Theodore Feight is a Lansing, Michigan-based financial advisor. He had set up an automatic sale, called a stop-loss, at $108.69, which would have been a 14 percent loss for an exchange traded fund he owned. In Monday’s tumultuous early trading, when the Dow opened down over 1000 points, Mr. Feight’s stop-loss was triggered. However, he did not get $108.69, he got $87.32, a 31 percent loss. By noon, Monday, the ETF had bounced back and was trading at $121.18, a 4.3 percent loss. From Mr. Feight:
“I’m really disappointed. They weren’t as liquid as they should have been.”
The Wall Street Journal, “Trading Tumult Exposes Flaws in Modern Markets,” 8/26/15
Liquidity in financial markets is often an illusion, disappearing just when market participants need it the most. That is not, contrary to the title of the WSJ article, a modern phenomenon. As a financial advisor, Mr. Feight should have known that liquidity dries up in crashing markets.
There is a more general lesson here. Countless speculators and investors during bull markets tell themselves that they will outsmart the market, and get out when the market starts to decline in earnest. The problem is, when they recognize that the market has begun to decline in earnest, so has everybody else. There are no bids that are even remotely close to the recent highs; bids often vanish before they’re hit, and even bids that are good are usually for small size. If you think a market is frothy, don’t fool yourself that you’ll sell after it starts down and hang on to almost all your profits. It doesn’t work that way. The time to get out of a frothy market is while it’s still frothy. You will never sell at the top, so you’ll leave some profits on the table, but the old trading adage is sell when you can, not when you have to. Bernard Baruch, who made a shekel or two in financial markets, is reported to have said: “I made my money by selling too soon.”
The other huge mistake that will be made in abundance will be by investors and speculators who belatedly realize the market is not all it is cracked up to be, vow as it crashes to sell on the first rally, and then, when the rally comes, do not sell but rather hope that they can get back to even, or even profit. The aphorism that rising markets climb a wall of worry is well-known. Another aphorism, not as well-known, comes from Robert Prechter: “Falling markets descend a slope of hope.”
There is a huge difference between professional traders who consistently make money in markets and the amateurs who consistently lose money. The pros know how and when to take a loss. As a rule, leave your emotions at the door if you want to have any chance of making money over the long-term.
