FinTekNeeks

From Minimalism To Tech

Pitfalls to Avoid in Inefficient Markets

Posted in Trading

The following article covers trading financial securities, such as stocks. The world of trading often comes with rises and declines of securities, and most things do not rise or fall in a straight line. By the time this article is published, circumstances involving what we mention may h ave changed. Often, changes in securities can be to the detriment to the traders – seldom is it beneficial. A person should only trade with money that they’re willing to lose because losses are guaranteed. By reading this post, you agree that you’ve read our disclosure.

Introduction

In the days before computers were ubiquitous, people would receive phone calls from “brokers” who would offer free advice on stock picks. These “brokers” were in fact salespeople (boiler room operators). They would tout quick fantastic returns, with stories of instant riches on penny stocks. Because trades were not computerized, many stocks will be low float stocks. Therefore, if there were increased sales, opportunities exist where the price moves dramatically. One way operators will gain credibility from gullible investors, i.e. speculators, is by referring to a stock that has gone up as their previous recommendation. The investor will look at that stock and be impressed by “that recommendation.” The operator will then give out a “free” recommendation. The operator will call 100 people. The operator will then say the stock will go up to 50 people and the stock will go down to 50 people. It’s a numbers game. If the stock went up the following day, then the operator will call back the 50 people with the “right” call. Now, the operator can sell a target stock to those investors. The boiler room may have acquired at a very low price that needs to offload shares. These investors will then become suckers.

The Sheep of Wall Street

If you have ever seen or read “The Wolf of Wall Street,” you know that the only ones who became rich were the salespeople. Although Jordan Belfort went to jail, he left behind probably thousands of victims who did not get their money back. I don’t recommend buying the book, because who wants to read about a swindler who stole money to have a never-ending drug-fueled party, and then pay the price by going to jail for a 22 months. Also, I am surprised why anyone would pay $2000 for his persuasion course. With Leonardo DiCaprio playing the role, it may be easy to confuse the person who stole millions with the likable character on screen. Personally, I could not even finish watching the movie. Ironically, the film has a controversial investment from 1MDB (Malaysian sovereign wealth fund). This may have come from embezzlement of the fund. I will speculate that maybe DiCaprio will act in a movie as Bernie Madoff, producing a likable role which gives “valid reasons” why he stole billions.

It is interesting that the financial markets are self regulated and these types of operations still exist today that target unwitting investors. When I was in the financial advisory industry 8 years ago, I too have received this type of call. Although it is not common to get these calls, there are many phishers who will call for “official business.”

Wolves Using Technology

Today, there are different forms of boiler rooms. These marketers, copywriters, and salespeople use emails, websites, and print mailers. Promotional newsletters are required by law to disclose the compensation they are receiving for marketing companies and their stock. However, like many legal notices, it is written at the end with very tiny print. With copywriting, these newsletters are very persuasive. Similar to boiler room calls, the newsletters may offer their services for free or a small subscription fee. They will entice your greed by promising incredible returns and quick riches. Many will tout penny stocks that recently went up. Similar to fake news of recent focus, many of these newsletters will set up multiple websites to spread their “recommendations.”

With the use of technology, websites and emails can reach millions of people. For some to take action on these free “recommendations,” which drives up the penny stocks’ price with above-average volume. Eventually, the emails stop going out and the volume drops, along with the price back to worthlessness. Those who bought as the price went up, now hold onto shares that are most likely at a loss. Only now they can hope that the price goes up, but the newsletters have moved onto the next stock pick.

Lately, some are offering “education” on how to trade penny stocks. Some are legitimate and offer many opportunities to gain through trading and community in chatrooms.  But caution is needed when joining those communities. Chatroom chatter can cause a penny stock to spike during trading hours. Enough traders will jump in, based on chatroom rumor. Also, Twitter and Stocktwits are prone to many accounts promoting penny stocks. Fake news is not new in wall street. Even an ‘objective’ article in Seeking Alpha may cause a stock to move based on ‘research’ of the company. Technology is beneficial is many cases, but it can be abused to detriment of many investors.

Avoiding the Pitfalls

As the saying goes, “There is no such thing as a free lunch.” Many times, I’ve tried to follow a hot stock pick from a friend, online, or even on CNBC. Majority of the times, I lost money following those “recommendations.” So here are my suggestions to protect your hen house.

Invest in your own education. Get to know yourself, and your own psychological bias when it comes to trading/investing. I highly recommend Dr. Van Tharp’s books and training courses.

Focus on one type of investment at a time. There are many ways to invest besides stocks. There are forex, futures, mutual funds, options, ETFs, private placements, IPOs, bonds, warrants, etc.

Focus on developing one or two systems of investment before expanding. It is better to be an expert with one system that will consistently make you money. Develop a system that fits your style and does not hinder you from sleeping at night. Investment should add to the stress you face daily.

If you are still losing consistently, reevaluate. The system may not have positive expectancy. Bias may be a bigger factor on the system and profits. Maybe more back-testing is needed. Or maybe the system is not optimal in present market conditions. You are running uphill if you are implementing a short strategy in a prolonged bull market. Draw-downs are inevitable, but understand if this is normal within the system, or if this exceeds the system’s expectation.

If you are winning consistently, reevaluate. Consider the overall market. If the market is on a bull run, you may think you are a genius trader, but “a rising tide lifts all boats.” Look for market changes that may affect the winning system, turning it into a losing system.

Keep a trading journal. This will allow you to review your trades. You can take notes of where mistakes were made, and identify improvements to your system. Also, the journal will keep tabs on your exit strategies. Writing it down will help you with sticking to your rules. I recently learned about the Bullet Journal by Ryder Carroll. I have been modifying it to keep track of my trades. It is a vast improvement over keeping mental notes.

Avoid free advice, cheap advice, and expensive advice. Eventually, they all become expensive. Online, there are investment advice that cost nothing to thousands of dollars. However, there are many tools you can use for free that will help while you are in your learning stage. Follow your developed system and strategy. With time and experience, you will be able to discern and filter out bad advice.

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