Saturday, November 27, 2010

An Interview with "Shelby Aldrich" - Part II

Its Saturday morning in Las Vegas. I am being interviewed again by our fictional reporter, "Shelby Aldrich," for the Summerlin Gazette. The Reading Room is warm and cozy, a stark contrast to the bitter chill in the air outside. The kids have scattered to the winds, so I have time for a leisurely interview session.

Shelby: Wink, thank you again for your time this morning. Where are your lovely kids?

Wink: The oldest is helping a friend with a move. My middle child is transfixed by Cartoon Network. And the youngest is skating at the ice rink.

Shelby: I see. Well, let's see where we left off. I wanted to ask you about your most memorable failures. Failure seems to be a precondition for success in many areas of life.

Wink: That's right, Shelby, particularly in investing and trading. Three bozo moves come to mind right off the bat. When the market started to crash in 2000, I didn't step back and stop investing. I just assumed that we were in a rolling correction and that higher prices were dead ahead. I would come to this library and read the Investor's Business Daily (IBD) every Saturday morning. Right over there, you see where they keep the newspapers? I just pored over IBD looking for the next Yahoo, the next Juniper Networks, the next Internet Capital Group. I didn't appreciate that a Bear Market is different in character from a Bull Market.

Shelby: Did you have stops in place?

Wink: Sure. But it didn't matter. The trend is your friend. If the trend is down, you're going to lose your money by buying stocks and hoping for a turn around. So, that whole IBD period in 2000 was a setback.

Shelby: And you used those lessons to protect yourself later?

Wink: Exactly. When August 2008 rolled around, I knew what to do when the trend turned down. Get out of stocks!

Shelby: What was your second hall of fame bozo move?

Wink: This is an interesting bozo move drenched in greed, pure unmitigated greed and emotion. When 9-11 happened, I was no longer actively investing and trading. I just assumed the long trend was bullish and I would profit in the end. The stock market closed for a week after 9-11. When the market opened again, I was curious to see what would happen. Well, the market dropped for 5 days in a row. I knew we were near a bottom but I wanted to see what would happen. I was like, you, Shelby, just observing and taking notes and thinking about things.

On options expiration day in October, 2001, I read a post on my favorite website, clearstation.com, about the performance of Juniper Networks (JNPR). Remember, last week I had said that I flirted around with Juniper? Juniper was one of my momentum stocks that I had seized upon after reading Forbes and Fortune. It must have had a price earnings ratio of 340 to 1! LOL. I didn't care during my predator stage. I just wanted price movement.

Anyway, I read a posting that caught my attention. October 20 calls on Juniper had increased from 0.05 on September 24, I think, to 3.5 by the third Friday in October. Even though the underlying price of Juniper had increased from $8.94 to $23.50, the options had increased 70-fold. A hypothetical $5,000 would have increased to $350,000 in 4 weeks! That little price move stuck in my mind. I mulled it over and thought about why this abnormal price event had happened. I eventually decided that I would bide my time and wait for another comparable opportunity in JNPR call options.

Shelby: But you can't depend upon those opportunities happening again? I mean, the market could have kept dropping after 9-11. In that case, those October 20 options would have expired worthless. Or, the price of JNPR might have risen but only up to say, 12 or 16 or even 20. It seems like a roll of the dice to me. Then again, we are in Las Vegas. LOL!

Wink: You're absolutely right. Today, I would chalk it up to a low probability, Black Swan event. But I was still in grade school as a trader and investor. The early years had been too easy. I had to learn to respect risk.

Shelby: So, did you get an opportunity to turn a hypothetical $5,000 into $350,000?

