Market Experience of a Naïve Stock Operator

Abstract : I wrote this article based on my real life experience with the stock market. I wrote it with a humorous slant, but still hope you can learn a few things about how stock market works. If you like this article, please contact me link from the right contactme. This article has been published in few local magazines and the english magazine of North American Bengali Conference 2006. A short version of this article has appeared in Rediff online (India's No 1 portal) : Lessons in how to pick a stock. Sometime in the third quarter of 1997, someone told me that I should play the stock market. Knowing nothing about the stock market, I turned to some colleagues to seem to know a lot about it. Following their advice, I opened an account with a stock brokerage company. Well, up to that point it was simple enough. But what should do I do next? So I go to my knowledgeable colleague of mine again. But now he says nothing. Hmm... The very person who was interested in opening an account for me, is completely indifferent now. So I stop pestering them. I understand why they would guard their trade secret. That's life. So I start watching the market myself. I go to Yahoo finance to learn the market. But I see at the top, Dow Jones, NASDAQ, Amex etc followed by volume. Now what are these Dow Jones, NASDAQ etc? Are they stocks or bonds? And what is volume? All I knew about volume was something related to space. So I start to do research. I learn that Dow Jones, NASDAQ are just indices. You can not buy or sell them, at least in the beginning. So I learn how to get quotes, how to put an order to buy or sell stocks: market order, limit order, stops order etc. I learn that a market order is an order to buy a stock such that , when one buys a stock at some price, then it immediately goes down. Then what is a limit order? It is an order to buy or sell stocks where one can specify a price. This sounds well and good, but actually what happens is the following: one either puts an order to buy at a price so low that the order never gets filled, or if one puts a reasonable price, it gets filled but when one check one's account, the stock is trading at least five points below. And what about stop orders? It is an order one is supposed to use to lock in profit. Sounds wonderful! Here is how it works. Let's say you bought a stock at $40 a share, and now it is trading at $50 a share. So you put a stop order to sell at $45. And you are happy that you will at least make $5 a share profit for this one. Well, one day the stock opens at $35, reacting to some bad news. Your order gets immediately filled. Later in the day, however, one institutional buyer, some hotshot fund manager of Janus super growth fund family, comes in, and the stock closes at $47, down only $3 for the day. So in stead of making $10/share profit, you are left with a humiliating loss of $5/share. So one can see putting a market order is risky, limit orders difficult to execute, and stop orders are completely beyond your control. There is yet another type of order called stop-limit order. Description of these kinds of orders is simple: just combine the characteristics of limit orders as well as stop orders. Anyway, I keep on learning. P/E ratio, PEG and YPEG, market cap, book value, uptick, downtick, short interest, put/call ratio and what not. At this point, someone suggested I start watching CNBC also. So I turned on CNBC one day, and I saw Maria Bartiromo (Or Maria Bartaromo?), speaking from the NYSE at the top of her voice. I thought stock market might not be so boring after all (months later I would see her on Jay Leno show one day, and I learned she was called business babe or money honey. I can see why someone would call her a business babe, but money honey? That was funny!). I also started listening to the expert guests. One day one analyst came, and he said instead of studying the individual stocks, one should study the economy and try to gauge the overall market. So I start studying the economic numbers, PPI, CPI, ECI, unemployment, wages, etc. So one day the unemployment numbers comes out, it was lowest in fifty years! I thought, wow! This got to be a good thing for the market. Wrong! Stocks tumbled big time that day! Later in the day, I learn from some analyst that this kind of stock market action was expected because what is good for the main street is not supposedly good for the Wall Street. I guess that makes sense. So I learn few more things. I learn that stocks go up because of good earnings. According to Peter Lynch, earning drives the market; it is not that complicated. (I am sure everyone has seen the commercial on television for Fidelity Investments. If you have not, it is a very funny commercial in which Perter Lynch, the renowned fund manager for Fidelity Investments, refuses to give a hot stock tips to the counter lady and risks being kept waiting in the line for much longer. In his opinion, it is the company's earnings that detemines its stock price, not how popular it is among the traders or the public in general.) Well, one morning one company announced excellent earnings for the year. In fact, their earning was up almost 100% compared to the year before. There were already lot of momentum in that stock! But the morning after the earning came out, market caught on fire! Maria Bartaromo was shouting on CNBC as if the stock was going to land on the moon that day. And boy was she looking awesome! I wonder how many people got attracted to that stock that day because of her! Indeed, when the market opened, it was up almost $5.00. I could not take it anymore. I bought too! After going up $1 more, the stock started to sell off. I thought it is within normal fluctuation. But I was wrong. It kept selling off and at the end of day, it was down by more that $10.0! I was numb with disbelief. After the market closed, the same analyst came on CNBC and said the good news was already priced in to the stock, so when the news actually came, the stock went down due to profit taking. According to him, this was a classic case of buy the rumor, sell the news. I wonder why didn't he come on to the TV and express his views in the morning. That