An Expensive Lesson

Apurva Sheth
My plan moving forward is to liquidate my and my wife's 401(k)s and try to work out a payment plan with Etrade. I'm also going to ask them to help out in some way...that's a longshot. I will pay them and be back trading....only with set stops this time. What an expensive lesson that was.

I hope my story helps someone else.

Those were the words of a small business owner and a part time trader - Joe Campbell from Arizona, USA. These words were a part of the letter he wrote to his fellow traders asking for financial help after he suffered a major loss in his trading account.

Joe short sold 8,400 shares of KaloBios Pharmaceuticals at an average price of $2. He expected the price to reach $1 as the company was going to wind down its operations and discontinue two of the drugs it was developing.

He shorted the stock and left for a meeting after markets closed for the day. He came back from the meeting two hours later and notices a message from his trader friend checking if he was okay.

The share price of KaloBios had shot up to $16 in the post-closing session. This was after a biotech investor had decided to get in the company and bought half of all the outstanding shares.

Joe feared that his entire trading account worth $37,000 would be wiped out. But when he logged into his trading account, he was horrified to see that his account was in the negative by more than 1 lakh dollars.

How could that be possible? It must be an error, he thought, as Etrade, his broker, should have squared off his position the moment it reached zero balance. But that wasn't the case.

When he called up Etrade he was told that he still holds his short position as the movement was too fast for them to do anything. He asked them to immediately cover his short position, which was filled at an average rate of $18.5.

After squaring off this position, Joe now owes Etrade $1,06,445.56. Joe plans to liquidate his and wife's 401(k) retirement accounts to settle with Etrade.

He also put up a request on a crowd-funding portal to help him pay off this amount. This is the first time that a trader has resorted to online funding or begging to pay for a margin call. Joe faced a fair share of criticism for doing this, which forced him to pull down his request from the portal before collecting just over $5,000.

Joe committed a few huge errors during this trade.

First, his overall exposure to KaloBios was worth $16,800 - far too much considering his overall account size of $37,000. By investing almost half of his capital in one stock only, he put too many of his eggs in one basket.

Second, he mistook his broker for a risk manager. The most important role a trader plays is that of a risk manager. When his account reached zero, Joe expected the broker to call him up and inform him about his position or take action on his behalf to square off the position. But the broker did neither, because a broker is just an intermediary who facilitates trades. One cannot expect him to make decisions for you.

The last but most important mistake was that Joe traded without a stoploss. This proved to be devastating. Although nobody would have expected the stock to move up as sharply as it did, that's what stoplosses are for - to protect you from the unexpected.

Whether you sympathise with Joe or not, all traders can learn from this incidence.

I will end this letter with Joe's words: 'This is a terrible lesson for me, but if this helps just one person then I'm happy I wrote this.'

Do you place a stoploss on your trades when you are away from your trading terminal? Share your views in the Club or share your comments here.

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8 Responses to "An Expensive Lesson"
Nitin Potnis
08 Dec, 2015
Always keep a stop loss in every position according market trend & technical levels. Believe in manual trading only. Don't depend upon risk Manager because risk reward factor defers from person to person Like 
K.G. Rao
07 Dec, 2015
My experience with stop loss is not entirely good. I used to day-trade regularly some years ago, and found that at times the stop loss just did not work. On enquiring with my IIFL manager, I was told that sometimes the movement is so fast that the system is unable to act on the stop loss. I dont know whether this was a reflection on the software of IIFL, or a fact of life one has to live with. Any views?Like 
vdmodi
06 Dec, 2015
Test checking slow trades no need for stop lossLike 
Ramarao Y
06 Dec, 2015
Very interesting real life story. people who want to place stop loss order are quite often caught these days in setting a limit for stop loss level..Due to high volatility,one does not figure out how near or far is the limit.usually the stop loss gets triggered fast and reverse movement happens on the same day in line with original prediction. How does one overcome this situation? this is a topic for discussion.Like 
Srivathsa
05 Dec, 2015
Sometimes, even a 'stop loss' order does not get executed when the price moves very quickly past the stop loss price level in case of volatile price movements. Hence, it appears that a stop loss, though very much advised, may not be a fool proof way to cap a loss.Like 
Rajesh
05 Dec, 2015
Future tippsLike 
Uday Pratap
05 Dec, 2015
Although Joe got lesson after huge lose but i think those who read the article :Expensive Lesson" could definately put stop loss on their evry trade to save themself from uncertain loss. Excellent article by Apurva Seth.Like 
Deepak Bedi
05 Dec, 2015
In the Indian markets you can place stop losses only on intra day trades. What happens when stocks open gap up or gap down the next day? So really how is this article helpful to us?Like (1)
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