Wink: Well, yes and no. That's why this trade is my Second Worst trade ever. 2001 came and went. I was surprised at how strong the market bounce was. My handle on technical analysis told me that the bounce was about to end due to negative divergences. I remember feeling a sense of satisfaction as the market topped in early 2002. I wasn't making money in my retirement account but I was happy because I had anticipated a top in the market and I was right. It is very important for an investor and trader to reach a place where market tops can be anticipated. Once you reach that stage in your growth, you will have more confidence when its time to sell. When its time to sell, the herd will be very bullish. When its time to sell, the media cheerleaders on CNBC will be giddy. Commentators will be beside themselves with glee. "There's no way this market is going down!" You ain't seen nothing yet!" Those are psychological signs of a market top.

Shelby: So, the market was topping. Why were you still thinking about that October 2001 move in JNPR call options?

Wink: Because I now knew that the market moved in clear cycles from high to low. When the next low came, that would be a good time to buy stock. It would be a good time to buy call options in JNPR.

I remember one of my best investments happened in 2002. Should I mention it now or later?

Shelby: Well, to keep my notes clear, let's stick with your failures for now. Later, we can touch upon your greatest hits. It might surprise you but I think readers will learn more from your struggles and flops.

Wink: You're probably right. So, the year 2002 came and went. I focused on my day job. 2003 came and I noticed that the character of the market had changed.

Shelby: What do you mean "the character of the market had changed?"

Wink: Stocks were going up more than down. Investors were buying the dips, not selling the rallies. I could see the change in the charts. The market had changed from Bear to Bull. I did some research on the market. I remember reading the Stock Almanac and noting that a dip in mid-December was oftentimes followed by a Santa Claus rally. I saw that the market had made a higher low in March of 2003 and a higher low in late August of 2003. Might this pattern of higher highs and higher lows be a setup for a Santa Claus rally? And, if so, might this not be a splendid opportunity to buy underpriced and undervalued JNPR call options?

I put two and two together and decided the opportunity was at hand. It was in front of me. I opened up an options account with a brokerage firm in New York. I deposited my money. I waited patiently for the mid-December 2003 dip in the price of JNPR. One thing I had remembered from September 2001 was that the price of JNPR had dipped below a psychologically important level of 9 before bouncing. In early December 2003, JNPR was trading around 19/18. I could see that it was declining but it was a gentle decline, as if the stock did not want to fall further. I knew from prior readings that a muffled fall is a sign of impending strength. The days ticked by, December 11, December 12, December 13. I waited with patience worthy of the famous trader, Jesse Livermore. December 14....

JPNR began to drop below 18, below 17. I placed a limit order to buy as many JNPR Jan 20 calls @ 0.05 as I could. I believe it was December 17, 2003 when the price of JNPR dropped to 16.84. I knew, I just knew that this was the time to buy! Weak hands would be removed by the running of stops. I pulled up Yahoo.Finance. I typed in "JNPR", "options", and scrolled down to the January 20 calls. The last traded price was 0.05!!!

Yes!! Yes!! Yes!! The price had hit 0.05. I was so happy! I was dancing on air. You would have thought that I was Reginald Lewis who had just closed the deal on Beatrice. I was happy and counting my money/smile. LOL

Shelby: What a build up! This seems like a very skillful move, one you had plotted and planned for over two years. That's a long time to stalk your prey. What happened? Why is this your second biggest failure as a trader?

Wink: If it seems too good to be true, it probably is too good to be true. I met a fisherman the other day in La Jolla that said the same thing.

Here's what happened.

So, I'm happy as a clam. I nailed the absolute bottom of the move into mid-December 2003. 3 days later, my calls were quoted at 0.20. That's a 400% increase in 3 days. Of course, I'm expecting a 70 to 1 return because of the October 2001 JNPR call experience. To hear the cash register ring, I called my options broker (name not revealed). I asked for a price quote on the balance in my account. The broker said, "You have x funds in your account, Mr. Twyman." I was stunned. I was speechless. The grin on my face was gone. I said, "But how can that be? I purchased the January 20 call options 3 days ago at 0.05. The last quoted price was 0.20." The emotionless broker replied, "That right, Mr. Twyman. The last quoted price was 0.20. However, your limit order to buy at 0.05 was never filled. Only 5 contacts traded at that point. Those 5 contacts were all purchased by specialists."

