Some Tough Lessons for Individual Investors and Traders

As I reflected upon today's trading, and my plan for tomorrow, the words of Michael Learned came to mind.

I have been in the business for a long time, over 23 years.  I have seen assorted crashes, mini-crashes, Asian contagions, S&L crises, Mexican bond problems, Latin American defaults, the dot-com crash, Long Term Capital Management, and the housing-related selling.

Today was one for the record books.  It was without specific precedent.  But it had a familiar ring for veterans.


By way of background, we need to understand that (at least at the time of this writing) certain stock trades have been canceled.  (I am writing this with information as of 10:00 PM EDT, so the story might change a little).  The NYSE explains that it has a "slowdown" procedure when stocks move too rapidly.  This is completely consistent with the tradition of market makers stabilizing the market, stepping in to  balance bids and offers, and seek participants on the other side.

This makes a lot of sense.  The evaluation of specific stocks does not change by 30% or more in a few minutes, especially when there is no specific news.  Similarly, markets do not change values that quickly.  The market lost $700 billlion dollars in ten minutes.  There was no fresh information justifying this.

In practice, the rerouting of orders did not work so well.  Market orders could not be promptly filled at the NYSE and got routed to alternative exchanges.  Bids disappeared.  There may have also been erroneous trades.  As I write this, we do not know all of the answers, but the precise reason is not important for the lessons.

Implications for Traders and Investors

Lesson #1.  Placing standing orders for market stops is a dangerous procedure.  In our firm we always use the "mental stop."  This means that we watch quotes and make a decision.  If you are not watching, your stop loss order may have executed far below the market price.  Apple traded below 200.  Is that what you intended with your protective stop?

Lesson #2.  Standing " buy" orders need careful calibration.  I like the idea of having a standing bid for a stock.  Here was the danger today.  Suppose you had a far-fetched bid for a stock, way below the market.  You checked in during the last hour of trading and discovered, to your amazement, that your bid had been hit.  You decided to sell for an immediate gain.  In the last hour of trading, the stock moves higher.  To your further amazement you discover that your buy was canceled because of some market ruling.  Meanwhile, your sale, and the associated loss, are completely valid.  What you thought was a great trade, worthy of a night on the town, turns into a big loss.

Lesson #3.  ETF pricing was completely wrong.  Anyone trying to trade ETFs without a sense of the fundamental values was completely shooting blind.


The trading conclusions are pretty obvious.  There is no substitute for constantly watching markets and avoiding bad prices.  Experienced traders have seen the "fat finger errors" and other problems before.  The facile solutions of entering trading stops and heading for an appointment with Mr. Titleist — that does not work so well.

The investor conclusions (different time frame) are a bit trickier.  I have little to add to my analysis from this week. but let me summarize:

  1. If you are a long-term investor you have made big gains in the last year.  Corrections are inevitable and the specific timing is unpredictable.  Keep focused on the long-term record.  [While I cannot legally advertise performance, I am delighted to discuss it.  I am easy to reach]
  2. Market valuation does not help you.  I wrote about the subject last year at the market bottom.  All of the "trailing earnings" methods will not help.  Focus on individual stocks — specific names.  There are many exciting choices that have little or nothing to do with Europe.
  3. Near-term sentiment can be crazy.  If you are a trader, you are supposed to anticipate and/or respond to this and make short-term money.  If you are an investor, you are supposed to take advantage of "blood in the streets" to buy stocks at good prices.
  4. There is obviously plenty of negative sentiment.  I am not looking for a good employment number, so I was cautious today.  I'll take a fresh look tomorrow.

One of the most difficult things to do – -and the thing that distinguishes people like Warren Buffett — is the ability to remain calm in the face of non-stop media coverage of riots and the like.

Final Thought

I wrote something important earlier this week, but I did not flesh it out as much as I like to do.  I need to circle back to this topic.  This is a labor of love, after hours, and I hope my readers understand.

The key point of my "sound bite" article is that those who try to do a careful analysis, showing the limited impact on the US, get little attention.  There is always one side of a discussion that is easy to explain, and it gets a lot of buzz.

In a perfect world I would have put up ten articles where people showed how little connection there was between Europe and the US, how it was not like 2008, how there was no leverage, how we were decoupled.  The simple fact was that I planned to take the night off (as I did tonight) and it was a summary or nothing.

There is only so much that one man can do:)

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  • Mike C May 6, 2010  

    Quick thoughts/comments:
    1. Great stuff on the lessons, especially #1 and #2. I’m hearing some real horror stories that could have been avoided with your points on 1 and 2
    2. Got gold (rhetorical)? Gold up big today. Today is the kind of day I’m sure glad I got a long-term 10% allocation to GLD. Good diversifier to these sorts of panic situation.
    3. To point #1, the last 14 months have definitely been great, but my guess is most long-term investors are still below the high-water marks of 2007. I think it is reasonable to point that out in the context of long-term investing and the gains of the last year.
    The specific timing of corrections to the day and week are inevitable, but the warning signs have been there now for awhile. Technically, the market has been extremely overbought for the last 1-2 months and sentiment excessively bullish as measured by AAII, Investor’s Intelligence, record low put/call ratios and speculative call buying, etc. which is definitely the combo for a rip your face of correction out of nowhere. I had been selling equities considerably the last 4-6 weeks based on that. I’m looking to reload, but I think a full retest of the 200 DMA is coming. I think we need to see bearish sentiment spike up to really set up a tradable bottom.
    The million dollar question on my mind is does today’s action point in the direction that just about everybody is playing technical upside momentum here with one finger on the sell button if it looks like this rally is ending. In other words, are the majority of longs here stock “renters” or do they really own what they think are good long-term “values”? I’ll readily admit I’m in the former camp here which is disconcerting because if and when numerous technical levels break, you might get a mad rush for the door simultaneously with no buyers stepping in until we really hit value levels like last March.

  • Curtis White May 6, 2010  

    You lost me here:
    Lesson #3. ETF pricing was completely wrong. Anyone trying to trade ETFs without a sense of the fundamental values was completely shooting blind.
    Market valuation does not help you. I wrote about the subject last year at the market bottom. All of the “trailing earnings” methods will not help. Focus on individual stocks — specific names. There are many exciting choices that have little or nothing to do with Europe.

  • Jeff Miller May 7, 2010  

    Curtis — IWD is a good example. It traded at ten cents! My point is that you need to have your own valuation for each stock.
    And then still be very careful!