This Simple Trading Strategy Will Help You Identify A Ponzi Scheme

The average person believes that the Stock Market is rigged because of events such as Ponzi schemes, stock market crashes and Madoff.

It is true that the large institutions have a huge advantage and access to more information but you have to realize that the large financial firms also lost a ton of money to things like the Madoff Ponzi scheme, the scams at Enron, Nortel, Bear Stearns and Lehman Brothers.

Every financial loss provides us with a few life lessons and my personal specialty is to turn those losses into trading lessons. 

Today we will learn how to easily to spot a Ponzi scheme.

According to Wikipedia, a Ponzi scheme is a fraudulent investment operation that pays returns to its investors from their own money rather than from profit earned by the organization running the operation.

Avoiding Ponzi schemes is a very simple thing to do and it all starts with understanding your investment manager's mandate.

The investment manager's mandate is outlined in the Investment prospectus (the long document with lawyer like wording that no one reads) and it tells you:

1. What securities the manger is allowed to invest in: 
Cash, Bonds, Stocks, Real Estate, Derivatives, FX, Magic Beans...

2. If the manager uses a LONG only approach to generating returns or is an Absolute Returns manager, in that case that manager is allowed to make Money by being LONG or SHORT securities. FYI, Most managers are LONG only so it makes spotting the potential Ponzi scheme much easier.

Let's study the 8 Year weekly chart of the S&P 500.

A picture is worth a thousand words and this chart will prove it to you. It doesn't matter if you utilize fundamental analysis, let the technical footprint on the long term chart dictate the type of strategy you will use. It's simple and child's play but this technical filter will stop you from being caught on the wrong side of the trade.

The chart clearly shows that the SHORT setup provided the best opportunities from mid 2007 to early 2009. Those who stayed long had their portfolios decimated.

The chart also showed you that from early 2009 to mid 2013 that the LONG setup provided the best opportunity to make easy money. Those who went short also got decimated.

So how does this simple chart help you spot the Ponzi scheme?

Find out if the fund invests in Stocks, Bonds, Cash, Real estate and use the appropriate long term chart see if their returns match the shape of the chart.

As an example, if the fund in questions invests in stocks then use the Stock market average like the S&P 500 and match the monthly returns against the chart. 

Most managers typically mirror the stock market averages so if that manager posts consistent and linear profits using a LONG ONLY approach in a DOWN market then that manager is either a Trading God or is cheating. 

Simple as Pie. This simple strategy can also be used to analyze the stock market. 

Don't under estimate the power of a simple trading strategy. Little do you know that it has taken me over a decade of institutional trading experience to refine a lot of complex trading ideas into easy to understand simple trading strategies.

If you want to join my trading mentorship program, then contact me on BehindWallStreet.com.

By Joel Laceda - September 16, 2013 BehindWallStreet.com