How I Taught Myself About Stocks

Here is a quick overview of how I learned about the stock market and started making my own investments.

First, I was always interested in money / economics / business / finance / markets. Both my parents would discuss different aspects of their careers since I was probably around age 12.

My grandparents had also given me small savings bonds on my birthday and at Christmas. That was an early lesson — the bonds looked like cash, but couldn’t be spent without going through extra effort. These are probably my first investment although I didn’t pick it.

At around age 16 I started wanting to participate in the market. I worked at a dry cleaners and on the weekends the owner and I would listen to a call-in radio show about investing and financial planning. I had a basic economics class in high school but that didn’t provide much info. Listening to the show it seemed like a lot of callers were trying to make tax-efficient investments, and I quickly gathered that I could use a Roth IRA. I would pay taxes at rates for a broke 16 year old and access the money in retirement tax-free. I opened an account and began making small contributions.

Once I had a little bit of money saved in a Roth IRA, I wanted to invest. I didn’t know how to pick individual stocks so I thought owning a composite of all of them was a good idea. I bought a basic index fund of the S&P 500.

Next I entered college. I worked odd-jobs and had a small income so I could still participate in a Roth IRA. I also realized that I could get a student loan at a very low rate. I took a small student loan, I think $2,500 per semester, and used that to help fund the account. Upon graduation I consolidated these loans into one low payment — at like 2.5%. Keep in mind I had to work odd jobs to have the income to be able to contribute to a Roth IRA. The idea made great sense to me — borrow at around 2.5%, pay taxes at my low income rate now, grow the money at ~7-12% per year, and withdraw in retirement tax-free. Amazing.

I also found sites that would compare bank interest rates. It baffled me that I could get a higher interest rate on my paltry checking account than much-wealthier adults. I felt like I had discovered something. Later in life, I met a very wealthy entrepreneur in his 70s. I was told to tell him my checking account interest rate — 4.5%! He replied that he was getting 7%+, which I couldn’t believe. It turns out he had so much money in a small town that he worked directly with the banks. He didn’t need certificates of deposits at internet banks; he had personal relationships and a lot of leverage.

In college I also really began studying the markets outside of class. I had already read a number of books, mainly about Warren Buffett or how to build wealth. My classes in finance and economics covered some of the information but I still think I learned much more outside of class once real money was involved. I began reading blogs, and stories about people in my situation who were making investments.

In college I also made some investing mistakes. I learned about dividends and dividend yields. Reinvesting the dividends made a lot of sense to me too (DRIP plans, etc). I thought it would be great to get high dividends — so why invest in S&P 500 index funds with such a low dividend? I sought out stocks with the highest dividend yields. At the time these were REITs, and I piled in 100%. There was a bear market while I was in college, and the REIT I owned liquidated their property and paid a one-time special dividend that made it a great investment. It was a complete accident, and I should have lost some money. It was a valuable lesson in diversification and dividends.

After college I started working for a consulting company with a 401k. I began imagining what it would be like to live off 4% of my assets and never have to work again. I had to move to a new city and was renting an apartment. I read Random Walk Down Wall Street and wanted to follow the guide the author suggested. I needed to stop renting and own a home.

At this point most of my saving was in retirement accounts and couldn’t be accessed as cash. When purchasing a house this was a problem. I found a foreclosure I liked, made an offer and it was rejected. It was still on the market a month later and they accepted. It worked out. I got an FHA loan that required 3% down and was able to make it work.

At this time I also got interested in methods to “beat” the stock market. What was the highest return I could get? I was willing to take a lot of risk. I would use a Roth IRA calculator and calculate my retirement at a 5% return .. and then with an 11% return. The difference was amazing. Clearly it was worth learning how to get an 11% return.

Trying to increase my stock market returns led me down several paths. One interesting path was stock screens. If I read about a famous investor, could I mimic his returns by using his well-tested criteria? I found stock screens that emulate famous investors and started purchasing individual stocks. Some of the stocks were very strange but I had to trust the system. I bought 10 stocks and spread my retirement across each equally.

The stock screening system was interesting. The stocks were often unusual — healthcare insurers who had a lot of bad publicity, obscure industrial companies, or state-owned companies in foreign countries. Some stocks would double, while one I remember in particular ended when the company was nationalized in Venezuela.

I found over a few years that the stock screening system would out-perform in a strong market, and under-perform in a bad market. That was strange because the stock screen was based off famous value-investors. The companies I owned were often worth more liquidated than as continuing operations — talk about a safety net. Yet in this highly unusual environment even safe investments went down. It outperformed the market though, say by about 1-2% per year. It was also interesting.

My economics background made me really averse to any “system” that would beat the market. Anything not time-tested, like value investing has been, made me suspect. However, it was hard to argue against a few market anomalies: the January effect, for example. I eventually started reading academic papers about momentum investing. It disagreed with everything I fundamentally believed about markets but there was science, peer-reviews, and known criticisms of the systems. I began chasing alpha, and dedicated half my portfolio to a momentum-based system.

The best thing about momentum systems is that you avoid major losses. I was raised to think — stock market goes down, buy more. Momentum would say — stock market is up, buy more .. and stock market is down, so sell. Completely opposite of my training. Regardless, the sell signal helps you avoid bear markets (and major crashes), and avoiding those dramatically improves your returns. Then I thought — didn’t Warren Buffett say Rule #1 is don’t lose money? Ok, maybe this isn’t crazy.

