Rally Diary Entry:
I’ve been on the (Social Media) boards for over a year now and I was part of the GME crowd. I’ve also traded a little in AMC and BB. I made money in GME but haven’t made anything since. In fact, I’m currently sitting in huge losses in some of the stocks that popped up recently. I still believe in these companies and I want to hold on but the losses are getting to be too much. Full disclosure, I haven’t even been able to tell my wife about it. I don’t know how much longer I can do this. What should I do?
Response from Preston:
Your situation seems to be pretty common lately, unfortunately, and in my opinion just proves that experienced traders like myself have a responsibility to offer the proper education and guidance for aspiring traders/investors because there just doesn’t seem to be enough of it available (at least not for free).
There are so many new market participants who could eventually change their lives through trading and investing but the question is which ones will change theirs for the better and which ones for the worse? I believe that, ultimately, the ones who choose to stay in the game and seek the proper guidance have a much better chance of doing the former while the ones who continue to chase around ideas hoping for the next GME could very well experience the latter.
Generally speaking, I realize the focus for many of the new market participants who are taking their ideas from Social Media like yourself is not on being slow and steady, diversifying their portfolios by investing in boring but solid companies in order to have something for retirement. They want returns right now and are willing to go big and double down.
And I recognize – and completely sympathize with – the sentiment of anti-Wall Street, anti-rich guy, anti-hedge fund. So I’m not bashing the mindset. I’m an old guy but I’ve always been anti-establishment myself and I get it.
But a stock move like GME doesn’t happen every day and it certainly doesn’t happen to every stock that may be undervalued or heavily shorted. Although big short squeezes do happen in the markets and there will certainly be more of them, GME was a true lightning strike. It was a perfect storm of passionate buying momentum, personality-driven mania and hedge fund panic, right up until the day the big boys and girls pulled the plug (don’t forget that there’s always broker risk on top of everything else, but that’s a topic for another day).
You were lucky enough to make money in this short squeeze, but you may not be as lucky next time. It can be easy to give back gains or take huge losses or both when participating in such a powerful short squeeze if you’re not nimble enough with your position management. I’m sure there were many people left holding the bag after that move and some who are still invested in GME hoping and praying it will go again.
But hoping for another move like that in GME or that the stock will eventually march toward $1K sounds like a strategy based more on hope than anything else. Better to heed the cliché that hope is not a strategy.
The thing is, you can still make a lot of money in the markets by minimizing your risk instead of throwing your entire wad at stocks based on other peoples’ research and holding on for dear life. This is because most stocks don’t go to the moon. Most languishing stocks continue to languish, and if they bounce it’s usually a short-lived bounce that comes right back down. Without an exit strategy you’ll end up holding the bag way too often, especially if you keep adding shares during the bounce. These stocks often languish longer than most of their holders can stay solvent.
I don’t know how to help you with your current losses, but if you have some money left you should consider making your next step learning how to flip the equation in your favor. Start making trading and investing decisions based on your risk (how much you’re willing to lose) instead of the amount of money you would make if the stock goes to the moon.
I know it’s hard not to focus on profits, and it’s certainly not as exciting. But it’s important to realize that just as much money can be made when focusing on risk instead. I’ve done it for years and it’s how consistently profitable traders earn consistent and sometimes outsized profits.
So, as you can see, I’m not talking about making 3%-5% per year in a retirement account. I’m talking about learning how to find 1-to-5, 1-to-10, 1-to-15 risk-to-reward scenarios in the markets and jumping on them. In other words, I’m talking about learning how to risk $100 to make $1,500.
I’m talking about learning how to find your superior risk-to-reward setups and then learning how to maximize what you might get out of them. This is how you not only stay in the game and live to trade another day but potentially make huge profits with less risk.
In 2020 my automated strategy in long volatility made 460% against an acceptable amount of risk. Once the economy began to shut down due to the pandemic the VIX spiked into the stratosphere and the leveraged ETF (exchange-traded fund) I was using to play the spike erupted to even higher heights because it was a leveraged instrument. Although I wasn’t happy about a deadly virus wreaking havoc all over the world, I was happy about being left with a fatter trading account that year.
Then toward the end of 2020 I put about $5,000 into RIOT based on a technical setup and the Bitcoin story at the time, and I placed my stop loss at an acceptable level not far beneath the price. I also had a clearly-defined exit strategy if it worked in my favor, which basically entailed scaling out at certain price points and trailing up the remaining shares. Initially it sold off but didn’t hit my stop loss, so I added more with the plan that I would still respect my stop loss if price traded down to it. But a little while later the stock reversed hard and shot straight up. I ended up making eight and a half times my investment.
The amount I made in RIOT was many times more than the amount of money I’d been comfortable losing. In other words, the risk-to-reward profile of the trade had been exceptional. Once the move was over and my trailing stop was hit in early 2021, I took profits and waited for the next setup.
You can lose several trades during a year but if you get one like RIOT that makes a big move, or even a handful of stocks that make decent moves, you can end the year on a very profitable note. You just have to learn how to find your setups and take advantage of them with your trading plans. And you have to respect your stop losses. If you’re actually willing to lose $1 to make $15 in a great technical setup, you’re doing it the right way.
Now, if you want to be an investor and build a portfolio of stocks based on company fundamentals, that’s a different beast and demands a different approach. But it certainly can be done if you have the passion and patience for it and you’re willing to do your own work.
You and nobody else should be the one who decides what fundamental metrics are most important and might give each company the best chance of success. And you can still invest in the most exciting companies as long as you work hard to uncover what you believe might be the diamonds in the rough, invest in them based on your level of conviction and then have realistic expectations.
When I say realistic expectations I mean don’t expect their stories to play out right away, or even in the next few years for that matter. For instance, technology companies, whether enormous with fortress-like balance sheets or small and up-and-coming with disruptive-type business models, can be very exciting and generate passionate believers. It’s easy to think that the big payoff with these companies is right around the corner, so many people want to get in early and throw all their money at them.
But even if these companies don’t get beaten out by others competing for the same market share they can take a long time to mature and to reach their potential. While the market is determining which fate will befall them, their stocks can experience high levels of volatility. This can be a tough way to make money if you’re watching the price action every day and hoping for the big move. So patience and conviction are key when it comes to investing.
So whether you want to be a trader or investor or both, do your own research and due diligence. If you want to generate big wins here and there and stay in the game, learn how to be tactical and opportunistic. Learn how to wait for your pitch because patience in the markets can pay off very well in the end.
If you have any money left, then now is your chance. This is what I recommend you do because this is your chance to flip the odds in your favor. I guarantee if you learn how to do this and get good at it you won’t hesitate to tell your wife all about it.
P.S. I highly recommend using Technical Analysis to find price levels where you can put your stop losses to create superior risk-to-reward profiles. If you’re ready to really apply yourself and to learn how to read the charts, a great starting point is www.swing-trade-stocks.com. There’s a lot of great free information on that web site that can serve as a launching point to finding meaningful opportunities through Technical Analysis.
If you want to be a more active trader and are willing to spend the money, I think there’s great value in SMB’s equities trading courses at www.smbtraining.com.
And as far as investing goes, I always recommend Benjamin Graham’s classic book The Intelligent Investor as a starting point, as well as anything Warren Buffett and Charlie Munger write or say. I also recommend anything Peter Lynch has written, but it’s good to study different money managers in order to come up with your own approach.