From the trader who gets his casino thrills from “investing” to the billion-dollar portfolio manager who crushes the S&P every year…and then flops, it boils down to one thing: trades need to be executed and managed trades in line with the TYPE of trade intended. It seems simple, but failure to execute, manage, and exit a trade according to the original thesis is often the reason that winners become losers. Let’s explore further by defining different types of trades with examples. We’ll look at the most common mishaps, and figure out how to avoid them. This should lead to some advice which will lead you to $$$$ millions…ok probably not, but hopefully it saves you some money at the least.
We’re going to start with the broadest and simplest types of trades then narrow down to more intricate trading such as DCF valuations and options trades. In an effort to avoid a 20 page blog, we’ll split this into separate blogs for each different type of trade. We’ll start with the most common – long-term investments.
Confusing long-term ideas with short-term trades
I can’t help but describe this using a terribly simple example that will get me a ton of flak from one of my buddies, let’s call him Nebby. He is bullish on Tesla (TSLA) and believes it will become one of , if not thee, largest companies in the world. I don’t necessarily disagree with him – I love the car, the company’s initiatives, autonomous driving, etc. Where I do disagree though, is how Nebby considers (confuses) short term stock moves as realization of long term value. Nebby buys TSLA call options under the premise that it is a great company, even though he’ll argue that some random Japanese company is going to provide it with capital (or something equally absurd that has nothing to do with long-term value). He’ll buy out-of-the-money call options with a couple months, or even a few weeks to expiration. Somewhere along this timeline, the stock fluctuates as any stock priced at 100x forward earnings would – in fact as I write this – TSLA is up $25 or 10% over the last 3 days. So once his call option goes in-the-money, he believes his thesis was confirmed, when in fact it was just noise and volatility. For those of us that think these types of moves represent the market finally valuing TSLA with 25% net margins and going from producing 76k Model S and X cars in 2016, to 500k in 2018….ok fine, it is possible. But here’s what’s not possible, the stock will not trade as if these are FACTS until these are facts! None of this is factual evidence, they are all rumors. Stocks trade on rumors, but are valued with fundamentals.
I’m getting worked up for the same reason that I refuse to talk to Nebby about stocks anymore. He doesn’t realize he’s trading rumors and that stocks like this fluctuate wildly. If you want to buy a stock with hopes that it will achieve long term goals…..buy the stock for the long-term! I’ve repeatedly called Nebby a f#$%ing retard for trading short term options under longer term premonitions. For example, TSLA was up $100 during the period where Elon Musk was buddy-buddy with Trump. This also coincided with the time leading up to TSLA’s 4Q 2016 earnings report. Nebby bought calls and it would have been a good trade if he didn’t confuse a short term move with his long-term thesis. His reasoning was that people realized that Tesla was going to sell a billion cars in China….or something that made me want to blow off my own head. In fact, it was a run-up before earnings which priced TSLA to perfection. After a ho-hum earnings report where Musk also confirmed they would do another capital raise, TSLA pulled back 10% in just one day. (side note – stocks priced to perfection leading up to earnings are another type of trade with a lot of opportunity, we’ll cover this in another blog)
The best way to trade stocks for the long-run is to buy and hold. The stock market’s fluctuations, especially when trading at multiples as high as TSLA’s (with no profit), are just noise and rumors between ultra-speculative buyers and sellers. One of TSLA’s X-factors is the question of whether they will be able to produce anything close to their forecast of 500k cars annually by 2018 (btw this is higher than sales of Mercedes C-Class and BMW 3-series, combined). The only time we will figure this out is……2018. Until then, this is rumor and the debate is no different from arguing whether Trump or Clinton will win the election in October of 2016. So, if you want to make sure you are in early enough, just buy the stock and sit on it. Or, if you believe the stock is going to fluctuate and you want to take advantage of buying at lower prices, use dollar-cost averaging (http://www.investopedia.com/terms/d/dollarcostaveraging.asp). If you go into a long-term trade with a long-term mindset, you won’t get chopped up worrying about short-term stock moves. Best of all, you won’t have to worry about bullshit due to “investors” like Nebby. Sorry bud.
Long-term buys – when valuations and research don’t matter
Another type of long-term trade is one where justifying with #’s doesn’t matter as much. After my own experience stumbling across great companies with great products, I believe there are times where research and stock valuations are not as important as emotion, excitement, and experience. When studying valuations, I would have never imagined saying, or thinking anything similar to the last sentence…but stick with me.
I’m talking about discovering market changing or even life changing products/businesses. Please realize that if you are the type of person that got pumped up about CROX’s IPO or any other fad, this is probably not for you (as much as you love hearing that this is based on the premise that stock research and valuations don’t matter). Describing my own personal experiences, rather than generalizing and justifying a formula of sorts, is a safer way to dive in and make sure we’re on the same page. Both of my examples are backward-looking so let’s imagine you already said hindsight is 20/20 and your criticism of this advice is completely warranted. That being said, I don’t think there is any better way to learn than from the past, so I’m jumping off that cliff. And since we’ve already jumped off the Tesla cliff, let’s revisit.
