In our previous article, How to take advantage of an impending crash- Part 3: ultra-conservative approach, we mentioned one conservative strategy. Today, we will introduce a short-term trading strategy?asymmetric payoff. Please note that our previous article, How to take advantage of an impending crash- Part 2: understanding a subtlety, contains pre-requisite understanding for this article.

The basic idea behind the asymmetric payoff strategy is simple. First, you structure your bet in the market such that if you lose the bet, your loss is very tiny, but if you win, your gain is very massive. Next, you bet that the market will crash within a specific period of time. If you lose that bet, place another bet for the next period of time. You do this repeatedly until the day of the Black Swan event when your profit overwhelmingly overshadows your accumulated small losses.

Obviously, the disadvantage of this strategy is that it requires fortitude to absorb small losses indefinitely while waiting for a highly rewarding final vindication in the end.

The next question is, how do you implement such bets in practice? We will slowly reveal the answer in the next series of articles on how to implement asymmetric payoff bets.

Hence, today we conclude this series. One final note: each of these strategies has its time and purpose?even the risky one mentioned in How to take advantage of an impending crash- Part 1: the risky way can be used when the bull market ultimately turns over into a bear market after the crash. Therefore, it is not necessary to restrict yourself to only one strategy. With planning, you can include each one of them in your grand overall strategy.

In our previous article, How to take advantage of an impending crash- Part 2: understanding a subtlety, we mentioned about understanding the crucial subtlety in today?s current market conditions. Now that you are armed with this understanding, let us consider some strategies. Please note that we are not in the business of giving financial advice. Therefore, the strategies that we are going to mention are neither endorsements nor recommendations?please consult your financial advisers before making any financial decisions.

Today, we will examine an ultra-conservative strategy?Liquidate and Wait. We will not judge this strategy to be ?good? or ?bad? because whether it is the former or latter will depend on your personal circumstances, personality, risk-tolerance and temperament. But if you are the sort who is particularly risk-adverse, perhaps this strategy may be suitable for you.

For this strategy, the first step is to ask yourself what you think the aftermath of the Great Crash III will be. The answer to this question will affect your investment decisions (more on that later). We can think of three models for the aftermath?1929, 1987 and Germany-1920s. Since we cannot foretell the future, our guess is that the aftermath may not follow exactly on any one of these models. In fact, it may be a hybrid of these models (and something else), or perhaps something no one in this world can see today. But these models serve as a useful tool to help us understand what may come in the future.

1. The main idea behind the 1929 model is deflation. In the Great Depression (that began with The Great Crash of 1929), there was asset deflation and economic hardship among the populace. It was said that it took a year for the effects of the great stock market crash of 1929 to be felt by the average person on the street.
2. For the 1987 model, the magnitude of the stock market crash of 1987 greatly surpassed that of 1929. It was the greatest one-day decline since 1929 in stock market history. There is an air of mystery with regards to the 1987 crash. Up till today, no one really knows why it happened. Fortunately, a global economic depression did not ensure, and by 1989, stock markets had recovered.
3. The main idea behind the Germany-1920s model is hyperinflation, which is also what Zimbabwe is experiencing right now.

The next step for this strategy is to identify assets that you would like to own at the right price. Your choice of assets will be affected by what you believe the aftermath of the Great Crash III will be. If you believe that hyperinflation will occur, then it is a priority to accumulate gold. If you follow the 1929 model, then strong businesses that can thrive in tough economic environment will be your priority. Our article, Inflation or deflation first? holds some of our thoughts in this matter.

The third step of this strategy is to liquidate a portion of your assets and wait for the crash.

The final step is to buy up the assets that you had identified in the second step after the Great Crash III.

What is the main weakness of this strategy?

The Great Crash III may take quite a long while to arrive. Keeping your assets in the form of fiat money (while you wait for it) will mean that they will lose their value through the ravages of monetary inflation (see Epic, unprecedented inflation) in the meantime.

Is there yet another strategy to take advantage of an impending crash? Keep in tune! It will be interest!

In our previous article, How to take advantage of an impending crash- Part 1: the risky way, we used a bad strategy as a negative example to show you how NOT to go about seeking to profit from the coming Great Crash III.

In the days to come, we will show you some better strategies. Before you can appreciate why that previous strategy (the negative example) is a bad one and why the ones that we are going to show you are safer, you have to make sure that you understand a subtlety. It is easy to fail to see it, which can be detrimental to your wealth. So, here it goes…

If someone asks us, ?Is the market going to go up or is it going to come down?? a simple and direct answer of ?Up? or ?Down? will be too simplistic to reveal a subtlety. Back in How dangerous are credit derivatives?, we quoted a document from the Reserve Bank of Australia (RBA):

… It is possible that the very developments that have contributed to the increased robustness of the financial system to most events, through the wider dispersion of risk, could actually amplify the disruption following a serious shock….

This implies two things:

1. In today?s market, the probability of the market going up is higher than the probability of it coming down. Hence, it is rightly called a bull market.
2. But should it come down (which is unlikely), it can collapse at extremely great speed and magnitude.

Hence, the stronger and longer this uptrend continues, the greater in magnitude and speed (as in volatility, not timing) the Great Crash III will be. Hence, the coming Great Crash III is a Black Swan event?an improbable but colossal impact event. Note: For those who are interested in the subject of Black Swan, we highly recommend Nassim Nicholas Taleb?s book: The Black Swan: The Impact of the Highly Improbable.

The problem with Black Swans is that much of the world?s financial models have blind spots with regards to it (see Expect the unexpected with risk models that can?t anticipate the future). For us, as investors, it will be a folly to assume away Black Swans.