AT THE CLOSE
Unwarranted Optimism
Many people can be grouped into one of two categories. I am an eternal optimist while my wife is pessimistic and we complement each other perfectly. Investors or traders need to know which category they fall into and acknowledge it as soon as they get involved with the market because it can have devastating effects on their decisions otherwise.
In late 2007, a colleague of mine — let’s call him Optimistic Oscar — was buying what he considered good deals. He did his homework and analysis both fundamentally and technically, and concluded that purchasing stock of some quality companies prior to the holidays was a good idea. Companies like Goldman Sachs (GS), Apple (Aapl), Honeywell (Hon), Research in Motion (Rimm), and Amazon (Amzn) were solid companies, and I didn’t think what he had in mind was a bad idea.
From mid-September to mid-October 2007, Goldman Sachs jumped $40 from $187 to $227 a share, and on a minor pullback he decided to purchase more shares because as far as he was concerned (being Optimistic Oscar), they were going to continue going up.
Meanwhile, Research in Motion (the makers of the BlackBerry handheld device), a company having nothing to do with the financial industry, ran up from the mid-$80s to $117 a share during the same time frame. Charting Rimm, Optimistic Oscar figured as long as it kept breaking out, he would keep buying on the pullbacks, and he did.
On November 29, 2007, Rimm was up at $122 a share and Oscar was buying more stock. The very next day, November 30, Rimm pulled back to $113 a share and he bought as many shares as he could.
Two weeks later on December 13, Rimm pulled back to $104 a share, and Oscar invested a large portion of his paycheck, as he was optimistic that Rimm would break out as it had in the recent past. Sure enough, Santa Claus gave him a Christmas rally and Rimm soared up to $118 a share on December 21, but the commentators on Cnbc kept commenting on how this wasn’t really the Christmas rally and that it would come any day now.
Two weeks and another paycheck later, Oscar bought more shares of Rimm on December 27 at $117 a share, feeling confident that the stock would break out above his original buy of $122 and then he could cash out a winner.
That day never came. The stock plummeted over the next 40 days, down to $84 a share, but Oscar bought shares every couple of weeks anyway. As I write this, late in 2008, Rimm — still a good company with solid fundamentals — is trading in the mid-$40s.
I spoke with Oscar every week or so during his roller-coaster market ride, and I never sensed a sense of loss or urgency from him; he was just optimistic about his choices and decisions. Little did I know that the pressure and stress of buying the Rimm stock and many of his other choices were affecting his family life and work. He wasn’t his cheerful self throughout the holiday season, and instead of cutting his losses at a certain point, he stayed optimistic. He had lost more than 80% of his investment when he finally did cash out.
Sometimes, traders refuse to ask for help from others. Oscar and I finally sat down and he told me about his heartache of buying a stock down while expecting it to go up. He felt he had hit rock bottom and he did not want to buy another stock, ever. He hated the market and his family and friends who kept telling him that trading stocks was risky. He had lost both his money and his passion for the market. He also taught me a valuable lesson, one that we must keep in mind: Check your emotions at the door when trading.
Since then, Oscar has opened up with his family and friends about the losses and the tough time he went through while trying to stay optimistic. Shortly afterward, we spoke about some new trading ideas he had, and since March 2008, he has jumped back into the market and even made a slight profit despite this ugly market.
When we are optimistic about companies and stock performance, it can be tough for us to believe the stock will move down. Today, for every so many shares of a company that Oscar purchases, he buys puts to cover his downside risk. He may not think or even believe that these shares are going to drop, but by hedging his trade, he protects his investments.
Always give yourself some room for error and protect your investment. Even if you are pessimistic, and in the current market I can understand why you would be, you should still protect your short positions. The market is stressful. The problem with traders is that we trade so often we don’t necessarily feel that stress we did when we purchased our first 100 shares of a particular stock. We become numb to the stress of the market, but it lingers and our family and friends feel it, so please check your emotions at the door and cover your positions, whether you are an optimist or pessimist.
Moses Sanchez is a freelance writer whose background is split between politics and business. He currently manages a stock option portfolio. He may be reached via email at mosesasanchez@yahoo.com.