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For short-term trading, volatility can provide opportunity. However, volatility also means that short-term plans sometimes go awry. Today, Briefing.com offers a few thoughts on the emotional side of investing in a volatile market.
Anytime you look at overall returns for a particular stock, or the market, it's natural to make the following kind of mental calculation: "If I had put ten thousand into Amazon at the beginning, today I would have two hundred thousand."
We all do it, but let's face it, if you had, would you actually have held the entire position the entire time?
Aside from employees, there are few people, as a percentage of everyone who has bought Amazon, who have held large stakes in a stock like Amazon.com (AMZN) from day one of the IPO until today. Certainly there are some, but many sold, or had a small position to begin with.
In fact, the people who have held their position in Amazon.com from the IPO probably succumb to thinking, "If I had only bought more!"
Consider for a minute if you had purchased $10,000 worth of Amazon at the IPO. Might you not have sold half when it doubled? Many people do. Might you not have sold when it shot up 50 points in one day, for the first time? Many did. It's too easy to assume you would still be holding it all.
We all go through the "might-have-been" style of thinking. It's natural.
But using it as a motivation for the next investment is a mistake. Selling everything and putting it into the IPO that you think might be the next Amazon.com is the logical deduction of the "if-I'd-only" calculation, but it is too risky for almost everyone.
Be wary of the "If-I'd-Only" calculations. More often than not, if you had, it wouldn't have.
Sometimes you find a repeatable pattern that works. For example, buying call options on Amazon.com stock one to two weeks ahead of option expiration date. In the past, this has actually been a terrific strategy, as AMZN stock always seems to take a significant rise just before expiration, often as a result of a timely press release.
So, after being successful at a game like this, with small size stakes, you finally decide to play it big. And you make a huge investment on a play that has worked in the past, maybe adding margin to get the most out of it.
And suddenly, it doesn't work. For whatever reason, the pattern doesn't repeat itself, or worse, it goes completely the other way. You lose all of the profits you've made in the successful execution, and maybe more. And you can't understand why it didn't work this time.
Professional stockbrokers talk individuals out of this all the time, particularly for option plays. The urge to go really big with a play that has worked in the past puts you at a much higher level of risk, but your confidence blinds you to this. If you are considering something like this, we strongly advise you to find someone to discuss it with first. Sometimes the very act of talking out your strategy helps you clarify it.
In close relationship to the double down idea is the "I've got it figured out now" attitude.
In this situation, common to beginners and experienced investors, the belief that you fully understand how the market, or a particular stock behaves, becomes stronger and stronger. Until something happens you don't understand.
Unprepared for the turn against you, you don't know what to do. Hours, or days, go by with indecision. Finally, you have to admit you don't know what is going on with the stock.
No one knows exactly what it is going to happen with a stock. Not every IPO doubles in the first week. Not all stocks go up on a split announcement. It sure seems that way when you look at the ones you aren't invested in, but we only remember the ones that go up. In fact, Barron's reported recently that in 1998 most IPOs lost money.
Anytime you think you've got it totally figured out, be cautious.
Extremely common is the short-term investor who becomes a long-term holder by turn of events rather than by plan.
Intending to make a short-term trade or play, the plan goes awry, and the expected profit doesn't materialize, or worse, the position becomes a slight loss. For example, you play a split for the pop, it doesn't happen. You hear about a new business development through a friend who works at the company and jump in before the press release. You hear a rumor from someone you trust on the street. You play it. But the expected jump doesn't happen. What to do?
You should stick to your plan and take the loss or mark it up as a draw. But do you?
Many wind up holding the stock, sometimes a large position, thinking one of two things. Either "I'll just wait until I'm back to break even," or "the pop is still coming, I'll hold on." The first, while practically human nature, sometimes never happens and you end up riding a slow train downhill for months. (Ask most long-term investors in Y2K stocks about this one.)
The second is self-contradictory. You made the first position because you thought you had the "timing" figured out perfectly. Now you are holding the same size position, but you are admitting to yourself that you don't have the timing figured out.
The better approach for a short-term trade? Stick to your plan. If it doesn't work out, sell it and look for another trade. The longer you hold a short-term position inadvertently, the more foolish it becomes. You may think that taking a loss is bad, but isn't holding a stock you don't really want for six months just trying to avoid taking a loss just as bad?
Robert V. Green