I received an email last week from a reader who said he was a fairly new investor and his learning curve has been painful at times.
I know the feeling.
Contrary to popular belief, I wasn’t born with knowledge of the stock market. My first words were “mama” and “dada,” not “cash flow from operations.” And although my grandfather had a seat on the New York Stock Exchange, it wasn’t until I was a young adult that he talked to me about it. He died a short time later.[ad#Google Adsense 336×280-IA]My parents weren’t particularly interested in the markets, so most of what I learned, I did on my own.
And like many investors, my learning curve was painful too.
But rather than lament my stupid mistakes of the past, I consider it tuition.
It was the fee I had to pay to learn how to be a better investor.
And maybe by detailing the worst trade I ever made – which taught me several painful lessons – I can spare you some of the cost of “higher learning” in the markets.
It was back during the dot-com boom, and I bought shares of Quokka.
Quokka streamed video of outdoor sports like kayaking, mountain climbing, etc. It had just signed a deal to stream video from the 2000 Olympics. I thought that once the Olympics were near and Quokka started getting some press, its stock price would take off.
The problem was Quokka was a garbage company. And I knew it.
Painful Lesson No. 1
Don’t buy stock in companies you know are not solid businesses or are lacking strong prospects.
It had a cool idea and some devoted and talented people working there, but its finances were in shambles. To make matters worse, in 2000, most people didn’t have high-speed Internet to watch video.
I knew all this, but I had gotten caught up in the dot-com mania and bought shares anyway.
I bought shares of a company I didn’t expect to succeed. Then I compounded the problem by buying too many shares – more than twice my normal position size.
Which leads me to my next point…
Painful Lesson No. 2
Position size accordingly. Never let any one position make up such a large portion of your portfolio that a loss will cause distress.
Because I had so much money wrapped up in Quokka, stress from the trade was hard to handle. Every tick up and down caused anxiety. No trade should ever make you lose sleep.
Still, despite making two big mistakes, I actually had a big gain. I bought the stock at $7 and it quickly went to $15. So I casually mentioned to my wife that I was going to sell half of our shares because I knew the company wasn’t any good and this way we’d be playing with the house’s money.
This created an even bigger problem: My wife disagreed.
Painful Lesson No. 3
Don’t let other people’s agendas influence your investment or trading decisions.
We were house shopping at the time and she thought that if the stock went to $40, we’d have enough for a down payment. I explained that made me nervous. When she couldn’t convince me to hold on to the shares with rational arguments, she challenged my manhood.
What happened next? I proved to her that I was a man… and didn’t sell.
Almost immediately, Quokka started to fall.
Painful Lesson No. 4
Use a trailing stop or some other exit strategy that you put in place when entering the position. That way, you take emotion out of the selling decision.
When the stock dropped to $7, I said, “I’ll sell it when it bounces back to $10.” When it hit $5, I said, “I’ll get out when I’m at breakeven.” At $2, I promised myself I’d sell at $5. Quokka eventually slid to zero and the company went bankrupt.
I had no one but myself to blame for the loss. I was trading purely on emotion and had no strategy for exiting the position. I should have used a trailing stop. That would have gotten me out with a profit (I could’ve defended my manhood by saying I was sticking to my discipline – and discipline is very manly).
Even if I had placed the trailing stop once I was back to breakeven, it would have forced me to exit the trade with a small loss instead of a devastating one.
When I look back at the money I lost – and what it could be worth today, properly invested – it makes me sick. So, okay, I guess I am still lamenting… just a little.
Was it the only time I paid tuition to learn to be a better trader? Absolutely not. But it was my most expensive learning experience. Hopefully, by reading my tale of woe, your investment education won’t be nearly as costly.
Source: Investment U