A Trader’s Story (Also known as “What to do when all hell breaks loose”) (Orig. written 6/17)

This story happened to yours truly (only a few hours ago) and serves as a good example of a few good trading lessons. I know it’s cliché, but it’s soooo true that we learn our best lessons when the going gets tough.

Yesterday, I made the decision to go long (that is to buy) 100 shares of West Company. It has shown good growth and was breaking out on stronger volume. Near the close, I made my purchase and as always, had confidence in the trade but was willing to accept about 2 points of risk.

Fast forward to this morning, and check out the chart of West, WSTC. You’ll see an unusual day on June 17, 2005 – one that is more volatile than any session I have been able to find for WSTC. The stock opened 7 dollars lower, and actually hit a tick down $17.88 (-47.66%) at one point. There was a 4 dollar spread between the bid and the ask price. At this point – what does a trader or an investor do?

1) Something’s wrong. I obviously made a mistake of some kind. The question is to figure out what the mistake was, and correct it.

Action: I scoured Yahoo Finance and CNBC to see if there was some kind of news for WSTC. There was none. Thus, I concluded that this was some kind of anomaly, a statistical glitch.

Action: I pulled up the chart and saw one of my mistakes. The stock has many days in which only 19,000 shares trade. This stock was not liquid enough for me to have in the first place! Thus, the share price is easier to manipulate, than, say GE’s stock price because of the number of shares traded daily.

2) My heart has dropped through my foot. Now what? I know I’m acting in fear. I’m also acting in greed saying to myself, “I can’t get out of this thing down 17 freakin’ points!” (I didn’t use “freaking”). So am I being too greedy telling myself that this thing will come back?

Well, here’s the thing: I know I’m afraid, and I know I’m being greedy. So, I’m trying to throw those emotions out and ask myself, “If I weren’t in this position, what would I be trying to do?” My answer was that I wanted to buy the stock down 17 points, figuring that the price would return to normal. This was because my “unemotional” (note the quotes) analysis led me to the conclusion that this was an anomaly. Therefore, I decided that I would hold it for a bit to let the dust settle and exit. I have a strong belief that most of these things clear up in 10 minutes or so in the market, when there is no news story leading to the stock price decline.

After a few minutes, the stock was still trading down 4 points. But, the spread was coming back to earth, and I wound up exiting the trade only 0.65 below my entry point. I DID have to sell, because in this situation, it’s better to get out so that I can think more clearly (not clouded by fear and greed), not to mention I have to execute on the discipline of my stop getting hit.

This situation reiterated some of the rules of trading / investing:

1) Check your emotions at the door – or at least know how they act on you and your decision-making so that you can assess the situation clearly.
2) Don’t lose money. This is better said as “Play Defense.” A good defense in football still gives up yards, just not in big chunks. You will not be right all the time in this business, but if you play defense like this, you’ll live in the markets and protect your precious capital. If you do expect to be right all the time, find something other than investing and trading.
3) Follow your plan. My stop on this stock was 34.55. It got hit (in record time), and I found a way out. Your brain comes up with the plan in an unemotional state, and is the best judgement. When you’re in a trade, emotional forces begin to act on and challenge your ability to make good decisions.
4) Be accountable for all of your trades. I was responsible here, nobody else. Blaming others or using excuses doesn’t cut it, and will only lead to your demise as an investor.

Thanks to Ugly, I learned that there was a firm having technical issues that probably led to the problems at the open for WSTC. Nonetheless, I will take my loss of $78 and live to fight another day.

There you have it. Quite the start to a Friday!