Dancing on Thin Ice
Imagine a frozen lake and a thousand people on the banks.
Let assume that they all know that seasonality is not great, but some of them are still willing to give a try.
As nothing wrong happens to the first courageous adventurers, other people may be convinced that walking on the lake is possible.
Of course, there might be a few accidents, as the layer of ice is likely to display local forms of fragility given warmer weather. But unlucky people who might fall into the lake could still rely on the help of the others.
Later, more and more people have decided to go on the lake, and no major accident has occurred. Therefore, everyone is now convinced that the place has become risk-free. By the way, this is the definition of positive feedback loops.
Finally, the thousand people are dancing on the lake and everyone is having a good time.
The question is, what happens if a significant part of the ice structure suddenly collapse?
All that being said, this is exactly what is happening right now on capital markets. And this is the question that every frenetic dip buyer should asker himself/herself.
At this stage of the mania, there might be no additional warning. Retail traders have already piled into equities and call options, bearish divergences are everywhere, market breadth is declining, margin debt may be peaking, and volatility is being sold at lower and lower levels.
In plain English, this literally means that there is no margin safety.
As Charlie Watts once said, “I will never be the guy who plays the drums in front of a thousand YOLO traders dancing on a frozen lake.”
Except of course that he never said that.