Learning from History: It Is Said Those Who Don't Learn from History Are Doomed to Repeat It. the Markets Are Littered with Carcasses of Those Who Didn't Heed This Warning. Derived from a Speech by Highbridge Capital's Henry Swieca, Here Are Some Case Studies of Market Shocks and Panics and What Traders Should Learn

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Markets are cyclical. That is an undisputed fact. So as part of a trader's toolbox, understanding market history, as well as using this information to take advantage of market reactions, is key to successful trading. Here is a look at some of the great "panics" of the past 25 years, how they affected the market and what traders should have learned from these volatile periods.

"A BILLION DOLLARS ISN'T WHAT IT USED TO BE"

The famous Hunt silver squeeze highlighted the combination of arrogance and greed in the modern commodities markets. Nelson Bunker Hunt and William Herbert Hunt were American oil billionaires and the sons of legendary wildcatter H.L. Hunt. Bunker personally believed in silver as a long term investment, primarily as a hedge against inflation, and that it had the underpinnings of a new economy. As a result, he decided to go heavily into silver, making large purchases in 1973 and 1974. In fact, the Hunts bought contracts so heavily at the beginning of 1974 that in less than two months prices doubled to $6.70 per oz. Even then, rumors abounded that the Hunts were about to corner the market.

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But it wasn't until 1979 the threat became real, and the Hunts convinced the Saudis to join them as big buyers in the silver market. Having risen slowly but steadily all year, silver prices suddenly jumped from $8 to more than $16 in only two months' time. Then a dangerous combination fueled the market even higher: voracious demand of big buyers, worldwide demand for precious metals as a hedge against inflation and unstable politics. Silver had remained relatively underpriced to gold, but was catching up. On Oct. 3, 1979, silver futures closed at $17.88 per oz.

Both exchanges on which gold traded, Comex (Commodity Exchange of New York, now a division of the New York Mercantile Exchange) and the Chicago Board of Trade went on red alert as prices rose. Conditions looked ripe for a squeeze, for along with purchasing silver, the Hunt's also held about 90 million ounces worth of silver futures, most contracts due for delivery in March on the Comex.

By the last day of 1979 the price reached a record $34.45 per oz.

On Jan. 7, 1980, the Comex announced new position limits restricting traders to no more than 10 million ounces worth of futures contracts. Strangely enough, the price of silver fell only one day in the wake of the Comex announcement then started climbing even higher. On Jan. 17, silver hit a record high of $50 per oz.

On Jan. 21, the Comex announced that trading would be limited to liquidation orders only. The next day the price of silver plunged to $34, a drop of $10 in a single day. By March 14, silver was down to $21 due to rapidly spiraling interest rates, which raised the cost of buying on margin.

On March 25, 1980, Bache International informed the Hunts of a $135 million margin call. Herbert responded: "We can't make it." It was the kind of news that raised the specter of a full-scale financial disaster.

On March 26, the Hunt group announced it was putting up its hoard to back the sale of silver bonds. The next day, the silver market collapsed; prices fell to $15.80 per oz. The Dow dropped a staggering 25.43 points, hitting its lowest level in five years.

Fearing the Hunts' inability to pay their debts might cause more major tremors in the national and international financial system, Federal Reserve Bank Chairman Paul Volcker gave his tacit approval on a plan to bail the brothers out. The Fed's fear was not only that some regional banks and investment houses would be hurt if the Hunts went under, but that the entire commercial paper market might collapse.

In January 1980, the Hunts' silver interests were worth $9.8 billion on paper. They came out of the silver crash with 80 million ounces, worth about $450 million five years later in 1985, assuming no further sales of their holdings. …