Shelby: Oh, no! (hand over mouth).

Wink: It had never occurred to me to confirm that my limit order was filled. If I had phoned in for a fill confirmation on December 17, 2003, I would have raised my limit order to 0.10. I was mad. I was angry. I was fit to be tied. And this is why this missed trade is my second biggest failure. It was not a failure because I didn't get filled at 0.05. I could have still gotten in a very good price at 0.20. My failure was that I became emotional. I allowed my disapointment to color my judgment.

Had I not been angry at those "floor specialists" who got my 0.05 calls, I would have gotten in at 0.20. Instead, I refused to play a rigged game.

Shelby: And what happened?

Wink: It was a very sad outcome. Rather than be flexible, I sulked. I watched as the price of JNPR leaped from 16.84 to 18.50 and 18.20 to 20 and from 20 to 22.5 and from 22.5 to 30 by the third Friday in January 2004. Had I picked up the phone to confirm the fill and been flexible enough to buy at 0.10 rather than insist on 0.05, I would have earned a 100 to 1 return on my January 20 JNPR calls in 4 weeks. That would have been my George Soros trade, my John Paulson trade, my best trade ever!

Shelby: I now see why you consider it such a failure. You failed to be flexible, to stay with a well-defined situation that you had been stalking for two years, and to heed the trend.

Wink: That's right. Opportunities like December 17, 2003 don't come around every day. I knew that at the time. I remember moping about the missed opportunity that I had foreseen. If you are right on the opportunity and right on the trend, don't quibble over 5 cents. You will regret squandered opportunities that you have sized up for two years more than a flat out losing trade.

Shelby: I fear that we are once again going over our time limitation. I lost track of time. I want to hear about your third biggest failure. Can we return next week and have you talk about your later years when you have made shrewd moves in your retirement account?

Wink: Of course, but the third time will be the charm. I don't want to reinvent the wheel and many of my thoughts are on my blog.

Shelby: I understand. So, you crashed in 2000 like most investors. You then waited for a rare options opportunity for over two years. When the time came to execute, you quibbled over 5 cents and became emotional about special access afforded to floor specialists. In doing so, you passed up a 100 to 1 rate of return. What would the third most notable mistake be?

Wink: By 2007, I was in the swing of things. I understood the ways of floor specialists and market makers. I had removed emotion from my decision making. I was well on my way to becoming a contrarian. Then, I allowed success to go to my head. After a successful campaign where I grew $700 to $20,000 within 6 weeks, I foolishly assumed that I was now King Kong. I could do no wrong. Traders like Larry Williams and Marty Schwartz have talked about losses after outstanding successes. It happened to me in October 2007. After reaching $20,000, I gave it all back on an ill-considered options play on Countrywide. I didn't have the patience to wait for a well-defined situation. As a result, I learned to value patience over greed, discipline over past triumphs. Nowadays, I am quick to sell hysteria after nailing a market bottom. Gains are fleeting when euphoria reigns. Its been an important lesson.

I would have to say, in all frankness, that my failures have taught me more than my gains. Patience, discipline, the clearly defined situation--I've put all of these lessons to good use with the Las Vegas Thrift Savings Plan Investment Club.

(Glances at my watch) Shelby, where did the time go?

Shelby: I know. Have a good day. I look forward to finishing up the interview series next week.

Wink: Me too.

Standard Disclaimers
1. This blog is for educational purposes only.
2. None of the individuals associated with the Las Vegas TSP Investment Club are registered financial advisors.
3. This blog is not an offer to the public to buy or sell any stocks, options, commodities or futures.
4. You are encouraged to do your own due diligence and to consult with a professional financial advisor before making any investment decision.
5. This blog cannot take responsibility for the results of your investment and trading decisions.

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