In the summer of 2012, I test drove and reserved a Model S as a gift for my father’s birthday. I thought the car’s interior and exterior, huge computer screen, and all other aspects of design were stunning, but what blew me away was the drive. There are a ton of beautiful and expensive cars out there, but I knew after driving a Tesla that they could not compare to the combination of electric power/silence and design. Before the test drive, dropping $5 G’s to reserve a Model S that day was farthest from my mind. After the test drive, the salesman did very little “selling” between the time I stepped out of the car and handed him my credit card 20 minutes later. I went home and looked at the stock and saw it was around $3 or a $4 billion market cap on zero sales. Without reading anything else or doing any research, I decided the awesomeness was already priced in and I forgot about the stock. A year later, TSLA was clearing $150, and another year later – $250.
The 2nd example is about something gaining great popularity as we speak, especially around the aesthetically focused (nice way of saying superficial) market in Newport Beach (sorry I live here so this is my environment). This is straight from the website (http://www.coolsculpting.com/what-is-coolsculpting/) – the “CoolSculpting fat-freezing procedure is the only FDA-cleared,* non-surgical fat-reduction treatment that uses controlled cooling to eliminate stubborn fat….” At the end of 2015 my ex-girlfriend told me about it and even provided me with the ticker for the company who had patented the technology and essentially holds a monopoly – Zeltiq (ZLTQ). She had been in the industry since it came out, knew it worked, and was a dedicated believer. That wasn’t enough for me since I still had not been through the procedure myself and the stock didn’t seem like a buy from fundamental and technical standpoints. By mid-2016 though, I had gotten Coolsculpted twice, in and out of the office within an hour, and I saw significant results within 1 month of each coolsculpting session. Side effects were completely negligible so this was obviously the future of non-surgical fat-loss. Plus, it was relatively cheap and much easier compared to working out or more complicated diets. This wasn’t a missed trade like TSLA though. I forgot about the stock and had not looked at it again until I heard that Allergan bought it out for $55/share a couple weeks ago. The shares were around $30 when I saw firsthand how revolutionary Coolsculpting was going to become though. It was an obvious buy, because of the previously mentioned 3 E’s – experience, emotion, and excitement.
TSLA and ZLTQ are two examples of game-changing companies. Hindsight is always 20/20, so in no way am I giving you the formula to discover stocks about to explode. I am pulling some takeaways from my experience which could help us in the future though. As far as looking at the stock’s valuation in these situations, past sales for the companies did not reflect widespread knowledge of the product. If you see “low” sales for NEW, and potentially revolutionary products, you might want to consider yourself the bearer of “insider” knowledge. Note the use of “low” and NEW and “insider” here; I won’t describe in further detail because these are important to the thesis but extremely subjective. If you can confidently say the general public is not aware of the implications of the product, then there is good reason to ignore the stock valuation. NONE of my friends or family had driven a Tesla or even heard of Coolsculpting when I discovered these. This was a pretty good sign of getting in the game very early. Also, for Coolsculpting, while there were only a few people in superficial Newport Beach who even knew what it was, there was absolutely nobody back east who had any idea of it. That was a regional advantage in discovering Coolsculpting and ZLTQ. Additionally, I experienced both products firsthand and knew from my very own experience that they were special. This is the most important part of the formula I am “giving” you. It is a direct conclusion from Warren Buffett’s tenet to only invest in businesses you understand.
I mention these examples in a very contextual manner. This leaves them widely open to opinion, instead of a checklist of sorts. By being vague, interpretation of the 3 E’s is left to your judgment. Let me say though, if nobody you know is aware of the product/company that just blew your mind, that stock might be ready for a tear. Electric vehicles and fat-loss are very human concepts which we can test ourselves – unlike 3D printing or some technology/medicine which we never experienced, and never might. Discovering these products/companies will not happen often, and that is half the reason we should know when it does happen. When it does we need to realize the context and follow our gut, given it is something we can grasp, understand, and fully appreciate. Again, if you’re the type of person who got excited about pogs in the 90’s or Pokemon Go, take a deep breath before betting the farm.
Other than that, I don’t think I can give enough disclaimers for this “advice.” If you find one of these stocks every month, or even every year, you’re probably the type of person who gets too excited about too many things and you should sit down and relax. Self-awareness will once again prove to be a great strength in this trade. This is probably best for people who realize a game-changing company is something they may never encounter firsthand. It is not something you will find if you look hard enough. But, if you are blown away by a company and you are rarely blown away, it might just be the next Tesla or Zeltiq. Feel free to check with me before you buy. 😉
1) Long-term bias can only be executed through a long-term buy-and-hold strategy.
2) Volatility, aka rumors and non-factual evidence, drives short-term fluctuations in stocks, not long-term value.
3) Formal stock research and valuations could be irrelevant when confronted with game-changing companies. 3 E’s are the contextual driver – emotion, excitement, and experience.