|
|
 NEWS |
|
|
|
|
Resident trader
Revenge trading
Will Kraa, August 6, 2007
As I mentioned in the last two articles there are times when ‘the market’ seems to go mad and the last few days have all the appearance of that. It must be the time for this sort of thing as prices of XJO stocks on my WebIress screen were almost all red on Wednesday but nearly all blue on Thursday. Fortunately the good folk at WebIress are thoughtful souls who colour down in red and up in blue and that means that colour-challenged people like myself can see which is which, not like some chart designers who use green for up and red for down forgetting that there is a significant portion of the population who cannot tell the difference.
Getting back to the subject of madness I might as well tell you about some very clever trading I did way back in 2001. There was this company called Pasminco which owned some very good zinc mines that were going to make a fortune except that the stock market did not seem to realize that. The price in fact was going down and down and it was getting cheaper every day.
That was in the days when shorting was still a somewhat complicated thing to do and if CFDs were around in Australia I certainly had not heard of them. I wanted to do some short term trading of PAS (Pasminco) and buy it when it was down and sell it again as it rallied a bit for just one or two cents profit. It would of course have been much better to short sell a stock in a downtrend but that was not so easy back then.
So on 21 June 2001 I bought 10,000 PAS for 26.5 cents and sold them on 26 June for 31 cents to make a total profit of $372.42 after brokerage. That seemed good at the time and so in view of the experience this gave me I thought I was now ready for the big profits wthat were obviously there to be made by this kind of ‘strategy’.
Being now ready for the big trades I bought 100,000 PAS for 23 cents on 6 July and sold them for 23.5 cents on 20 July for a grand total profit of $434 after costs. This trade was obviously a bit slow so to help things along a bit I bought another 100,000 on 13 July at 19.5 cents and sold them the same day at 20 cents for another $434. Those of you who are observant might have noticed that this means the trade I opened on 6 July was at that stage showing a loss of about $3,000 while I did the 13 July trade but fortunately it recovered by the time I sold it so I could get out of it at a small profit. Trusting in luck is of course not a very good trading strategy.
But on 20 July after I closed the 6 July trade at 23.5 cents prices fell to 22.5 cents during the day, an obviously very good buying opportunity (since I was desperate to make some profit out of this stock) so I bought 200,000 this time at an average price of 22.75 cents. Shortly after this the price dropped even more and the small profits previously made were rapidly disappearing. It became plain that there was something wrong and the rational thing to do was to sell, take the loss and move on.
As you have probably noticed by now rationality did not enter into the equation as I did these trades and since taking a loss was not to be contemplated I looked for reasons to hang on and hope for a recovery. I found it in a fundamental software package I used at the time. PAS certainly was not a ‘Star’ stock but from the financials it seemed that there was no likelihood that the stock would fail. There were more assets than liabilities so it seemed reasonable to hang on and hope for things to improve.
These financials did not take into account things like hedging the zinc price and that is what brought things undone. As things got worse there came a stage where the hedging became a liability which the company was not able to cover and the receivers were called in. Finally a deal was done which gave the assets of the company to secured creditors and left shareholders with nothing. The company was refloated by the creditors under a different name and the PAS shares became basically worthless. The new company was called Zinifex and as you can see from its chart there was actually plenty of value in the company but none of it came back to the shareholders of the previous company. Certainly the creditors did very well while the shareholders lost all. No doubt a very fair arrangement for the banks and who cares about the shareholders?
Now you might wonder what on earth I was doing trading in this way. In the first place there is little sense in going long in a company which is in a serious downtrend and there is a simple rule which would have kept me from losing over $40,000. The rule is never to buy a stock which is trading below a declining 30 week (or 150 day) Moving Average. I learned this rule from Stan Weinstein’s book ‘Secrets for Profiting in Bull and Bear Markets’ which I can recommend as a good book to study. Unfortunately I learned it too late for this trade.
What posessed me that I should be trying to make profit from going long in a stock like that on the brink of failure? To understand that it might help to know that I had previously owned the stock when analysts lauded the merits of its Century mine. Unfortunately some things did not go to plan and the price fell so I lost money as I sold the shares. I should have left them alone after that but somehow I was keen to get my money back.
