To explain why I am still here trading today after numerous years of disastrous results and losses, I decided to put in writing how I got myself here, perhaps as a reminder, or as an open solicitation to others for more insight on what other lessons I should take away in developing my portfolio.
The Nightmare That Was
I turned to the stock market to invest for growth and I fell into a series of mistake for years.
2001 - CMGI - Lost 97%
2004 - Creative Labs - Lost 210% (Margins)
2005 - Penny Stocks - Lost 20k at the age of 17
2008 - AIG - Lost 97%
That was my track record. Awful. Horrendous. My only saving grace was that at least I was whiz kiddy enough that I could make enough money from my own startup ventures to cover those holes.
I was ambitious. I was naïve. I was arrogantly stubborn.
I've paid dearly for those mistakes, and in 2013, with the markets where they are, plenty of traps are set for the novice in the coming months. While I do not predict 90%+ losses, there could still be plenty of pain if you are not careful.
How did I get here?
Sin #1 - The Hot Trade - CMGI
2000. The tech bubble. It was a fantastic time, a fun time. I turned $200 into $2,500 from 1998 to 2000 at the age of 10. I thought I was invincible, "whiz kid". You could practically buy anything and it would go up. It was all decisions on emotions and feedback loops. I didn't even bother understanding what CMGI was when I got the tip.
Today we are hit with a deluge of information. Analysts tout new picks on CNBC as filler, pundits screaming into your screen, articles on Yahoo! Finance and Seeking Alphas flying by left and right, and tweets popping up like mushrooms after a rainstorm on StockTwits. We are hit with opinions all around and "noise".
The takeaway: Step above the crowd and filter.
John Paulson; A superstar in the hedge fund world. Made a killing in 2008 shorting subprime. He's now down 30+% in 2012 and I know plenty of people who followed his picks that went right with it.
Be a stock picking hipster. (Or a hippie, whatever your vintage may be.) Have a free, independent mind. Ask why does the stock belong in your portfolio. Does it execute your investment thesis in the broad picture??
Shoot down 99% of the noise and theories you come up with until you find that hardy idea, that top 3 or 5 ideas that stand tall in the face of relentless ridicule and bombardment of your own logic. When you do find it, hold onto it and be stubborn with it: don't let a 3% down move shake you out.
I would ask anyone who invests in these names to really scrutinize their reasons in investing. Is it really a business you believe in the long term? Do you have conviction in your own projections? Does it fit your investment strategy? Or are they just a distant reminder of a Jim Cramer call?
Both Apple and Salesforce are names with a halo around them, and I am avoiding them here both names could suffer drastic pullbacks if they disappoint. Both stocks are in a "show me" year, and I personally am uncomfortable with that prospect. With the size of Apple, it will require an potent catalyst for the stock to move from here and I see numerous names with better upside potential.
Sin #2 - Stubbornness - Creative Labs
So you found that idea. You bought the shares and you're now in deep. Then the shares tank. Maybe it's news of a new competitor. Maybe its event driven. Maybe it is broad market. Or maybe it is just plain stupidity.
I bought Creative Labs believing in their products and their business. I rode it all the way from $17 to $3. I kept doubling down on margin by buying on dips too. It imploded spectacularly.
Only I didn't ask why. What caused the stock to collapse? Why is my thesis not playing out?
Takeaway: Review and scrutinize your portfolio, hard and clear.
While it is important to be stubborn about your best ideas, you also cannot be overly stubborn. Ask yourself, is the portfolio you have today something you want to hold onto going into the debt ceiling talks?
Set a threshold and take your loss no matter how painful. Every bet in the market is like a look into the barrel of a gun. Learn to bail if wrong. You might just live to die another day.
My Flavor: Curb your position in weak names and take your losses. We are in a volatile year and you don't want to be riding names down hard. We don't have the luxury of an oversold market of 2009-2010 for buy-and-hope.
My picks and pans: Semiconductors and Biotech
I would consider Intel as a more speculative contrarian play here at this point and avoiding HP with its SEC investigation like the plague.
Biotech - Are you sure you have enough knowledge to bet assuringly on the next FDA announcement is going to be positive?
