Examples of Bad Trades
I have taken the time recently to look over my investments from the past few years and examine those ugly trades I wish I had never done. As painful as it was, it was a very enlightening experience for me. I found a correlation between my trading style and the return on my money. Of course, a sample of one is by no means statistical evidence, but after talking with others about their investments I find that I am not alone.
So, what is that correlation you ask? My worst investments have been the ones where I did not follow the same reasoning for selling the stock as my initial buy. The simple fact remains that for one to invest and plan to be successful, one must have a strategy, regardless of what that strategy may be. A trader can be a trader and an investor can be an investor, but woe to the person that thinks they can have feet in both camps. What follows is a description of two types of trading styles that may lead to significant reductions of your returns.
Buy as a Trader, Sell as an Investor: This type of person usually uses technical analysis and story headlines to find their latest "hot pick". They may even use a momentum technique for buying, such as CANSLIM or maybe one of Wade Cook’s books. All well and good. I, myself, use the CANSLIM method from time to time, but the key is that I use THE ENTIRE method. This means you fire the stock from your portfolio after an 8%-10% decline. Period. Unfortunately, the type of investor I describe feels that somehow they must hold onto the stock with a death grip. We’ve all had friends like this, right? These individuals will hold onto some dog stock that they bought on a whim or a tip from their broker. They usually end up selling the stock two years later for a fraction of its original worth or, if they’re lucky, for a few bucks profit so they can brag about it on the golf course.
What I find interesting about the "Buy as a Trader, Sell as an Investor" type is that this individual has had the recent opportunity to make huge gains. The Internet stocks are a primary example of a great opportunity if you were you willing to ride the wild swings. A straight trader in the Internets would take a much more cautious approach. A good trader would never get caught down 30%-50% in their position, which is exactly the type of price swings you’d have to stomach with the Internet stocks.
So how do you know you fit into this category? Chances are your investment has the following attributes:
1) You’ve bought near the all-time high because the stock looked to be moving, and it is still moving…down.
2) You evaluate where you are going to sell the stock based on your cost rather than looking at what the company should be worth.
3) You find that you’ve told yourself several times already that the next quarter will be better than the last one.
4) Your analysis for the company consists of using yardsticks that are two or more years out just to get the stock price to look reasonable.
Buy as an Investor, Sell as a Trader: This category is a horrible one that most of us have fallen into at one time or another. You do all the analysis: the hours of calculations, ruminations, investigations, and sweat. You finally decide that this company belongs in your portfolio for the long-term. Then one of two things happens and your emotions take over:
1) The stock jumps in a quick period of time, maybe even after lying dormant for a while. In the excitement you pull the trigger for a 25% gain. The stock then goes up an additional 100%, which just happens to be your original target goal. Ouch.
2) The stock starts to languish and you begin to second-guess your fundamental analysis. You fire the stock from your portfolio and are promptly rewarded with the stock rebounding in your face.
This type of investing behavior is the hardest to overcome. The urge to take your money and run can sometimes be unbearable. The fact remains that if you buy into a company based on fundamental analysis, your reason for selling should likewise be based on fundamental analysis. Now this doesn’t have to be a price target at all. It may be something like, "When the sales of the flagship product drop off", or "If the company isn’t able to achieve XYZ in ABC timeframe".
So, how do you know you fit into the "Buy as an Investor, Sell as a Trader" category? Look for the following attributes:
1) You constantly check the price of the stock.
2) You trade in and out of the stock regularly even though you bought the company based on good long-term fundamentals.
3) Like the "Buy as a Trader, Sell as an Investor" type you also have a tendency to value the company on your cost basis, possibly even subconsciously. Oddly enough, I have seen people do this even when their initial analysis was flawless.
I’m not trying to say that everybody fits neatly into these two categories. For example, maybe your portfolio has become too lopsided or you find that your risk tolerance isn’t exactly what you thought it would be. There is nothing wrong with these reasons for selling, just so long as you have taken a long hard look and KNOW why you’re selling.
Now, after all that investigation I have come to one conclusion to keep me on the straight and narrow, a rather simple solution…every time I contemplate selling my stock in a company I ask myself the question, "Why did I buy?"
Now, after all that investigation I have come to one conclusion to keep me on the straight and narrow, a rather simple solution…every time I contemplate selling my stock in a company I ask myself the question, "Why did I buy?"
