The little guys are once again on the run. The activity in small news stocks seems to run in cycles. For months we will see little or no interest, and then suddenly they will start popping up like mushrooms. So it pays to track the action. That way you are prepared to take advantage of the waves when they do come in. And recently, the momentum in small stocks with news interest has once again been heating up.
Things like Catuity Inc (CTTY:Nasdaq), Host America Corp (CAFE:Nasdaq), and yesterday Bos Better Online Solutions (BOSC:Nasdaaq) and Salton (SFP:NYSE) have been doubling, tripling, and sometimes quadrupling within hours. They have been giving us some great plays off the bottoms if you are quick enough to catch them when the momentum moves in, and they are small enough that you can load up on shares, so it’s a fun way to make some quick cash.
Here’s the danger though… These sudden, mesmerizingly large climbs, tend to bring out the worst in us. I’m talking greed and hope and fear, and all the other emotions that traders are supposed to be suppressing. These are the emotions that cause you to stray from your system, forget your discipline, and lose control over your trades. They bring out the gamblers in us.
A couple days ago I saw someone, let’s call him Joe, load up shares on CAFÉ to hold overnight after the big run. He was hoping to catch a nice gap up. The problem is, after a big run-up there is a lot of profit-taking incentive built up in the short-term. Any negative news overnight can cause the stock to gap down severely. You have no control over an overnight trade, so loading up a large number of shares is very risky. I called him a gambler, which might have sounded harsh, but it caused him to do some self-reflection. He said that no one had ever said that to him directly, but that after some thought, he agreed that he was in fact gambling.
During the late 90’s Joe turned $15,000 into 7.2 Million. That is an impressive feat, and those numbers would imply he is a very skilled trader. To his advantage he had an incredibly bullish market working for him. Combine that with very aggressive trading habits, and you have a recipe for huge gains. Around 2000, he said to his wife that the smartest thing he could do that that point would be to put the money in double tax free bonds and make the coupon rate. But that would be boring wouldn’t it? And his goal was 10 Million. He was addicted to the thrill.
Now it is 2005, and Joe has slowly lost 4.3 Million in what he describes as a slow death. What happened? He is a very aggressive trader, and at times he makes a lot of money, which is a lot of fun to watch. CAFE did in fact gap up nicely on July 13. Anyone holding shares overnight made a bundle. But was it a good trade? Other times we have seen him blow stops with a hair-raising number of shares.
This is a typical case of the turtle and the hare. Rather than settle into a lower-risk consistent routine, setting limits on the amount of trading capital they use and risk they accept, the hare will parlay. Rather than take the predictable scalp on the small news runners off the bottom, in a trade they can control, they will roll the dice and hold large numbers of shares overnight. So they will make a lot of money in an accommodating market, far more than most, but to achieve those kinds of gains, they take on a lot of risk. And when conditions get tough, their losses will also be far more than most.
If Joe had fundamentally sound trading habits, he would have worked harder for less money, but wouldn’t now be slowly bleeding his portfolio dry. For every trade you need to ask yourself, “How predictable is this trade, how controllable is this trade, and what is the loss potential?” If you are playing the odds, relying on discipline and system, keeping your risk reasonable, and staying in control, you are trading. If you are relying on luck or hope, and taking on unreasonable risk, you are gambling. If you are looking for the thrill, you are gambling.
Your focus can not be on the money. Your focus needs to be on playing the game properly. Your reasoning for a trade needs to become more important than the outcome. It’s the challenge of the game that matters, not the results. How can the results not matter? Isn’t that why we are trading in the first place? Yes, but until you can learn to forget the results and simply follow the rules, you won’t get consistently good results. Follow the rules, and the results will come automatically. That is the paradox of trading.
Let me tell you a little story. A samurai was commanded by his lord to kill an enemy. He went to the man’s house and found him. As he raised his sword to take off his head, the man spit on the samurai, which made him very angry. He put his sword away and walked out, because killing the man would no longer be from duty, but revenge. So he waited for another day. If the goal is your main focus, then you will take the man’s head off, angry or not. But sometimes keeping the rules and playing the game properly means you hold back and do nothing. Remember that the next time you are tempted to gamble, especially on these small news runners.