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Educational Article

The School of Hard Knocks

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By David Popper

There I was, fully invested in the best stocks in the universe including DELL, MSFT, CSCO, TXN, etc. I thought that I was on the verge of making a lot of money because for the first time I was fully margined. True, I could have made more money if I had purchased these stocks at a sound entry point. Unfortunately when an entry point was available, the stock had dipped and I was too new to understand the gift being presented. After the issue bounced off of support and raced ahead 20% I purchased the stock because it was a rocket that had "proved" itself to me. Somehow I felt safer buying these winners. The day was August 31st, 1998 and over the course of the next two days, I was going to learn some very expensive and valuable lessons.

As you may recall, August 31st and September 1st of 1998 were classic climax selling days which caused the Nasdaq to drop more than 500 points before reversing sharply in the afternoon of September 1st. This formed the bottom which began a powerful 30 day rally. During these days I felt panic as the market dropped, relief when I sold, and utter disillusionment when the market reversed after I sold. I realized that had I stayed in the market, my losses would have been erased. I realized that if I had purchased the stock correctly, I would have made money. I finally realized that if I had been a panic buyer instead of a panic seller, I could have made a year's worth of profits in only one day. Yes, there was more to this game than just picking stock. I realized that there were rules to this game and if I was going to be successful, I had better learn these rules. I realized that this was not a one time event, and I had better play this situation better the next time. Below I will discuss some of the lessons that I have learned.

1. ONLY TRADE THE TOP STOCKS Institutions have certain favorites. These favorites are often bought on dips. Flashy stocks without earnings simply do not survive the hard times. You can rest assured that institutions will buy the generals like SUNW, CSCO, and ORCL on dips. I would not bet the farm on KOOP, KTEL, KREM, or MSTR however.

2. ONLY TRADE STOCKS THAT ARE ON THE CUTTING EDGE Technology is changing fast. What was cutting edge 2 years ago is simply a commodity, or worse, obsolete now. Remember those traders that used to exclaim in the chat rooms that they would keep AOL and Dell forever? Well, at the time it seemed that the party would never end, but it did end. Computers and the net are not the rage, broadband replaced it. Will broadband last? Only until the next technological breakthrough occurs.

3. MONITER THE QUALITY OF YOUR STOCK ON A MONTHLY BASIS Love may last forever, but even stocks in cutting edge areas may falter. Consider LU for a moment. LU was a market darling in the early 1990's. The LU management wisely noticed that the fiber optic market was white hot and LU entered the arena. For whatever reason, LU has not fared well. Virtually every stock in this sector is doing well except LU. LU is now at a 52 week low. It is important to monitor your stocks on at least a monthly basis in order to avoid being stuck with a has-been. Inasmuch as my strategy of choice is covered call writing, I am compelled to evaluate my holdings on a monthly basis.

4. ONCE YOU HAVE SELECTED QUALITY STOCKS, DO NOT SELL INTO A GENERAL MARKET PANIC When markets panic, as they occasionally will do, do not panic. Institutions will view this as a buying opportunity and will purchase quality stock at a discount. When the market rallies, often quality stocks rapidly reach new highs, while lesser stocks continue to wallow. DELL reached an intra day low of $40 on September 1st, 1998 and was double that price within 30 days. Just the same, INTC had some bad news which may have some relevance to box makers and DRAM chip producers, but it does not have any meaning to other areas of technology. On such a downturn, other good issues from other dynamic sectors may experience an initial plunge, only to roar back. It would be better to be a buyer on such dips, not a seller. Peter Lynch once said that more money is lost in preparing for corrections than would have been lost in the correction itself. Again, owning quality stocks is the best defense to corrections.

Next week I will discuss other lessons learned the hard way in 1998.

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