The Smack Down Is Humbling!

Wow!  Like the title said, this week I've gotten the Rick Flair "Whooo" smack to the face from the market.  Last week was the 3G mistake and this week an unlikely probability actually happened with a BIDU trade I made.  Months of gains down the drain!  But I'm by no means ready to call it quits.  I want to learn from my mistakes and try to get better.

So like I mentioned, a week or so ago I placed a 95/100 spread on Baidu (BIDU).  BIDU is like Google of China. It had been trading in a tight range since about February of this year and the probability of it breaking 95 by May 18th was fairly low.  I followed all the general rules I've previously wrote about and everything looked good so I pulled the trigger.  Then out of nowhere this week BIDU announced its acquisition of a company called PPS Net TV.  Apparently the market liked the purchase because the stock reacted to the positive.  When I saw the quick movement I read the writing on the wall and exited my trade for a loss.  BIDU closed on Friday at 95.45.  This stock may be at 100 by the end of next week which would be a catastrophic loss for me if I held on the position.  I could have rolled the position over to a later month but that just didn't really seem to make sense.  Take you lumps and go home!

The real question is how can you avoid having months of gains only to lose a big chunk of it with one bad outcome?  I don't think you can EVER take all the risk out of playing the market but in the case of what I'm doing some adjustments can be made.  So after pondering about it the last few days I've decided to adjust my rules as such:

1. I will no longer write options on individual stocks.  I will only use major index tracking ETF's like SPY, IWM or QQQ.  This rule will hopefully avoid the sharp increase in volatility that comes with unanticipated news for an individual stock.

2. I will adjust my monthly income requirements to 1% per month to include commissions.  12% per year still isnt too bad.

3. I will only make trades where the short strike (95 in the case of the BIDU trade) is at least two standard deviations from the current price of the stock.  This should make the probability of losing only 1-2%. 

We'll see how things go!  Have a good weekend everyone.  I'm going out to work in the yard!

Why I Stopped Investing And Started Trading

 

As a kid growing up in suburban Maryland no one ever taught me about the wonders of the stock market. Both of my parents were federal government employee's and looked forward to generous pensions when they retired. Their financial future never depended on the stock market so that probably explains why they never shared its existence with me.

After high school I went to college and later to the U.S. Army. Even during that six year period the stock market and investing wasn't a part of my consciousness. It wasn't until I began working for the federal government that I was introduced to investing. For those not familiar with the federal system, government employees have a 401k like benefit plan called the Thrift Savings Plan or TSP. Within the TSP I found out I had the option to invest in five different "funds". The TSP opened my eyes to benchmarks like the S&P500 and the Russell 2000. When I learned about dollar cost averaging and compound interest I just knew it would be just a matter of time before I became a millionaire. At the time, my plan was to max out my TSP contributions and then with my extra savings mirror my TSP fund allocations in a regular brokerage account.

So how did things go? Well, for a while everything went great! For a few years it seemed like the market was headed for the stars. Everyone at work bragged about how fast their accounts were growing. The real estate market was also going bananas at the time. I should have known something was wrong when all my neighbors talked about how large their lines of credit were. The idea that it all (or at least a good chunk of it) could disappear almost overnight never even occurred to me. Well, as we all know the bottom fell out. And as I now know the market moves in cycles. No matter how smart you are or how much you've mastered technical analysis (and all that other fancy stuff) I'm convinced no one can time the market. All we know is that it will rise and it will fall. This cycle just repeats itself over and over again.

After experiencing my first crash I must admit I became shell shocked. I didn't know if I should stay the course, forget stocks and move to bonds, focus on REIT's and dividend paying stocks, buy gold or just bury my money in the back yard! During that period I tried EVERYTHING! And just like the market my brokerage account went up and down. I knew there had to be a better way. I just didn't know where to turn or who to trust. Luckily, one day in my local Barnes and Noble I came across a book about trading options. I'll explain in my next article how that book opened up a whole new world for me. That book was the beginning of my transformation from an investor to a trader!