W. Bush issued an executive order on July 14 removing the ban on offshore drilling that had been in place since 1990. This was largely a political tool, as it did not change production or distribution capacity. By the end of July, oil had retreated to $125. It appeared that the worldwide demand for oil, which six months before could never be satisfied, was now overwhelmed by supply. The global meltdown in housing prices further reduced the amount petroleum by-products needed in construction.
Throughout the fall, oil prices continued to collapse, as the global stock markets plummeted and cash was poured into US Treasury Bonds. The world didn't seem to care that the yield on the 30-year investment was less than 3 percent, the lowest return in 80 years. The cash price of West Texas crude oil bottomed at $38 a barrel on December 21, 2008. In less than six months, the price had fallen by 75 percent, and trillions of dollars had been lost.
Who was to blame for this unprecedented implosion?
Well, according to testimony before congressional committees, the government claimed that there was a single source – the usual suspects, the greed on Wall Street. On June 3, 2009, testimony before the Senate Committee on Commerce, Science, and Transportation, former director of the CFTC Division of Trading & Markets Michael Greenberger fingered the Atlanta-based Intercontinental Exchange founded by Goldman Sachs, Morgan Stanley, and British Petroleum as the agency playing a key role in the speculative run-up of oil futures prices traded off of the regulated futures exchanges in London and New York. In January 2011, crude oil reached the $100 a barrel mark once again.
Bitcoin 2009 to Present: Crypto-Currency Meets Greed
The last bubble we will examine is one that is current, and the final results are not in. Proponents claim that this is the techno-currency of the future; detractors claim it is a way for criminals to hide transactions and is most likely a Ponzi scheme.
Look at the results thus far and you can be the judge.
Bitcoin first appeared in a scientific paper and is credited to the name Satoshi Nakamoto. Since no one has come forward to claim its authorship, it is difficult to determine if it is a pen name or simply an individual or a group that wants to remain anonymous.
Bitcoin is a digital currency that doesn't have any ties to a central bank. The point-to-point payment system allows for transactions to be made in complete anonymity. The coin is created by a complex set of computer codes that create the currency through a process called mining. Unlike central bank–issued currency, which can expand and contract the money supply, bitcoins have a finite number, and once the final coin is mined, it is a closed environment. In addition to being untraceable, the value of the currency is not being manipulated by a central bank. Proponents claim that in the long run, it will allow for a stable market and that supply and demand will establish its value. Opponents claim the opposite – that this trait gives it all of the features that promote extreme price manipulation and can give seeds to a massive Ponzi scheme.
The price history of Bitcoin suggests that the opponents' view is hard to argue.
In 2011, the price of a single Bitcoin fluctuated from a low of 30 cents per US dollar to as high of $32 before crashing back to $2. If this is supposed to be a way to put stability in a currency system the initial result seems to indicate the opposite. In March 2013, the Bitcoin exchange known as Mt. Gox had a software meltdown and triggered another massive selloff in the crypto-currency, as prices plunged by 70 percent in less than three hours. The market recovered and rallied back to over $1,100 a Bitcoin before a selloff in January of 2014 saw the price go down to $500 in less than a month. A rally in February of 2014 took the price back to $1,000 until money laundering and Internet scandals involving one of its strongest proponents rocked the currency. Later in February, Mt. Gox was again the victim of a computer glitch and suspended withdrawals. This time, the exchange closed and admitted that $350 million worth of Bitcoin was missing from its vaults. The victims of the loss are currently looking for a legal jurisdiction to pursue criminal action. The irony of this is that the traders who are searching for their money ($) were using the Bitcoin to avoid legal detection, and were manipulating the crypto-currency for profit; they are now complaining that they were scammed!
Isn't this the same defense that Bernie Madoff's minions used to defend the millions that they helped to steal off of investors? They also claimed that they were the victims because they took the stolen money and invested it with Mr. Madoff!
As of this writing, the Bitcoin is trading around $350, a drawdown of over 70 percent from its peak value during the height of the mania in December of 2013. Whether it will turn out to be a highly speculative investment or just another Ponzi scheme can't be determined at this point, but one thing is certain – it has not proven to be anywhere near as effective as advertised in combating the weakness of central bank–issued currency. In fact, it has multiplied any of their shortcomings many times over!
Lessons to Be Learned
Six famous markets have been examined. The time frame stretches for almost 300 years. Four of these markets resulted in bubble tops, one ended in an implosive bottom, and one is not a final score. Various reasons were given in order to justify the price action. Various underlying assets were involved in the bubbles.
Can we find a common thread?
● At market extremes, emotions drive the markets, not rational thought!
When the markets were rallying, it was not the value of the underlying asset that drove the market higher; it was the mind-set of the investors.
● Investors become overwhelmed by greed.
When it seemed that anyone could get rich in the South Sea Company, no one wanted to miss that ship.
● Investors become paralyzed by fear.
In the case of the implosion after the 2001 terrorist attacks, fear drove investors to unload their stocks in a hurry.
● All market extremes are driven by two forces – fear and greed.
Markets might generally pay attention to asset value, earnings, and global trends, but when emotion starts driving price, it can take over in a hurry.
You might be wondering why a book on how to trade weekly options would start with a chapter about economic history. I believe in order to be successful trading in the markets, you must be able to understand how the price got to certain levels and how to control your emotions when everyone around you is losing control of theirs.
Without an understanding of market psychology, it is almost impossible to be successful. You have to know what the other side of the trade is thinking and how they are reacting.
After each chapter, there will a brief quiz. Take it and check your responses in the answer section in the back of the book. The questions will be multiple choice, and the number of points you can earn on a question will vary from one to three. If you can score 90 percent on any of the tests, you are ready to go to the next chapter. If you struggle with the quiz, please reread the material before going to the next section. This book is a building-block system to approaching the markets, and, therefore, if you don't build a solid foundation, the whole structure can come crumbling down.
Chapter 1 Quiz
1. The South Sea Company was set up to:
a. take advantage of new trade routes to the South Seas
b. be the world's first franchise
c. fund the Crown's debt from the Spanish War of Succession
d. do all of the above
2. Who funded the South Sea Company?
a. investment bankers
b. the British Crown
c. individual investors
d. all of the above
3. Why did Sir Isaac Newton lose his fortune in the South Sea bubble?
a. The South Sea stock was allowed to trade freely.
b.