Every trader and investor claims to follow rules each day.
While some trading rules are sound philosophies and keep you grounded, there is one that is tantamount to your success: risk management.
The allure of risking capital to gain more wealth is tempting, at times it's hard to resist. But it is this fundamental exercise that will save save us from the inner greed we all possess.
Discipline is tough to rein in when you're in the middle of battle. In trading, we see opportunities arise out of the ashes and want to participate. That's all well and good, but how about when a "hot trend" is happening and your eyes catch it? Don't you want to pile in, like the rest of the crowd? Of course you do, but you have to remained disciplined and use care.
Let's take the recent GameStop ( GME) stock move that happened recently. It was a massive short squeeze driven by the Reddit page "Wallstreetbets," who managed to drum up support and enthusiasm for buying this very low float (available shares) stock. Late in 2020, the stock was cheap enough, around four bucks a share, to buy hundreds, if not thousands of shares with a small stake.
The fundamentals of GameStop were well known, but that did not matter to this buying crowd. They wanted to roar, make a statement -- and did they ever! I read that some who held onto their shares were instant millionaires. That's great! The American Dream -- put risk capital on the line and hit the jackpot.
But, now what?
When dealt such a strong hand like this, many are not aware of what to do or become obsessed with greed that common sense is thrown out the window. About a month ago I heard the story of a Missouri man who followed the cult like Wallstreetbets into some shares of GameStop stock last year, along with some call options later on.
He hit the jackpot, his account rising to over a million dollars (he flashed it on the screen). This gentleman works a job that pays him $35,000 a year. So, he just nailed a fortune that was 30-times more than his annual salary. Quite the haul, wouldn't you say? GameStop had soared to over $320 a share by the end of that day, was even higher earlier in the session.
When asked by the reporter what he would do -- even sell -- the man smirked, and said he believed the stock would go to $500 a share, then $1,000 a share. Nope, no need to sell any of it. Wallstreetbets was telling him and all of their followers to hold on, it's going higher. GameStop would make him even richer than that day -- so he thought. But why not sell some? Maybe half of it?
The following Monday, Feb. 1, the stock started to crater. After three weeks of intense selling, GameStop is now at a paltry $40 a share. Still higher than it was at the start of 2021, but down hard from those nosebleed levels.
Well, we all could see how this was going to end. Greed is very hard to control when it wakes up in your body. I'm not sure if the man from Missouri ever sold his GameStop and at what level. If not, I'm sure he learned a valuable lesson. Take heart of the lesson here. When given an opportunity for a life-changing opportunity, taking risk and being paid for it, follow your head, not your heart to the promised land. You might not get out at the top, but you'll be better off in the end.
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February 22, 2021 at 11:00PM
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Here's the Only Rule You Need to Follow to Manage Risk - RealMoney
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