What can traders learn from Brazil's defeat?

The World Cup has unsurprisingly spurred much media coverage (see above) as the world has been glued to the spectacle for the past few weeks. Brazil's defeat at the hands of Germany by 7-1, has prompted many questions. Absent from Brazil's team were Thiago Silva and Neymar. Whilst I am not a football pundit, it seems difficult not to attribute part of Brazil's loss to their absence. In a sense the team was centred around Neymar and without him (and also the usual captain), Brazilian goals were hard to come by and worse, the team lacked cohesion. Simply contrast that to Germany's performance, which really was a team effort.

There have been numerous articles on how Brazil's performance at the World Cup could impact Brazil's markets and more broadly even its politics (wonder what the odds are of Dilma winning now?). Before the World Cup, I wrote a Thalesians piece examining the relationship between vol markets and the tournament.

However, from a trading point a view, I believe there is something more fundamental which traders can learn from the defeat: diversification. Brazil had too many eggs placed in the Neymar basket. There was no diversification, just like a portfolio which has its risk concentrated in one position. This might well work, if your number one asset where you have all your risk is performing. However, it fails miserably, in all other cases. This is particularly the case if you are leveraged, where drawdowns can force you to exit a position sooner than you might want to do so. The idea of diversification is just like that of a team: together the portfolio should have better risk adjusted returns. Furthermore, when it does all go wrong, diversification is designed to make a bad situation at least bearable (admittedly easier said than done).

Whenever constructing a portfolio, we need to be aware of where the possible losses could come from and be prepared to mentally assign probabilities to them. If the probability assigned to a catastrophic event which could negative impact your portfolio is very high, is it really diversified? Are there hedges we could employ to reduce the risk or should we simply cut our leverage so that the risks are manageable (yes, simply cutting you risk can sometimes be an alternative to a hedge!). Just like a football team relying on its start striker, a trader cannot simply rely on their big trades going the right way all the time and needs to plan accordingly.

Football is the beautiful game. Trading by contrast is simply a game, whether it appears "beautiful" is another question.

To read more about this topic please see the below work I've done, which describes the impact of the World Cup historically on markets. My book Trading Thalesians also has a chapter where I discuss what ancient Greek sport can teach us about trading (mixed in with a bit of ancient history).

Thalesians - Jules Rimet still gleaming - Impact of World Cup on financial markets -3 Jun 2014 (available for Thalesians clients only)