would have helped a lot of clueless investors like me. I guess he was too busy selling in the news. As I was learning various things, watching CNBC, surfing the web, surfing yahoo finance, reading motley fool etc, I started placing some trades also. But to my horror, all stocks immediately goes down after I buy! I would watch a stock for a while and see it going up down, between say 30 and 40. So I tell myself why don't I buy when it touches 30, and then sell at 40? It had never betrayed this trading range, I have been watching for two weeks! Little did I know. As soon as I buy the stock, it starts falling prey to gravity. That day it closes at 28. What do I do now? Do I sell it and incur a $2 loss? NO! In stead, I put a limit order to sell at 30. I want to just break even this time. But guess, what happens? Next day it opens at 27, and drift lowers the whole day, finishes at 26 1/8. Now it looks like the stock has never seen 40 in its life. So I say to myself, I want to hold this one a little longer. One day it must come back to 40. Seven days later (which felt like an eternity to me), the stock close at 20 5/8. It seems like it is ready to fall into teens. At this point, my patience breaks, and I sell it for almost 10 point loss. I console myself, well it will go 10, then I will but it, and sell it at 20. So I will break even after all. The very next day, the stock gets upgraded by an analyst, and it rallies like there is no tomorrow. It goes up for three straight sessions and close at 29 ½ for the week. At this point someone like you may be thinking, I must have bought this stock at that price. No I didn't. I can not say I was not tempted. But I got fed up with the stock and had moved on to some other stock equally defiant. My losing streaks continued! It was interrupted by a few winning trades, but they were very few and far in between. For quite a while it went like loose..loose..loose..gain..loose..loose..loose..loose..loose..loose..gain..loose. At this point I start getting worried. As a small investor, what do I do? How will I get insight about a company, or about the market in general? Or are stocks not for me at all? Should I just invest in mutual funds and forget about stocks? Or may be leave the money in the bank account where it has been ever since I landed in the country! Oh well, where is the fun in that! No, I was not ready to bite the bullet yet. Bank account was out of question. I have had enough of that. Even I thought mutual funds are for old people and retirement accounts. I still thought stock market has a big reward in store for me. If George Soros, William O Neil can do it, why should not I be able to do it. Moreover, if I play .............
the market, I can watch CNBC, and Maria will always be there! I only hoped she knew how much I was suffering. At some point of time, someone told me to apply technical analysis. At first, I thought that will be a fairly complicated thing. But I got to know that their main tenet is simple : stocks which are in uptrend, tend to go up, and stocks which are in downtrend, tend to go down. May be it is just me; I cannot see what is so technical about it. I could have said that. I thought it would tell me something I didn't know. There are some methods by which, they claimed one can make sure fire profitable trade. But some of the methods seem very complicated to me. One such method will say : watch a stock to want to buy for a while until it gives a buy signal or sell? But to identify these signals one has to go through hoops. As an example, one needs to watch a stock with rising momentum. What is a rising momentum? It is a combination of rising price as well as rising volume. But that is not the end of it. Once you have spotted rising momentum on a stock, you watch for a setup which happens in the following manner. The stock should have four consecutive days of up followed by two down days, with diminishing volume. It is important that the down days don't go below 10-day average. At this point, one should watch if any divergence is occurring between the 10-day standard deviation and the 20 exponential stochastic indicator. If all these conditions satisfy along with some others, one should place a buy order after four days of watching. At this point if one is not sick, one can buy the stock on the fifth day if the volume is above average. Now it comes to selling, and you guessed it, the rules get even more complicated for selling. I would rather leave it for the purpose of this article. At some point, I started watching the internet stocks. I see that everyday they are up. So I delve into them. But their business did not seem to be very impressive to me, however popular their web site may be. In fact most of were not making money even though they had very high traffic web sites. Some analysts were predicting their stock price on their daily page views. To give an example, if some internet company's web site receives one million visitors every day, then their stock should be at least one hundred thousand dollars if not one million! Their stock was always up even in a day when every other stock in NYSE, NASDAQ, and AMEX was down. This got me puzzled. However hard I think, I cannot seem to make head or tail about it. One day it dawned on me. Hey! These stocks are simple. They don't have any revenue, or profits! May be that's why they are going up so much. Who has time to do complicated analysis? Market is always right, as they say it! I wonder why took such a long time for me to realize it. Yahoo! But interpretations varied. According to some guests on CNBC, people are buying these stocks not because of what they are today, but what they will be in two hundred years from now. Wow! I want to know what kind of glasses they are wearing. I cannot even predict what will happen to me in two hours from now. Yet another interpretation had it that they are going up because they are new economy stocks. Their stock price can not be valued on old fashioned parameters e.g. profits, revenue etc. Rather they have to be valued on the promise they have in store for future. Their work culture is also different: employees come and go anytime, drink beer and play ping pong in the