Everyone loves to be a winner in life. "You play the win the game!" Yes Herm Edwards, we absolutely do. But in life, just as the markets, we never win all the time, and we probably don't even win MOST of the time. If you do win most of the time, then maybe your sights are set too low.
Let us think of very successful people, whose vision and goals are certainly grander than most normal people. In fact, let us use Michael Jordan, certainly one of the greatest basketball players to ever play, as an example. The allure and the art of winning, as an individual, comes down to game winning shots in the fourth quarter. He certainly has hit his fair share in his career. So this following quote is even more surprising, coming from an immortalized player,"I've missed more than 9000 shots in my career. I've lost almost 300 games. 26 times, I've been trusted to take the game winning shot and missed. I've failed over and over and over again in my life. And that is why I succeed." His willingness to take on the responsibility of executing the game-winning shot is a bold task in itself. But beyond his strong will, his willingness to accept the less desired result, failure, shows us how some great achievers in life are able to take on a task many normal people do not relish. When he releases his fade away jump-shot in the waning seconds of the game, MJ realizes that there are two results to his action: failure or triumph. Because he is human, he cannot triumph all the time. So while bathing in glory after winning a game is great, his true self is shown with how he handles failure.
Many similarities have been drawn from athletics to trading, because both arenas harbor the most competitive people in the world. There are certain attitudes that successful competitors have and the acceptance of failure is one of them. Don't get me wrong, no one likes to lose and certainly any equity position that you would take in the market is based on the premise that you think you are right. But the laws of life do not allow someone to win all the time and only the lucky and great ones win most of the time over the course of their career (Dan Marino was not lucky, to say the least). So while you enter into your equity position believing that you are right, you better be damn sure to have a backup "what if I am wrong" plan, aka the stop. And if you do happen to lose on a trade that you were so sure was going to work, just be like Mike.
A quick mention about volatility. I met with one of my friends yesterday who is very interested in the market and has started to dabble with some of his disposable income. While he's making most of the mistakes market newbies usually make, his willingness to invest in AMZN seemed very bold to me. It may be because he's an extremely successful entrepreneur and innately realizes the concept of risk reward, in this case, high risk but higher reward. Regardless, most people who start off screw around with "lower priced" stocks, because they feel like they are getting more "value." First of all, it is perceived value. There is a reason why these stocks have lower P/E ratios than their competitors. And by the off chance that the stock does sky rocket, it can be one of 3 things: 1. Market upswing 2. Company or competitive landscape has changed 3. Pure luck. Just because you can have 5000 shares of a $1 stock doesn't mean that it has a higher payoff instead of buying 500 shares of a $50 stock. The concept of volatility is lost in their translation; a $50 stock will certainly move more than a $1 stock and thus, if the quality of the company is top notch, it more than makes up for the position sizing.
Secondly, institutions move the market. You, me and the millions of other retail traders will not move the market. Concentrated pools of capital cause markets to move, because they have the muscle to do so. Even if all the retail traders pooled their money together, it only accounts for 30% of the average trading volume on the exchanges per day. It's David vs. Goliath big time. Because they have so much money to put into use, do you think they will toil around a $1 stock with only hundreds of thousands of shares traded daily? They could barely put a meaningful percentage of their capital to work. People can try to roll the dice and hope that their dollar stock comes into favor of institutions (a la SEED) or they can follow stocks that actually will move certain percentage points. For those who are afraid of volatility but still want to be a part of the market, I would advise you to buy SPY, the ETF that traces the S&P 500 index. For those who are in the game to make money, I would suggest following the Goliaths.
Feel free to post comments, I will respond and appreciate every one. Also, if you would like me to discuss a certain topic in my next post, post it in the comment section as well. Until then, never leave home without a stop-loss.
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I can never agree with you on payoff comparing a low and a high price stock. 1)A low P/E stock is different from a low price stock. 2) In general, 100% return on a $1 stock is more likely to happen than a $50 stock. Of course, there is much higher risk one is taking by buying the $1 stock. 3)There are typically more numbers of institutional players trade the $50 stock than the $1 stock. If the $1 stock has small mktcap, one institutional player can swing the price of $1 stock much easier than $50 stock.
ReplyDeleteWell again, I am an investor and portfolio manager, not a trader. We are looking at payoff from different perspective.
Mr. Anonymous,
ReplyDeleteI don't think we are at odds here. Maybe I came off the wrong way but absolutely the "ease" to which a $1 stock moves up 100% is higher than a $50. But what is the likelihood that YOUR $1 stock that you bought is seen by an institution that decides to commit into buying that company? If they do commit, the institution must also consider the lack of liquidity and must be the ones to commit themselves to the stock. They have no one else to unload to.
And let's just say that per chance, you happened to be lucky and bought one of the few that had a meteoric rise. What is your opportunity cost of not trading stocks that you know will move? What could you have gained trading a RIMM, AAPL, etc instead of waiting for a heavenly sent angel? Finally, would you ever commit a sizeable position to that one stock? As a trader who chases the "fat tails," I am confident enough in my position that if the trade acts accordingly (which doesn't happen often), I can use full leverage knowing full well that if I were to be wrong, I can exit the stock without worrying about outsized liquidity risks.
Hey, if you happened to catch those moves from $1 stocks, the more power to you. But for those who are not as experienced or as analytically savvy as you are, they could be waiting for months, years for an event that may never come.
Yes, you are correct about a low P/E stock being different than a low priced stock, my apologies. My point was that it is very likely that one might be playing around with a "dog" of the sector, when one should be looking to follow the "leader" of the sector instead. Obviously was not very well-articulated on my part.
Lastly, it's most likely that our time-frames are disparate. Yours is probably in terms of weeks, months and maybe even years. Mine are measured in days, weeks at most. My entry points and exit points can be hit within minutes of each other while you probably give your more room. And while I question your opportunity costs using my time frame, that idea might be irrelevant to your system. As long as your and my systems work for us, there is no reason to change our beliefs.
I forget to mention one important fact:
ReplyDeletePayoffs= Return * Odds
Although your returns are outsized, how probable is it that the dollar stocks that you buy do have this meteoric move?