The Path to Wealth: Slow Road vs. High-Speed Lane
Like a lot of other people, Tom Herring has a wife, a son, a job--and a stock portfolio that was up more than 300% last year.
A bit more than a year ago, Herring took $22,000 and began aggressively trading stocks. Today, he says, he’s nearing $100,000 and has visions of much more to come.
“There’s a lot of money to be made out there, and the better I get [at trading stocks] the bigger the piece of the pie I can get,” Herring said.
Say what you will about amateur investors blindly piling into “momentum” stocks. The fact is, many people are a lot richer today than they were 12 months ago courtesy of 1999’s astronomical jump in technology stocks.
When large numbers of individuals began actively trading stocks online a few years ago, experts worried about two things: Would newcomers know what they were doing? And before they could learn, would they lose their wallets?
To be sure, many novices are suffering bruising losses in today’s supercharged market. Still, given the tremendous gains in many tech stocks last year, and the high popularity of those stocks among individuals, it’s clear that many people have racked up big short-term profits in shares such as Qualcomm, Yahoo and America Online.
The debate about small investors’ trading now centers more on how much of the success achieved can be attributed to improving skills--and how much is pure luck. Have busloads of neophytes simply been at the right place at the right time?
Individuals clearly deserve credit for realizing the potential of many tech stocks, and for having the nerve to buy them at valuations that scared off many professionals.
Indeed, some of the favorite strategies of small investors--such as latching onto leading companies in burgeoning industries and holding them as they rise--have been preached by professionals for years.
“They’re underestimated as a group,” said Doug Fairclough, strategist at Clearstation.com, a popular market Web site. “You still read a lot about how individual investors are having a party and how they’re just guessing right. But the professionals don’t understand that individuals are getting smarter because they have better tools.”
However, even some people with large profits admit they aren’t too sure what they’re doing, and have almost backed into their gains.
“I used to check the potential of companies with low [price-to-earnings] ratios and solid finances,” said Malak Seriani, a New Jersey resident who has traded stocks for 11 years. “Now, I just follow momentum. I don’t even know the names--just the stock symbols--of a lot of companies I invested in. If making money makes me a better trader, then I guess I am, but in a market where Yahoo is worth $110 billion [in market value] and Qualcomm goes up a $156 in one day, there is no logic, and that worries me.”
Some experts are worried that the bubbling confidence of many small investors dabbling in highflying tech stocks will be short-lived. Newcomers give themselves too much credit for gains, and take for granted that they all can get out of stocks at precisely the right moment once the tide turns and the market sags, trading pros say.
But “the door is not going to be big enough for everyone to get out at the same time,” warns Bill Yancey, equity trading manager at Southwest Securities Group.
Some amateurs even poke fun at their own high spirits. “If somebody comes up to me at a cocktail party and says, ‘My portfolio did 20% better than the S&P;,’ I say, ‘What a bummer, dude. How do you sleep at night?’ ” joked John Posada, a New Jersey technical writer who has half a dozen stocks that he says have jumped 300% to 400% in the last three months.
Still, many individuals say they have learned important trading lessons from the market’s wild ride over the last year--lessons that will enhance their gains and limit their downside in the future, they say.
Posada, for example, sets aside only a small portion of his portfolio for trading. And when entering a stock for the first time, he goes lightly. He buys more only if the price moves up shortly thereafter, figuring he’s playing with house money. “You use a gain that a stock gave you to buy a little more.”
Herring, a Navy SEAL who lives in Guam, also follows some very basic rules. If he buys a stock and it then drops, he sells at a small loss rather than risk a greater decline in the hope the price will recover.
“If it doesn’t make the move you’re expecting, chances are you should just take the hit,” he said.
In fact, most professional traders advise cutting losses in such fashion to prevent a portfolio from absorbing deeper declines. Many pros head for the exits if a stock drops 5% or 6% from what they paid.
Likewise, while “value” investors believe the time to buy stocks is when they’re down sharply, small investors like Herring believe that the momentum strategy--that is, focusing on market winners--makes more sense.
Averaging down, as it’s known, means committing to a stock and buying more if it gets cheaper. But an investor could suffer a huge loss if the stock never recovers.
Nevertheless, averaging down is exactly what many small investors still do. Because the long bull market has seen many stocks recover from losses, investors tend to look at any drop in a stock’s price as an opportunity to buy.
That was the case late last year with Sabratek Corp., a medical devices company. After management warned of poor earnings in early August, the stock sank rapidly from its early June peak of $30.50.
Despite the firm’s troubles, however, the Yahoo Finance chat board devoted to Sabratek was peppered with messages in late summer and early fall urging investors to buy shares. By mid-November, one investor left a posting lamenting that he had taken that advice.
“I have to look back with amusement to the days when this stock was dropping 15% every day and this board was loaded with, ‘Oh buy, another buying opportunity’ commentary,” he wrote. “I have told myself never again. Sometimes a stock takes a beating because it deserves to.”
Last month, Sabratek filed for bankruptcy.
Small investors who shun the idea of bargain-hunting, and instead chase market winners, note that often their companies have very high potential earnings growth rates. In other words, there’s a fundamental reason for the stock’s upward momentum.
Even so, many individuals insist they understand how quickly the momentum game can reverse.
“The really important thing is to not get too greedy [and realize] it can turn around,” said Ben Lee, a 29-year-old software product manager from Fremont, Calif.
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Walter Hamilton can be reached at walter.hamilton@latimes.com.
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Overly Optimistic?
Brokerage PaineWebber’s December survey of individual investors, as performed by the Gallup Organization, shows people’s average expectations for market returns over the next 12 months at 18.4%--well above expectations in surveys earlier in the year. Expectations for stock portfolio returns in forward 12 months:
Survey of 1,010 investors selected at random. Investors must have at least $10,000 in savings/investment to participate in survey.
Source: PaineWebber
