Great comment. Volatility is definately a very important variable in assessing any market.

What makes me particularly interested in the upcoming housing crash is that the nature of the housing market has irrevocably changed in the past 5-7 years.

This change is not unlike the changes in the cash currencies markets between 1999 and 2000 (when electronic access to these markets altered many of their characteristics).

The primary reason for this change in the housing market is higher leverage. Before 1990 it was extremely rare for you to be able to get a home loan for less than a 20% down payment. Before 1995 zero down and adjustable rate mortgages were not widely available. Although many economists have argued that adjustable rate mortgages are a small minority of the total mortgages, I would argue that this group could still have an impact.

All it would take would be a shakeup in the housing market (at least here in Southern California) to start the slide. In fact, the current downturn in the construction industry (due to fewer home starts) and the mortgage lending industry (who coincidentally utilize 70% of all office space in Orange County) could cause enough people to be laid off or “right sized” to cause a wave of foreclosures. This wave of foreclosures could hurt the above industries further causing a synergistic feedback cycle that would erode housing prices while devestating the economy.

This isn’t as farfetched as it sounds, especially in light of the all time household debt and country wide debt levels. As I’m sure you know as a fellow currency trader, if the Chinese (and Asia in general) were to lose confidence in the U.S. dollar and start selling U.S. Treasuries it could definately have a serious impact on the U.S. economy and housing prices.

I don’t think you truly appreciate the risk/reward characteristics of the equities market. The stockmarket has always been home to alot less risk averse participants, because all those participants understand one important historical characteristic of stocks: They have much higher returns (compared with real estate), because they require you to take on alot more risk.

Being a currency trader myself, I rarely dabble in the equities market or the derivatives of them. However, when I first got started, I was primarily involved in equities, options and warrants, and so have a broad understanding of all investment vehicles and their associated risks.

Furthermore, liquidity is an important measure of risk, but definately does not rank as high as you put it (especially from an investment stand point, as you put it). The most important measure of risk is the historic volatility of the security your are investing in, and by all accounts, the safest vehicle an investor can drive is definately real estate.

On a side note I enjoy reading your blog, this was a rare bump in the road for you.

The higher maintenance and upkeep is another reason real estate is more risky than stocks. Stocks can be pretty much hands off but real estate is as hands on as you can get.

Ah derivatives. Those were fun days. I would do a blog post about it but I fear my readers would get a head ache trying to understand it.

Real estate’s main advantage over the stock market is leverage.

I disagree. The main advantage (in Australia) is taxation. You get can set it up so you can rent out your investment property and negatively gear it. (Which isn’t so good) Or positively gear it and claim the cost of maintenance and repairs as a tax deduction. In Australia we also given free money - called the “First Home Owner Grant”.

Leverage is availed in the stockmarkets through margin loans, the use of equity from your property and through the use of derivatives like options (too complicated to summarise in a sentence, but basically a contract for a right to buy or sell a stock at a certain time), warrants (buying a structured product from a market maker which instills an interest component in the product) and CFDs (Where you trade on margin and can possibly “borrow” $1,000,000 from $10,000 but very risky).

Learn to manage risk and the return will pretty much take care of itself.

I agree… much of stock market trading is also about managing risk.