In the world of financial markets, a widow maker is an investment that results in large, potentially devastating losses. It can also refer to a trade that results in a loss for virtually everyone who tries it. The phrase has historically been used in forestry and medicine to describe something with the potential to kill quickly.
Key Takeaways
- In financial markets, the term widow maker refers to a trade that results in a large, even catastrophic loss.
- Widow maker can also refer to a trade in which the market repeatedly confounds market consensus and even defies historical patterns, leading to losses for all participants.
- The term widow maker has also been used in forestry and medicine to denote the potential for sudden death.
- A common widow maker trade in financial markets involves natural gas futures.
- The most infamous widow maker trade is shorting Japanese government bonds (JGBs), owing to Japan’s persistent push towards lower interest rates.
Understanding a Widow Maker
Traders frequently apply the term widow maker to financial investments that cause catastrophic losses or are risky enough to do so. In forestry, the phrase refers to loose limbs lodged overhead at risk of suddenly falling. In medicine, it refers to a blocked artery likely to cause a fatal heart attack.
Excessive risk often plays a critical role in widow maker trades. Investments likely to offer high returns also carry the potential for larger losses. Many investors base decisions on the amount of risk they’re willing to assume to achieve specific returns, measured by the risk/reward ratio.
However, certain widow maker trades, which might seem rational from a logical perspective, ultimately confound market consensus and historical patterns, resulting in significant losses.
Real-World Examples
Japanese Government Bonds
Shorting Japanese government bonds (JGBs) is perhaps the most renowned widow maker trade. For over two decades, traders have shorted JGBs as Japan’s national debt soared. Despite this typically sound strategy, the Japanese central bank has continually driven interest rates to record lows, even into negative territory, causing JGB prices to hit unprecedented highs and creating vast losses for many traders.
Amaranth and Commodities
Another notable widow maker trade involved natural gas futures, known for their price volatility. In 2006, Amaranth Advisors, a hedge fund, heavily leveraged a trade on natural gas futures, attempting to replicate prior success.
Amaranth, valued at $9.5 billion, had to close when it lost $6 billion due to a rapid decline in the natural gas market. Leverage amplified their risk, and instead of reaping substantial profits, Amaranth had to liquidate its assets after massive losses.
Natural Gas Today
The perpetual volatility of the energy market’s futures spread, particularly between March (a low trading point) and April natural gas futures, qualifies it as a widow maker trade. This spread shows the change from the demand-heavy winter months to the re-storage phase in April.
In December 2021, natural gas futures plunged to a three-month low. A miscalculation in supply and demand led to significant losses for investors on the wrong side of this volatile trade.
What Is a Widow Maker Stock?
A widow maker stock is one with high risk and high returns, capable of causing significant losses to investors. Generally, the term doesn’t refer to a particular stock but to trades that can result in major losses.
Why Is Natural Gas Called the Widow Maker?
Natural gas is dubbed the widow maker because of the price volatility between March and April futures contracts, based on fluctuating demand through winter. A wrong bet on this spread can wipe out investments, making it a highly risky trade.
Related Terms: risk/reward ratio, leverage, futures, interest rates, central bank.
References
- Trading Economics. “Japanese Interest Rate”.
- CFA Institute. “Amaranth Advisors”.
- The Hedge Fund Journal. “Amaranth Advisors”.
- Reuters. “Winter Is Coming. The U.S. Natgas Market No Longer Cares”.
