John Paulson has had a tough year, and that’s probably a bit of an understatement. Ever since he made the prescient call that the housing market would collapse, and the sub-prime mortgage market would implode, everything he’s touched has turned to coal.

Paulson’s Advantage Plus hedge fund was down over 53% this past year and then there was his disastrous call on the Chinese timber company Sino-Forest, which over stated its timber holdings and Paulson’s hedge fund sold their entire stake at a $468 million loss. Most recently, Paulson sold his stakes in Bank of America and Citi, only to see the financial sector soar at the start of the year.

So, it was a relief and a sign that perhaps his luck had turned when he won the Mega Lotto this weekend. However, Muddy Waters, the same firm that investigated Sino-Forest, and said they were exaggerating some of their assets, now says Paulson’s lotto ticket is a fake. Paulson is fighting this allegation and says he bought the ticket at a 7-11 in Southampton along with a hot dog and a large Slurpee. Muddy Waters made this statement about Paulson and the ticket:

“We’ve had our forensic accounting analysts examine the lotto ticket and it’s blatantly clear that this is a forged ticket. To think that Paulson, who made billions of dollars years ago, would stoop to this level just shows how much he and his hedge fund are struggling. Plus, there’s no way that Paulson would ever buy a Slurpee at a 7-11.”

Plus, his own hedge fund has taken some big hits of late, suffering heavy losses. His fund is down big with a huge loss on Chinese timber company Sino-Forest and then his positions in Bank of American and Hewlett Packard haven’t been winners to say the least. Despite all of this, Paulson wants to keep buying stocks.

“Price-earnings ratios are at historic lows. This has created many buying opportunities where companies are trading at extremely low valuations irrespective of strong performance.”

It’s a brilliant read, touching on all the major hedge funds and their various strategies. What jumped out though was John Paulson putting on his big bet via the subprime mortgage index the ABX – here’s the passage from the book. I love the line the trader uses, ‘Tell us your picture’.

The challenge was how to do the trades in the size that he now wanted. Paulson could bet against mortgage bonds by borrowing them and selling them short, a cumbersome operation. Or he could buy an insurance policy – a credit default swap from a bank – but that depended upon finding a bank that was interested in selling.

To Paulson’s great good fortune, in July 2006 Wall Street’s top investment banks created an easier option: Hoping to earn themselves a stream of trading commissions, they launched a subprime mortgage index, known as the ABX. Paulson now found that, on any given day, it was easy to buy insurance on, say $10 million of subprime paper. Then, a week or two later, he took a call from one of the big banks. The man on the line was an ABX trader.

“What’s your picture?” the trader demanded. He was willing to deal with Paulson in size. How many millions’ worth of subprime bonds did he want to buy insurance on?

Paulson considered. He didn’t want to scare the trader off. If the ugy knew ho much insurance Paulson really wanted, he surely would not be stupid enough to sell without first moving the price against him.

“Five hundred million,” Paulson ventured.

“Done,” the trader responded.

“Another five hundred million,” Paulson said.

“Done,” the man repeated. He wasn’t flinching in the least. Then he said again, “Tell us your total picture.”

“Call me again tomorrow,” Paulson said, and the next day he bought insurance on another $1 billion of subprime bonds. In the first half of the year, he had hustled to lay his hands on $500 million of this stuff. Now, in just two days, he had bought four times that quantity.

“Tell us your picture,” the trader said again.

Paulson thought to himself, this is the holy grail. He remembered Soros’s words: Go for the jugular.

“I’ll do another $3 billion,” he said. At this, there was a silence on the line. The trader agreed to another billion, then balked at doing any more.

Well, CNBC’s Kate Kelly is also saying that Paulson may regret selling his BAC shares after this news. Is this odd? Yes. Doesn’t really seem like much of a story. Seems more like waffling on the part by Paulson, is he bullish on BAC or bearish? Hard to tell. And not good for any investors looking to follow Paulson – who become legendary when he bet, correctly, the housing market would fall apart in 2007-2008.

During the course of the past two months, Paulson sold a substantial portion of its 124 million-share stake in BofA, according to these people.

In light of yesterday’s news, firm founder John Paulson may now, in fact, be regretting his decision, these people say, and looking to upsize his holdings in the bank yet again.

The apparent selldown is significant because of Paulson’s outsized influence both in the hedge-fund world and at BofA, where he is the eighth-largest shareholder of record, according to first-quarter securities filings.

ZeroHedge, the get to the point and straight talking financial blog, is saying Bank of America is under reserved and there’s more likelihood of other mortgage backed settlements from the CountryWide purchase by BofA. In other words, the stock will have to sell shares to raise capital at some point.

“Due to the uncertainty over Sino-Forest’s public disclosures and financial statements, we have sold our stock and await the results of the independent committee’s investigation,” a spokesman for Paulson & Co said in an e-mail on Monday.

While it wasn’t immediately clear how much Paulson lost on the sale, his 14.1 percent stake in Sino would have been worth C$897.4 million as of the end of March. The same stake would be worth just C$94.8 million at Monday’s closing price.

So, if you ever feel bad about losing money in the stock market, refer to this post. However, remember Paulson made billions of dollars shorting the subprime real estate market in 2007-2008, so he can afford a loss, even if it’s upwards of a billion dollars.

The debacle in Sino-Forest is of course due to a short trader from the firm Muddy Waters, who said Sino-Forest was a Ponzi scheme.

What did the Muddy Waters report say, it called Sino-Forest a Ponzi scheme. The full report is here.

Sino-Forest is a Chinese lumber and forest plantation company, basically they buy and sell forests in China. Buying Chinese stocks has always been a risky business, as too much is unknown and their rules and regulations are even more fragile than the ones in the United States. They seem to be ripe for fraud and extremely violate.

However, some guru investors aren’t afraid of buying Chinese stocks, one being John Paulson, who wisely shorted the financials prior to the market collapse and then bought back the banks just after the collapse. The hedge fund of Paulson and Co. is Sino-Forest’s biggest shareholder, as they own 34.7 million shares. So, if Paulson didn’t sell his Sino-Forest shares prior to the Muddy Waters report, he lost half a billion dollars in a day or two.

Here’s the story on Sino Forest from CNBC’s Herb Greenberg:

So, if you’re stocks took a hit this week don’t feel so bad, can’t be as bad as that.