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The blowup in Netflix (NASDAQ:NFLX) has been epic on multiple levels and provides a great reminder for what I would call a very old lesson about investing in certain stocks. Netflix is, was and always will be a fad stock in my opinion. This can be even in the face of a very useful or convenient product but not all fad stocks have something as convenient as Netflix as their main product.

There have been a lot of these over the years of course, some of which you may not even remember and at the very least you have not thought about how hot these stocks were both in price action and media attention. Do you remember how hot Snapple was once upon a time? Bottled ice tea trading like it would change our lives.

What about Andrea Electronics? Do you even remember that one? I don't recall what the product was but it went wildly parabolic in its 15 minutes. Comparator was another one from way back when. Of course there are many others as well.

The first AOL.

The nature of these tends to be the same in that there are always a lot of people who make a lot of money in these on the way up. The story is always compelling in one way or another as potentially life altering (in a good way). As I've said many times the actual internet has far exceeded the hype from the mid 1990s but it did not have the expected result on the stock market as many related stocks are trading at a fraction of their share price from 12 years ago and many others of course disappeared.

At some point for no reason (or any reason) the music just stops. Netflix is down 72% in three months, which probably means the music for this one has stopped. Assuming the party is over for the stock the service is still very convenient, which will always have a decent appeal (I realize subs went down a little over 800k) but maybe the future is that at some point it gets absorbed into another company or competitors come into the market to offer something that, as far as the end user is concerned, is the same service.

When the music does stop people get crushed. The people getting crushed are always some combo of people who held on too long with too much and people who got in very late.

There will be stocks like this of course that come along in the future. The strategy here is quite simple, which is sell some as it whizzes higher. You don't have to sell all of it but selling a 1/4 or 1/3 or 1/2 of the position every 50% or 100% or any other strategy is a good way to make sure the eventual implosion that you probably won't see coming (and good for you if you do) doesn't do you in. Had you tripled your original investment in NFLX and then reduced your position by selling 2/3 of your stock by virtue of making a couple of sales on the way up, then the current implosion is far less of a traumatic event.

The above example may seem ludicrous but it is far from impossible that some stock you own goes parabolic for whatever reason, making some sort of risk management prudent. If you start with the assumption that this one is not different and that rules of risk still apply then you can still do very well and not give it all back.

Source: Netflix Will Always Be A Fad Stock