I’ve been asked by my investment group to present an anatomy of a trade I made last month. It was a trade based on a company with a good business model but trading on what I can only say is a lot of hype. A dangerous combination but the plan and the rules I followed can apply to any trade or investment.
The key to any successful trade is having a plan and following your rules.
For this example, depending on how one looks at it, I broke at least one rule and followed many others.
Wednesday November 8th:
ROKU closed at $18.84 per share. They were due to report their first quarterly report since going public and most everybody was pessimistic. The company had yet to make money and were set to continue their losing streak.
I considered them a popular, trendy streaming, cord cutting alternative product that had a good business model. I have been exploring cutting the cable cord and have purchased a long range HD antennae as well as one of ROKU’s streaming sticks. The tech is not what impresses me. In fact, they are practically giving it away. That is not where they plan on making their money. Roku intends to make their money on programming and selling advertising. In order to do that successfully, you need market penetration. Roku is making their hardware cheap to get it into people’s homes and build up market share. But Roku is also teaming with HDTV makers and having their streaming service imbedded in today’s popular smart TV’s.
If you think about Microsoft in the early years of the PC, they basically gave away the OS so that they could gain market share and sell software and ultimately services. ROKU is attempting to gain market share with the adoption of HD 4K smart TV and imbedding their platform (the OS) in each TV sold. From there, they focus on selling content and advertising.
So I was really torn. On the one hand I really liked the company. On the other, they were still young and had yet to prove that they could succeed in this highly competitive online content streaming world. So I held off on buying until I saw which direction the stock moved based on their report and outlook.
Well, it turns out that ROKU is still not profitable but they lost a lot less than expected and absolutely killed it on user activations and loyalty. So much so that ROKU even tossed out the possibility of becoming profitable as soon as next year.
What happened next was Simply Amazing.
Thursday November 9th:
ROKU opened at $24.75. A 31% increase over the previous day’s close.
I bought 100 shares.
Here are the rules I broke.
- Chased the money
- Bought after the stock had already passed profit taking zone. (see notes below)
Here are the rules I followed or (at least) did not break.
- I bought on volume. Institutional confirmation
- I bought at an early entry point below the buy point. IBD had the buy point at $30 per share based on previous highpoint shortly after initial IPO. But this early entry is OK based on institutional buying.
Yes, these rules are a little fuzzy and subject to interpretation. Here is my point of view.
Depending on how one looks at this, from an IBD perspective, I may have broken 3 rules…. or not. Technically the profit taking zone (20% – 25%) is after a breakout past a buy point. Sometimes it is OK to buy a small position before a buy point if institutional buying is there.
As soon as I bought my shares and saw that they did not stage a reversal, I placed a trailing stop.
Rules I followed:
- Protect capital and gains. At this point I was protected from taking a loss. – Unless the stock happened to gap down at the next open….
Friday November 10th:
I canceled my trailing stop and sold 50 shares shortly before close at $35.16 for a 41% profit.
Note: The stock closed at 33.21 which would have been below my trailing stop, but because I had cancelled it to sell half my gains, I still had 50 shares invested.
Rules that I broke:
- Changed my rule of setting and keeping my trailing stop to protect profits.
Rules that I followed:
- But this was done to protect my profit from the downside risk of a gap down.
I reset my trailing stop right before close. I fully realized this would not protect my remaining shares from a gap down on Monday’s open but I truly believed that the “hype” was not over. After all, we still had all the weekend traders (those who only follow the market and their stocks on the weekend). Sure enough, there were many articles hyping the breakout stock. Even IBD got in on the action and published a “hype” article.
Monday November 13th:
No gap down at open! Hype and irrational exuberance was still in full force!
But even hype has it’s limits and …
Sometime during the lunch hour my trailing stop got activated for $45 a share.
And… I was out with a 81% profit on those remaining 50 shares.
And an overall profit of 61%.
Rule #1 to investing is not to lose money. Or at least minimize your losses.
- I utilize trailing stops on almost all my trades.
Rule #2, see #1 😉
- But seriously, I also use trailing stops to protect my profits.
- Yes, I sometimes get stopped out of a stock on a sudden drop or as those who think of conspiracy theory, on a sudden drop by MM to flush out weak hands. But, hey I usually make a profit and if I still like the stock, I can always get back in.
Rule #3 I base a lot of my buy and sell points on percentages and not dollar values.
- For me this is a pure psychological rule. I learned early on that I could get hung up on “making money”. Sometimes people start seeing all the $$$ signs and let their emotions rule their investment and trading decisions. I am no different. So I try and base all my buy and sell decisions on percentages.
- Do I ever sell too early and miss out on future gains? Yes, but if my goal is 20% profit, then I am happy. Would you be happy with a 20% gain on your investments? The percentages are there to manage risk and avoid letting my emotions (such as greed) take over.
- Do I ever sell too early and get stopped out of a loss before the stock recovers? Yes, but not all stocks immediately recover and the stop loss is there to minimize my losses and protect my capital.
Rule #4 is you need money to make money.
- Don’t lose all your hard earned money to the stock market, irrational exuberance, or emotional trading decisions.
- Follow rules # 1 and # 2.