Three Months and the Kid Thinks He Knows Something

On the 26^th of October (this coming Friday), it will mark 3 months of trading stocks and options online for me. The starting amount was fifty thousand dollars (spelled out for effect as usual). I had no idea what to do, how to do it, or how I was going to do. All I had was a history of investing through retirement accounts and doing quite well for myself (IMO). I was confident, but at the same time very scared – I know this doesn’t make sense, but this is how the market makes you feel. At the very minimum two faced.

First, the results: After losing six thousand dollars today my account balance is roughly at eighty five thousand dollars. That means I have made thirty five thousand dollars in three months. A seventy percent return. Now I’m sure that there are plenty of pros out there that have done better, and I’ve seen with my own eyes the people out there who could have possibly made over two thousand percent return in the same time (which with an initial fifty thousand dollar investment would equate to an even million – ok I’ll stop spelling out now).

To recap from when I originally posted this – I felt I could beat the 8.74% interest I would be paying on my home equity line of credit. And I’ve done it – for now. And since I had dreams of grandeur, I figured I should take a shot at getting to my destination as quickly as possible.

My first goal was to beat out the interest rate I’m paying on the money I borrow. Once that goal was surpassed, the next stepping stone would be to beat the average for the market at 12%. (For those of you invested through other “professionals” – please ask them if they are outperforming the market and by how much – I’ve heard that 80% of fund managers don’t). My next goal was to reach and possibly surpass what I will continue to shoot for every year since my first full year investing: A 34% annual return.

This is one of my favorite calculators: http://cgi.money.cnn.com/tools/savingscalc/savingscalc.html

Check it out when you get the chance. It’s amazing what putting 15% of your money away a year and the possibility of earning a 34% return every year can get you. The goal is to make enough money so I can retire and live off of interest for the rest of my life from 42 onwards. That’s 16 and a half years from now. Not saying I’ll stop working – but maybe I’ll work for fun instead of having to.

Now on to what I really have wanted to write about (it took me freaking 5 minutes to find that calculator – someone better use it).

Over the past 3 months, here are a few things that I’ve learned. And a few things I’ve wanted to teach myself. So when I write “you” here, I’m not referring to you – it’s just something I’d like to read for myself when I go through another day like this, and remember where I came from – and hopefully how much I’ve grown.

-First and foremost, I’ll probably end up stealing from the best. Because I feel it is probably the most important thing about investing – Warren Buffet’s rules:

Rule #1 – Don’t lose money

Rule #2 – Refer to Rule #1.

Easy peasy right? Wrong. On August 16^th 2007, a day I won’t soon forget – my account balance dipped below the $50K mark, and in to the red. Although it was intraday, I was down about 40% of the way to the MAXIMUM loss point I was allowing myself (and still allowing myself) of $10K. That was a scary time. I don’t ever want to live through that again – although I’m sure we’ll have plenty more days like that over the next 17 years.

-Which brings me to my next point: Protect profits. Make them, keep them. I gambled yesterday and got killed. 2 weeks ago I was at a profit of $46K. Less than 8% return away from 100%. And I got caught with how much capital I had to swing around. A bit of hubris and they all start to fall.

-You’ve got to have guts of steel (or balls – or something) in order to play. Big returns require a lot of risk. You have to have conviction the reason you’re making a certain play will work out. I don’t know how many times I’ve sold way too early only to kick myself a week later for missing out on more profit. And I kick myself for missing profit more than I congratulate myself for getting out while the getting was good. So over the past 3 months I know my plays have been solid. One thing I’m going to try to teach myself is to let enough of a position go to where I feel comfortable in just letting it ride. I’m too quick to pull the trigger on an entire position as soon as I’m in the green. I would’ve been a much richer man if I had left some scraps on the table for myself to eat later (terrible – makes no sense, but I’m leaving it).

-Options are not for the faint hearted. Neither are hot sectors, or Chinese stocks (as of today). High flying stocks can move 20% in a day – in either direction. And you can lose 99.9% of your option value or at the same time make a 7000% return. Welcome to one of the most ridiculous games on planet earth – gambling with ridiculous amounts of green.

