how to ride a hot streak into the ground

A few years ago I went on a cruise to the islands with my wife, Bubelah. We decided to stop in the casino briefly one evening, even though neither of us are gamblers – I generally find it boring and she generally doesn’t understand it. It was ‘formal night’ on the cruise, which for you non-cruisers means tuxedos for the men and evening gowns for the ladies. So we swept into the casino looking every bit the James Bond – Bond Girl bit, right down to the dirty martini I ordered (shaken, not stirred, which is genuinely better). I know the rules of blackjack (not how to win, though) but Bubelah didn’t so we decided to play roulette instead. We put down $20, and through a few lucky spins we built up to $400. Not wanting to miss the reception, or push our luck, we kindly cashed out and happily decided that at least we had defrayed the cost of the cruise a bit.

On our next cruise, we decided to try our luck again, but there was no formal dinner to attend on the particular night we went, so we were in no rush. We spun, we lost. We put down another $20. Ciao, bella. Another. In the end, we had a 100% loss on a $60 investment, versus our original 2000% gain on a $20 investment. The loss happened JUST AS FAST as the gain – 3 spins. That original winning might have gone to $0 on the next spin.

This anecdote, however, is NOT the point of this post. In the mid-90s, I bought a tech stock in my retirement account. This was back in my “mindless” investing days; I saved money, but I did it almost unconsciously, seldom putting much thought into strategy or even rational behavior. So I bought $2000 worth, if I recall, which was the one-year limit on IRAs at the time. I forgot about it.

A couple of years later, it had soared – my money had almost tripled. The stock wasn’t paying a dividend, but I thought I was brilliant. I let it ride. It stayed up. “Excellent work,” I congratulated myself. “You are the next Warren Buffet.” Then it started to slide a bit. Then, as the dot-com bubble burst, it slid a LOT. Finally it was back down to my original purchase price. I said “well, I might as well stick it out now,” thinking that it might someday come back. It didn’t. It stayed stagnant for another couple of years before I sold it, more or less at the purchase price.

Buying a non-dividend paying single stock in an IRA was not a wonderful investing idea. It could have easily appreciated tax-free outside of my retirement account, and I could have used that IRA money with a dividend-producing stock, a mutual fund or any one of a million different things. But I did not. If it had been a dividend-paying stock, I would have at least collected some tax-free dividend income while it languished. But it wasn’t, and I didn’t. And unlike the time I played roulette on the cruise, I didn’t recognize a fantastic streak of good luck for what it was and tell myself “sell this speculation! It doesn’t pay dividends and you never expected in your wildest dreams for it to triple in price – unload it! Lock in the gains!” I missed a chance to invest wisely, and when my first poor decision resulted in a fantastic windfall, I failed to cash it in, making a second poor decision.

In the end, it was a profitable experience, though, because I learned from it. I learned to put a little more thought into an investing strategy, including my idiot-proof stock sell point calculation (more on that in the future, but basically once it goes up 25% or down 15%, start selling some of it). I also learned that sometimes the smartest financial decision, just as in gambling, is to get up and walk away from the table.

(photo by adewale_oshineye )

  • http://www.moneybeagle.com Money Beagle

    I’m not sure how available it was back then, but nowadays, you can setup a trailing stop loss order on a stock, which will lock in your gains. For example, if you set up a 10% stop loss order, the ‘sell price’ will automatically adjust as the stock goes up, but if it goes down 10% from wherever it hit it’s high, it automatically triggers a sell order. You can take a hit if it gaps down more than 10% (say on a bad earnings report) but it’s still a good way to limit how much you give back once you’ve made gains.