So now I’m running my retirement portfolio at 50% value-screens and 50% momentum.

I moved for work and sold my old house in a housing bubble. This gave me some cash to put towards a new place. I was living back in my hometown and I went shopping for real estate. I couldn’t find anything that made any sense, nothing at all. We were at the height of the housing bubble and it didn’t feel right. I ended up sitting on the money and renting a crappy apartment in a bad part of town. That much was a good decision.

However, this cash was burning a hole in my pocket. I needed to chase a return, invest, do something. I was watching CNBC every morning, reading tons of financial blogs, and reading investment textbooks at night.

I was looking for market anomalies or arbitrage opportunities — is there any investment which would provide a high return with little risk? I began looking at buyout offers for stocks where the target stock was trading at a discount.

This seemed impossible — if a company was to be bought out at $100 and closing in a month, why is the stock trading at $95? Ah, risk of deal not going through. Well, what if I found all of the current buyout offers and live-calculated the discount? If I had a basket of these, wouldn’t it spread the risk? I did just that. I think at one time the list had 117 names on it, and it was a nightmare to maintain. There were all kinds of news stories constantly about deals falling apart, or a higher offer coming in from a competitor. I kept adjusting the basket to keep the weights even, adding/subtracting stocks, and maintaining the spreadsheet. It took forever. I did this for about a month, and made probably .. a 5-10% return? It just seemed like so much work. The stock market crashed, deals started falling apart, things went crazy .. I stopped doing the system. Given all the new opportunities with the market crash, there was too much else to do.

I had been studying options on the side. I applied for a high-level trading account and was approved. I dabbled in a few options to learn the system and probably took a few small losses. Along the way I found the calculators, learned the spreads, watched the data, and hunted for opportunity.

Keep in mind two things: 1) the market was crazy at the time 2) I only believed in time-tested investments. Options seemed a way to seriously magnify the returns I might get on a regular stock.

I was an analyst at the time for a tech company. I had learned how to do some forecasts for sizing a new market and had a decent feel for what was happening. I was reading voraciously (high-quality blogs, wonky policy, The Economist, etc etc). I was also watching CNBC and Bloomberg and beginning to outgrow most of the programming on CNBC. I loved that Bloomberg would have an analyst on, let him fully express an opinion, ask insightful questions, and then move on. It felt so much more informative.

So on CNBC they would track IPOs and there would be a lot of news around each new stock. While the market was crazy, odd things kept going up in value. This particular company IPO’ed and there was a ton of attention. It turned out to just be a spin-off of a more-boring parent company, my first clue. All the bankers who analyzed the stock set a market price of $29 — it opened at that, and then hit nearly $65 in no time at all. That was my second clue.

I’m a contrarian so started digging into the stock. I read SEC filings and knew all the relevant dates — when insiders could sell, when new float could be added. There was a major short squeeze.

I couldn’t believe a parent company could trade for nearly the same as it’s child, when the parent company was highly profitable on it’s own. I did more research, and it seems this happened with 3Com and Palm back in the Dotcom Bubble.

I started shorting the stock by itself. The position went south on me, but I still believed I was right in the arbitrage opportunity. I started selling naked calls, pretty much the highest risk/reward option available to me. Then I started getting margin calls and having to meet them.

When the stock hit $114 (remember, it had just IPO’ed at $29) I threw in the towel. I ended up losing a tremendous amount of money to me at the time. I had significant long positions (LEAPS) in the parent company but they never went up in value to offset. I learned about hedging, margin, short squeezes .. all sorts of valuable lessons.

I was disappointed but glad to take the losses before the stock hit $119 (I would’ve lost even more as I had leveraged positions). In a few days the stock fell back to $85 where I would have profited tremendously. I learned about liquidity, and being “early”.

I took out my frustration by doing more market research. I started looking at oil prices, which had increased irrationally high, irrationally quickly. I was looking at international energy subsidies and countries in trouble trying to keep up with the massive price increases. I had charts of oil production, historical patterns, key countries with political risk.

I remember carrying my research to a bar with an old boss. I was really passionate that oil prices had to correct. After explaining it to others I put on a short position that week. The oil market finally plunged and I profited. I had purchased out-of-the-money options on 3x oil price decreases. It worked.

I was basically back to even.

I watched my dad cash out his pension for retirement and put it all in the stock market. Then the market crashed, circa 2008. It made me think I didn’t want to have to depend on the market in my retirement. I agonized over it on his behalf, but he never sold. I might have sold when things were looking the bleakest, but he rode it back up through 2012. I learned that if you ever get a lump sum, you should put it to work in pieces, say 25% at a time, with time intervals between, say 3 months. Live and learn.

So I felt burned from the market. I later would feel better to know that hedge funds couldn’t believe the irrational things that were happening around the same time period. I started to look at real estate because it felt more stable, more real, more controllable. Instead of stock research, I would replace water heaters. Seemed like a good trade.

That’s pretty much it. If I had to summarize, I would say:

  • Read a lot
  • Play the market when you’re younger
  • Learn from your mistakes
  • Find what works for you




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