Names like Vivus (NASDAQ:VVUS), Arena Pharma (NASDAQ:ARNA), and Dendreon (NASDAQ:DNDN) all have promising pipelines. However, none of which qualifies for my portfolio as I have little to no confidence level in what the FDA could do with their key drug pipelines. I would scale these names accordingly to your risk appetite at this junction.
Sin #3: Ambition - Penny Stocks
High beta: It doesn't get any higher than penny stocks where one tick can push you up 20%+. I traded these names for a while making massive gains for months on end. The adrenaline rush was palpable. In the words of Gordon Gekko: "It was better than sex."
I always thought that was an exaggeration, until that year, he was not kidding. At least until that last trade, where my entire profit was wiped out and I realized I was $20,000 in the hole.
Takeaway: Set your expectations and manage your exposure accordingly to scale with your returns. Put on hedges on your top bets.
Being 24, I now realize even if I achieve a gain of 20% on average a year, I will be a very, very potent and successful investor by the time I hit my 40s.
Time the market and analyze. Know when it is the right time to cash in and call it quits.
If you had a solid skill for analyzing a business and you find just 1 ticker that could double that year, that might be all you need. You might only need 6-7 trades like this in your entire investing career to make bank, even if it takes 2-3 years before you find just that 1 single trade.
Law of probability that if you made 20 trades a year, it's next to impossible you will have a total winning streak. Hoping is not a strategy.
My flavor: I make one big bet when I find it. But only when I have utmost conviction in the name and I have to hedge the portfolio one way or another.
My Picks and Pans: High Beta names post political showdown, and panning Chinese growth plays
The coming year pose many uncertainties for the US political arena. This would create a fantastic buying opportunity playing on sentiment. (see the fiscal cliff rally)
I am currently keeping a fair amount of dry powder aside. Even though we still have 2 months before the next Washington drama-session begins, I would rather defend my portfolio than to squeeze alpha from an extended market.
I am also negative on speculative Chinese names in the face of a slower Chinese economy. While growth in the past decade has been spectacular and the opportunity to generate massive long term growth is there in many names in this space, the quality of growth in China has been problematic in the last decade (see the ghost cities here) and I believe we are entering a phase of moderating growth.
To those playing basic materials: A structural rebalancing of the economy to focus on higher quality of growth could prove disastrous for names like Freeport McMoRan (NYSE:FCX) and Rio Tinto (NYSE:RIO). I would strongly recommend hedging with some puts or other options play, as the market is still betting too heavily on a Chinese recovery.
Sin #4 - Trusting the management (or not) - AIG
After a disastrous run in with the penny stocks my risk appetite swung the other way fully to buying blue chip stocks. I developed a fascination with the insurance business model and after research in 2007 I bought into AIG. Only a sudden announcement of writedowns one morning in Q3 2008 did I realize how much filth management had hidden from the public until it was too late.
Takeaway: Not much you can do when management engages in fraud, but just take note of what they are doing, and try to write an insurance policy on your investment if it makes sense and if you can afford it.
This is the trickiest of them all. Sometimes a fraud is just that good. Enron, WorldCom, AIG, Chinese reverse mergers, there's plenty of blame to go around. These are the nightmare scenario every investors should be afraid of, and sadly, it will always keep happening.
My flavor: Out of the money puts on risky names. Again, proper risk management hedging.
My pans: Herbalife (NYSE:HLF) and Hewlett-Packard
Issues with management's creditability have dampen stock prices in the past year. I am avoiding these names due to the controversial nature of these tickers. Until these issues are resolved there would most likely be a cap in the stock price in the foreseeable future, despite their supposed attractive valuations here.
There are plenty of other tickers with far better stories and fundamentals offering better risk-reward structures (see picks below).
Only investors with the highest degree of risk appetite should consider these turnaround/validation names and they would be a gamble at best.
The Story That Is…
I have only made 3 major bets since 2009.
Wynn Resorts at $16 and International Paper at $5 in 2009
Take Two Interactive at $11.50 in 2012
But I'll take what I got out of them.