office, wear any clothes and have long hair. This all sounds good, but I don't see how their stock price keep on climbing because of this. But whatever, who am I to judge? Market gurus knew what they were talking about! From technical analysis angle also, they were simple to analyze. They just go up, there is not much to analyze. One can just draw a straight line; the stock will follow that. Some day may be slow, and the stock may end down a little for the day. But very next day, traders will be all over it to bid it higher as if it deserved punishment for one day of slacking. Since everybody was buying the stock, I decided to buy too. Why would I want to be any different? So I bought some shares of Amazon.com. (One may ask why I chose Amazon.com! Well they seemed to be in the worst shape of business. Yahoo! was making some money. But Amazon was loosing money like crazy and had no prospect of turning a profit in the foreseeable future. So I thought this got to be best of the breed.) And this time, bingo! It went up after I bought! Two days after I bought they announced a three for one stock split. That was exciting to me, I will have three time as many shares. The stock doubled in a month or so. It started itching, also some fear sets in. So I sold all the shares. This time, I had a sizable capital gains. But in another month, the stock doubled again. But I thought I didn't do bad this time! What started as a mere curiosity has turned, rather painfully, into a sordid affair to make money (lose money), then to a pathetic effort to regain the lost money, has eventually turned into success, albeit unexpectedly, which, in turn, has turned into greed and more greed... I thought to myself, if I can make few more winning trades like these, I may even be one of those millionaires. With that thought all my happiness vanished, and I returned to the world of worries. If you like this article, please send your feedback by filling the form at below. I HOPE YOU ENJOYED THE ARTICLE ABOVE WHICH IS BASED ON MY PERSONAL STORY OF INVESTING IN STOCK MARKET. THIS WAS SUPPOSED TO BE HUMOROUS AND YET EDUCATIONAL. YOU CAN NOW GO ON TO THE SECTIONS BELOW WHICH ARE WRITTEN ON A MORE SERIOUS NOTE. I HOPE TO ADD MORE AS TIME PERMITS.


Importance of Stop Order Even though all kinds of orders have drawbacks, one needs to undestand the importance of stop order at the very beginning. As described above, it is order to protect profit and also to cut losses. To understand the stop orders, let us look at where stock is on nice uptrend and you have bought at the point specified. It looks like you are climbing a mountain, right? Only difference is unlike mountain climbing, you are not having any control on the stock price now. Only thing you can do is wait and watch. If other traders buy this stock, the price will keep rising. If, on the other hand, others decide to sell the price will go down. Unlike in mountain climbing, you do not know what lies before you. Do you want to be in that situation? What is the solution? That support level is your stop price. Never ever enter a trade without a stop order. But this is the mistake most traders make in the beginning, including myself. If it feels like burden to you then think of why you wear seat-belt in a car or pay hefty premium to insure your home. In the first example do you regret if you did not have accident so the seat-belt did not prove to be useful. In the second case, are you unhappy your home was not destroyed by fire or flood so you could not use the insurance? There is another aspect to protecting your capital. As you loose your capital, it becomes harder to recover from the loss. For example, you start with $10,000. If you loose 10%, you are left with $9000. Now from this point, you have to gain 11% to get back to your original value. Similary, if you loose 25% (you now have $7500), you have to gain 33% to recover all your losses. If you loose 50%, you have to gain now 100% to recover all your losses. If you loose .... well let us not get that depressing. You got the idea. Temptation of Limit Orders In the beginning, everybody want to use limits order to buy and sell stock. This is because it allows one to buy at a lower price and sell at higher price. Some people are attracted by the daily fluctuation of a stock and think as if they can make money by trading by limit orders. One may get lucky a few times, but if anyone think this can done consistently to make money one is dreaming a fools dream. If you think you can stock price movement each day, you might as well think you can predict lottery numbers or outcome of any elections. Don't they all look familiar after the result are out? I would not dig deeper into the lottery case, but in the election scenerio, remember Bush-Al Gore? I can go on, but you get the idea. Is it market top or bottom? It is also very important to identify market tops and bottoms. Novice investors always get lured into market top and forced to sell at market bottoms. How is this possible? The end of see-saw is way up and there so many people cheering. Now is the time to go down. In wall st lingo (Dallal st for India) there are too many bulls. So there are not many people left to buy stocks and stock price rises if there are more buyers. Similarly, at the bottom there is nobody around (because everyone is scared to own stocks). It is time for the market to make a move up. Some people may not agree with this explanation of market's movement. But see-saw nature of the stock market can not be emphasized enough. Market is always going from up days to down days, from bull market to bear market, from being overbought to oversold, from euphoria to doom and gloom, and most importantly, from insatiable greed to extreme fear. I may have become little philosophical. Coming back to cold hard reality, it is very important to understand the market top and bottoms. Common investors, however, should not try to catch a market bottom. It is a very dangerous thing to do so. There is no way one can always catch a market bottom successfully. One should wait when the market stabilized enough to enter. However, one should always be wary of market tops to take profit or be careful enough not to get into it.