How I started trading
When I was 23 my mother introduced me to a financial advisor at the college campus branch. The advisor encouraged me to open an investment account, and since I had money from working as a software engineer intern, and I already took a corporate finance class at the university, I followed her advice.
I bought a Canadian index fund and expected to make 7-10% per year. Why? That was the widely cited statistic. I thought I’d buy and hold to beat inflation. Easy money.
I checked the account 1.5 years later and found the account only went up by 2%, barely keeping up with inflation.
Why 2%, not 7% or 10%?
I asked the financial planner at the campus branch. She pulled up the graph for the 1-year performance and pointed at the midyear dip: “You bought high, that’s why it only netted 2%.”
She also explained that the index fund is made up of the major Canadian sectors: finance, mining, and real estate, and those industries tend to be slow-moving in a late bull market. She then pulled up another fund that returned 45% during the same year.
What was different with that fund? I asked.
That fund invested in the US stocks and grew thanks to a weakening Canadian dollar.
It was as if the wool had been lifted from my eyes; there was so much free information online that affected my returns. From then on whenever someone mentioned an index fund I would look into the fund in detail. Instead of investing in the fund, I’d scour the composition and pick a few stocks to trade.
2020: a comparison
Fast forward five years later to 2020: the year when I picked an index and stocks. During April 2020 I bought into a mutual fund tracking QQQ (would have been better off with an ETF, but I was overwhelmed from a new job). After purchasing the fund I was curious if I could beat its returns, so I traded stocks in my smaller retirement accounts.
Which stocks did I trade?
It was during the epidemic so I looked for battered stocks; there was plenty to pick from. I bought and waited for the rebound of Nordstrom (JWN) and SPG, a REIT.
The result? The QQQ-tracking fund performed around 60% within a year, but the highest return went to me trading Nordstrom(JWN), generating nearly 3x return in 4 months. In my other account, I’ve invested in SPG and while that didn’t 3x, I still managed to beat the S&P 500.
First-principles of trading
Stock trading seems complex, yet it can be boiled down to 5 principles
1. What to buy
- Blue-chip Consumer stocks that I can sleep on if I get hit by a bus. Consumer stocks include airlines, clothing retailers (JWN), electronics (Apple), and sometimes REITs. I look for stocks that are relatively stable with high trading volume. I still look at these post correction; the expected returns are lower, but I need some diversification from tech stocks.
- Hand-picked smaller technology stocks eg. < $5 billion market cap: I limit these as I already get tech stocks from compensation. These are volatile so I’ll settle for quick gains and less upside e.g. 10% gains in a few days
2. When to buy
- Near 52 week low and when there’s momentum. Need both because I don’t wait years for a stock to move; waiting is an opportunity cost
- When there’s a large dip e.g. -10%+ due to a market correction, or an over-correction from an event ie. earnings report
- Target profit is 15%+ within a month, though I’d settle for 10% in a few days
3. How much to buy
- Contrary to popular belief of spreading the risk, I’ve benefited from going all-in on the rebound of blue-chip Consumer stocks and waiting for a rebound. When there is a sale I buy more
- Technology stocks: when I get the order confirmation I place a limit order for 10% or more. The volatility of these stocks cannot be undestated.
4. When to sell
- For technology stocks, when the limit order is triggered
- For turnaround consumer stocks e.g. bought near 52 week low, wait for a rebound to previous levels
5. Risk management: what to do when the market moves against the plan
- Small loss: e.g. sold a put and the option is in the money by a little bit: take the assignment and sell the stock for a profit
- Large loss: roll for a credit. For example, when CRM spiked on earnings and the covered calls were tens of thousands of loss on paper, I rolled forward 10 months for a lower strike price, then closed with a $1,000 loss/contract
- Are there better alternatives? For example last year I was tired of waiting for XOM to rebound. Instead of waiting, I switched to SPG, a quality REIT, which was also battered from the pandemic and paid a greater dividend while waiting.
No better alternatives:
Do I still believe that the stock will rebound to 10%+?
- Hold and look for better alternatives, or
- Buy more to lower the cost basis
- No: sell for a small loss
Practices and philosophies
In addition to the principles, these practices and philosophies affect how I trade
1. Not taking a risk is a risk.
What is safe short-term e.g. savings account and treasury bonds will get hurt by rising inflation. Sitting on money long-term is bad for returns.
2. Trading is a valuable skill
Passive indexes print money on bull markets and lose money during corrections. Yet corrections are the best times to make money for the opportunistic trader, so I practice while waiting for a big one. Most of the time I stick with the principles, but I’ve strayed once by trading GME profitably. I’m trying to get better at avoiding overtrading options; sometimes buying stock beats selling puts.
3. Cut the losers.
Trading means losing small amounts of money to pursue chances of a larger upside, so minimizing the downside is key to profitability. Sometimes I use stop limit orders on stocks, other times I sell for a small loss.
4. Watch only the key stocks.
My watchlist has <10 stocks. These are quality stocks that are near the purchase price, or stocks I have significant positions in. I rarely trade random stocks on Reddit; each stock comes with its history, industry, fundamentals, risk factors, …
5. Avoid overtrading.
A 5% gain in one day is common for certain stocks, but that trade can easily turn into a 10% loss if not managed well. It’s better to sit out than to manage a bad trade.
I’m pretty happy with my returns so far. The best way to learn how to trade is to trade, and I’ve become more confident and remained profitable with time.
It will be tough in 2021 to generate the same returns as 2020; we’ll see what happens.