How Investing Drives Us Crazy: Lessons From a Trade

Carlos Portocarrero — Fri, 30 Sep 2011 10:24:16 +0000

Investing can be incredibly frustrating, even when you're doing things "by the book." I'm going to walk you through a recent trade I made using real money, pointing out all the things I did well. Unfortunately, even though I did everything "right," I still lost money on this trade. Let's take a look at what happened. (See also: 7 Common Investing Mistakes)

Starting Out: It's All About the Sentiment

I was convinced the shares of a certain tech company were headed lower. And since I love tech, I had read up on them and knew what was going on. I felt I could make a very strong case to put my money where my mouth was.

So I bought what’s called a bear-put spread. I bought five September puts and sold five September puts at a lower strike. It cost me $275, and it would make me $225 if the stock stayed under $30. At the time, the stock was around $31.

Monitoring Your Trade: Pay Attention

Right after I made the trade, things started to happen in my favor. By August 8, it was all the way down to $25 — good job, Carlos!

Then it climbed up past $35...and I got a little anxious.

And then came the curve ball — a huge tech company bought another big one, and rumors started circulating that the stock I was trading might get bought up as well, which I definitely didn’t see coming.

If you have money on a company, pay attention to every piece of news, even if it isn't directly about that company. Read everything.

If Things Change, Make a Move

This current situation was no longer the situation that existed when I put the trade on. Because of the rumor, my original sentiment no longer applied. At that point, I had two options: stick my head in the sand and do nothing, or get out of the trade.

So I sold out of my trade for a total loss of $70, including commissions. I felt bad losing money, but I was also proud of myself for being proactive and doing “the right thing.” I felt like I was practicing sound risk management, which made me feel like some investing hot-shot who knew what he was doing.

If the landscape changes, get out while you can. Don't let greed keep you hanging on to a trade that's gotten out of hand.

The Aftermath

I was feeling great about my "risk management" skills right up until expiration came around. With the stock at $34 the day before my trade was going to end, I almost stopped paying attention.

But earnings the day before had been a catastrophe and the stock plummeted all the way down to...$28. I would’ve made a profit of $225 if I would’ve held on to the trade. Instead, I was down $70.

Here’s a P&L Chart courtesy of OptionsHouse that shows what my trade did from one day to the next:

It went from being down $275 to making $225 — all in one day! Talk about being filled with regret...

Even when you’re right and do the “responsible” thing, trades can turn against you. All you can do is learn your lesson and move on to the next trade.

Disclaimer: I am an employee of OptionsHouse. LLC and the views and opinions expressed herein are my own and not those of OptionsHouse, LLC or any of its affiliated companies. This post is meant as an informational post and should not be construed as investment advice or a recommendation of any particular security or investment strategy. Any similarities between this hypothetical investment scenario and any actual investment results are unintended and purely coincidental.

This article is from Carlos Portocarrero of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

7 Common Investing Mistakes

Craig Ford — Fri, 21 Jan 2011 14:00:52 +0000

We all make mistakes.

Looking back on my years of investing, I notice some small and some big mistakes I’ve made along the way. As I’ve talked to other people, I’ve found that others have made the same mistakes. In order to help you learn, I’ve complied this list of the top investing mistakes. (See also: Investing With Your Values)

1. Starting to Invest Too Soon

Conventional wisdom says invest now, but there are reasons not to invest now.

Many new investors hear a story about some gal tripling her profit in three months and rush home to tell their spouses they need to start investing. Within a couple of days they own stock, but they don’t know a lick about stocks or the stock market.

There is a right time to start investing.

Start investing when your finances are in order. For example, you might consider paying off credit card debt before you start investing.

Start investing when you’ve learned how to start investing. Don’t invest in anything until you have at least a basic understanding of how that investment benefits you.

2. Paying Too Much to Buy and Sell

There’s a great place to buy and sell stock, mutual funds, and index funds. You’ve probably heard of it — it’s called the Internet. Buying and selling online is so simple, and it is a competitive market. That means you can save some serious money by choosing an online discount stock broker.

3. Focusing Too Much on Fund Fees

You might think that #2 and #3 contradict each other, but we’re talking about fund fees, not trading fees. Sure, fund fees are important. If you can get the exact same product for .5% fee instead of 1% fee, then that is a good choice.

However, you might have one mutual fund that charges 2.5% management fee and one that charges a 1% fee. So which is better?

If the one fund has an average annual return of 10% and the other 15%, then the 15% fund is better no matter the fees you pay to own that fund. Returns are more important than fees.

4. Discovering Your Risk Tolerance at the Wrong Time

Everyone has a high tolerance for risk when the market is going up. Hey, I’ll take a risk to gain an extra 10% this year. But then when the market turns, you find out that you just lost an extra 10% because of the risk you took.

It is often in the middle of a bear market that people decide to sell. They sell because their losses are greater than they anticipated.

5. Changing Your Investing Strategy Based on Market Conditions

Let’s say a person was going to invest $100 every month for the year. However, after a couple of months that person sees that he has a loss, so he decides to stop buying until the market goes back up. It seems like that would make sense, but it is a very bad move. It means you actually pay more because you waited for the price to go up.

In fact, that is one of the strengths of dollar cost average and value averaging — they can be effective in good and bad market conditions.

Yes, you may need to re-evaluate your strategy based on market conditions, but don’t let your investing approach change with every ebb and flow in the market.

6. Looking for Hot Stock Tips

If you listen to any talking head who knows which stock will skyrocket next month, you should run for your life.

Investing hot tips are for movies. In real life, people realize no one can predict what’s going to happen next. Don’t believe me? Ask 100 investing professionals if the market will be up or down this year, and I doubt you’ll find more than 10 people who have the same prediction for the same reasons.

7. Paying Outrageous Fees for Investing Advice

Several years ago I fired my financial advisor. The reason was that he would only advise I buy mutual funds that had a 5% front-end load. That’s how he made his money. That’s how I wasted money.

Too many of us think professional financial advisors have some hidden knowledge. They don’t. Getting financial advice is good, but just don’t pay outrageous amounts of money for it.

What other common investing mistakes have you encountered? Have you made any of these investing mistakes?

This article is from Craig Ford of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

investing errors