It is called ‘revenge trading’ and involves trying to trade a losing stock to recover the money lost from a previous trade in the same stock. It does not involve rational rules so it is a very easy strategy to follow. Naturally it is the kind of trading eminently suited to beginners who like to donate lots of money to those who know what they are doing. There is a way to get back the money from a trade where money is lost but it is not by trading the same losing stock while it is still in downtrend. It is by finding another trade where the signs are good and then following the rules in trading it.
In fact this revenge trading is simply an emotional reaction which almost inevitably leads to greater losses. That in itself was bad enough but it set me up for worse. Seeing I was desperate to recover previous losses there was no chance I was going to admit that I had it all wrong and that the best thing to do as the stock went down to 18 cents was to get out quickly and accept the $9,500 loss this entailed.
Of course I did not do that, it probably was impossible for me to do it as I let my emotions rule and so I hung on and watched the stock cease trading and lost the lot.
You can see there was no semblance of risk management of any kind. It was just plainly stupid to risk thousands to make hundreds. Even if I had stops they would have been little help to make a profit from this kind of trading. I did not have a clue what I was doing and so got the results my ineptitude so richly deserved.
My ‘strategy’ was just a vague idea, my risk management was non-existent, I was motivated by the desire for profit and I allowed emotions to dictate what I was doing. A recipe for disaster and disaster surely followed.
I hope you learn something from all this so that I have not exposed myself to possible public ridicule in vain. Not long after that experience I came across a book called ‘Trade Your Way to Financial Freedom’ by Van Tharp and that opened my eyes to the folly of what I had been doing. It is a book that requires some study and thought and if you are interested in being a good trader you will understand that this cannot be achieved without such effort. If you are keen about trading then I would suggest that you get this book (now in its second edition) and take the time necessary to read it. It is easy to get in most bookshops as is Stan Weinstein’s book.
Alternatively if you do not want to do this and don’t want to spend too much time on the stock market (which is fair enough) then I would suggest you read a much easier book, not so much about trading but more about investing in an active way. This is ‘Active Investing’, a book written by Alan Hull and it outlines a method which gives good reliable profits. There are many people who have followed this method and have done very well and if you want to do a minimum yourself he also publishes a weekly newsletter (ActVest) which gives all the information needed to carry out his strategy.
If you do decide to use Alan Hull’s method, do not alter it, follow the rules strictly and have patience as you may not make a profit for a while when first starting. His method is good and hundreds of people who use it have done well from it by only spending a short time on the weekend attending to it.
It would have been good if I had been known these things when I first started as it would have saved me a great deal of money. I hope you are wise enough to learn from my mistakes and so save yourself a lot of pain and worry. It’s likely you may have lost some profit or capital this week. If so, use rational methods to get it back - don’t ‘revenge trade’.
And be patient; don’t be in a rush to get it back in a volatile market.
Lessons:
- Trade to protect your capital, if you lose it you will no longer be able to trade.
- Trade with sound risk management rules. If you don’t know what that means, stop trading and find out.
- Trade against your own inclination to disregard rules, not against the market so you will not be tempted to ‘revenge trade’.
- Trade with the trend, not against it unless you have a very good and well proven strategy that can do this.
- Take a trade only when the likely reward is bigger than the risk by a factor of at least two.
- Trade with the objective of following your rules rather than trying to make money. The money will follow good trading.
- Learn from reading good books and if you find that hard then learn from someone who knows how to trade. Might I suggest that if someone is good at trading they won’t need to charge you a fortune to teach you – they will be making good money from trading. There are some good people out there like Alan Hull, Daryl Guppy and Jim Berg who do not charge excessively and know what they are doing.
(There is no chart of PAS trades this week – this stock has been delisted for a long time - but believe me, it was in a serious downtrend when I traded it. There is a chart of ZFX, the company that rose from the ashes of PAS and as you can see there were some excellent assets there).
More articles from this week's CompareShares newsletter:
Commodities: Nuclear power here to stay
Resident trader: Revenge trading
Lottery winners: The perils of sudden wealth
Superannuation: Getting behind the wheel
CFDs: Volatility highlights strengths and weaknesses
Politics: Backing a winner
Smart Investing: Rising debt levels an issue
Shares: Market depth explained
Stock of the week: ASB
Investing: Oil rising to the top… again
Gold: Gold vs the dollar
Whatever your views, you can discuss this article - or any of Will's articles - on our message board Your 2 Cents.
 Email to a friend
 Print this article
|
|