-Picking stocks for me is easy (I laugh). First check the fundamentals. Jim Cramer says that growth to wall street is like crack to addicts. Revenue and profit growth, and hopefully a company that’s on it’s first leg of the growth cycle – you’ve got a winner right there. Compare it with the price to earnings though. A good stock should have a P/E ratio of at most 2 times the percentage of revenue growth. (The sweet spot is around 1.5 times for me). The current average is a P/E ratio of 22 across the entire market. High growth stocks deserve high multiples. After comparing with the average, compare with competitors. One of my favorite plays I’ve made this year is investing in Hewlett Packard (and I just bought one of their laptops – awesome). The growth looked good, they make a good product – and their closest competitor (at the time I bought HPQ), Dell was trading at a 10% higher P/E multiple than them. If that doesn’t scream “FREE 10% RETURN!” I don’t know what does. After doing your comparisons, watch the stock. Don’t jump right in. Understand the movement – where it’s headed. A lot of emotion drives the price of the stocks – so get in tune with that. I’ve seen a lot of good companies with great fundamentals but wall street just hates them. And it might be awhile before that sentiment changes. Each stock has it’s own story – understand it as best you can before risking any money.

-Price. I’ve made plenty of plays these past few months just based off of price. Stocks will oscillate with no news. You can make plays on price alone. Game Stop (GME) has climbed and slipped between $54 to $60 and back down to $55 over the past month. Make 3 moves at the right time and you’ve got a 30% return (or more) and the stock hasn’t moved really at all. Buy and hold my ass. Set price points for yourself though. Entry and exit. If you’ve made a profit and if it still doesn’t hit your price point, you still have my blessing to sell (or buy to cover). A stock’s price should never be anything other than what it currently is. I believe in an efficient market where all knowledge is priced in to a stock. So when I hear that HPQ should be a $54 stock today – it bugs the hell out of me. People will pay for a stock what they believe it to be worth. Nothing more, nothing less.

-Making money is better than making no money or losing money. So what if you made only $5 in the market today? That’s more than you had yesterday. Enough said.

-Build positions in a security. Buying it all at once ties your hands if in case the position starts to move in the opposite direction you expected it to. I give myself typically 2-5 purchases at most. Buying 25% of what I want my maximum holdings to be. Then possibly doubling that position, then doubling again if need be. Building in a good average price will make for more profit when the position starts moving in your favor. Remember, it’s not a realized loss until you sell.

-Respect the market. On a given day, an average of 70-90% of stocks will move along with the market. Regardless of what high flying tech stock you own, if the Dow is down 400 points that day, I’m willing to bet (and give you odds) your stock isn’t going up. Be ready. At any time the market could fall out and if you aren’t paying attention you might have just lost your shirt (along with possibly your house in my case). Respect is definitely required – but I don’t feel that fear is necessary.

-Don’t waste mental capital. As much as I write this one out, I’m not sure if it will ever come true for me – or stick for that matter. Remember the “kicking myself” I wrote about? I do that way way way too much. Always telling myself that I sold too early – or that I should’ve sold. Or that I should’ve bought more. I need to learn to move on and stop wasting my time on the past. The market is lightning fast and there is opportunity for profit in every corner. Wasting my time thinking about how I could have had some ridiculous amount of profit in a play I screwed up on 2 weeks ago is not going to help me make profit now. Learn the lesson. Move on. (This is probably my #1 biggest struggling point right now)

-The definition of “smart” to me – in regards to the market – is seeing something way before the other guy does. Or, I suppose, the other guys - the masses. Spot your trend or the movement in a security even days before everyone else does and you’ll make enough returns to possibly go pro. Everything in the market is connected. Connect the dots before anyone else does and it’s free money. For those that realized what was going on with the sub prime market – the stated income, no money down, negative amortization loans – there were people out there who knew that sooner or later all of them would come crashing down – just a matter of time. The guys that saw that coming probably just bought themselves another Manhattan sky rise, or possibly a bigger yacht (if that’s your type of thing). Get in early, have conviction, let it ride. That basically defines this blog post.

-Research. Read as much as you can about stocks you are interested in. Understand what everyone has to say about those companies – and check your own bias against theirs. Think for yourself. Following the crowd may end up getting you trampled if they turn quickly on you and you’re not paying attention.

-Investing is a marathon, not a sprint. I have at least the next 16 years of my life to reach one of my goals. But between now and then is a lot of time. Things will happen I can’t control. Time will change almost everything. Not every day will be a homerun, or even a single. Some days I will lose, and I expect to lose. The market has made me feel rich like a king on a given day and the next day made me feel like a complete idiot novice who should quit while he’s ahead. I do hope that over this marathon, the steep climbs and the huge drop offs will start to subside as I get better at this. I’m not sure my knees (or my heart) could take much more of the swings. But I do know that as long as I continue to keep my head up and look at the big picture, I’m sure I’ll do just fine.

Good luck to us all (especially me).