The "Perfect" Trade

Don't overthink it.

This week there was a perfect setup for an amazing trade, and I killed it.

No, actually, I completely botched it and actually lost money. Let’s walk through what happened.

The Setup

I wrote an overview about Mirror Protocol almost a year ago. Give that post a quick read if you haven’t been using Mirror Protocol, and then meet me back here…

Mirror’s governance decided to raise the minimum collateral ratio (MCR) for two mAssets, mSPY and mKO. It was previously at 110%, and was raised to 130%. That’s a level with greater safety for the protocol, but resulted in liquidations for any users with collateral ratios in that range. Since the liquidations would go through right at pre-market open after the change, there would be a big spike in mKO and mSPY trading prices, at a known time, for a very short window.

Joseph Savage ⚑ @MasterGerund

There are ~$3.5 million worth of mKO positions on @mirror_protocol that will get liquidated tomorrow when the MCR increases, and only $6.5 million of mKO in the @terraswap_io Liquidity Pool. Probably nothing... #Terra #IYKYK

The Execution

Even though I knew that mKO had a lot more pending liquidations than mSPY, I split my position 60/40 between mKO and mSPY. Diversification, amiright?

I saw dollar signs, big payday, potential 25% move… so I locked all my mKO and mSPY into vaults, borrowed other mAssets against it, sold those into the market, and put on as much size as I could.

I had so much confidence in the trade that I took the 60% of my portfolio that I could liquidate easily and shift into this trade, and then levered it up 70%, so my total trade size added up to … 60% * 1.7 = 102% of my total portfolio. Highly confident, much size.

The Fallout

Pre-market opens at 4 a.m. in New York, and I was at my desk at 1 a.m. on the west coast, freshly brewed coffee, 3 hours of sleep.

Pre-market opened, liquidations start to go through, and both mSPY and mKO spiked 25%, exactly as expected. But I had only $4000 of mSPY liquid and had to work through all my vaults, one at a time, to fully unwind the rest. Got 20% premium on the first couple of trades, great start… trades on terra taking 20-30 seconds (compared to normal 3-5 seconds), not very helpful…

I get through about 1/3 of my vaults with an average exit up 10-15% from my entrance price, which is a great beginning. But by that point all of the liquidations have worked their way through the market, and everyone that took an unleveraged trade has taken off their profits and started shorting because they expect the mSPY and mKO prices to revert back to a small discount to Oracle.

I get through half of my vaults, and the mSPY and mKO premiums have completely disappeared. I’m now at breakeven on my mSPY and mKO pricing, but i’m still paying closing fees for my borrowing, along with slippage on buying in my short positions that I used for leverage.

By the time I unwind everything, I’m down 5% overall. Since I was levered up to 102% of my portfolio, that means I’m down 5% on the week, after a ‘perfect’ trade!

Summary

I broke all my rules, and I turned a “perfect” 25% setup into a 5% loss.

If I followed my normal risk framework, I would have had about 20% of my portfolio on the trade, made about 25% on it, and walked away with a 5% increase on my total capital base!

If I put in 60% of my portfolio, but with no leverage, it could still have been a juicy 15% gain on the week.

Lessons

• Lesson 1: stick to your risk framework

• Lesson 2: don’t overcomplicate it

• Lesson 3: don’t get greedy, it turns “smart” into stupid

• Lesson 4: leverage changes the risk parameters of a trade - make sure you fully understand the impact, or don’t use leverage

• Lesson 5: when a trade is still crowded, you have to time it perfectly or you can still get carried out

• Lesson 6: a “perfect” trade is always crowded. You are not the only smart person in the room.

• Lesson 7: aim small, miss small. Since you can’t time it perfectly, make sure that your size is manageable, so that you can at least get it close

Incidentally, I keep relearning Lesson 4… This should teach me something. Maybe I’m learning the wrong lessons from this. What do you think?

Not financial or tax advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. This newsletter is not tax advice. Talk to your accountant. Do your own research.

Disclosure. From time-to-time I may add links in this newsletter to products I use. I may receive commission if you make a purchase through one of these links. Additionally, the Savage Corner writers hold crypto assets and actively trade in certain markets.