This Stupid Mistake Will Cost You

It's hard to admit that you're stupid.

You could turn $400,000 into $20,000 and still walk away without that self-awareness.

But when one young trader saw such a $380,000 loss on a single call option, it taught him a valuable lesson. He wrote an article for Vice in which he called himself stupid 10 times.

This wasn't even a story of complete stupidity...

Sure, this anonymous trader gambled in "meme stocks" like AMC Entertainment (AMC). As with many young people, these stocks sucked him into the excitement of the pandemic's bull market.

But those were the trades where he made money. He emerged from a series of speculative bets having turned $5,000 into $50,000. He was ready to start playing it safe.

That's a smart instinct. But his execution was terrible.

This trader found one good investment thesis. Then he put everything he had into it: the $50,000 he'd made from his previous trading, plus all the savings he'd built up by working a good job and spending conservatively.

The company he pegged all his wealth to was Alibaba (BABA), the e-commerce giant that's like China's version of Amazon. He did some research. This was a stable, wildly successful blue-chip company. Yet its share price ($245) was down more than 25% from its peak.

The company was still making tons of money, pushing down its price-to-earnings (P/E) ratio. Analysts he found online were confidently calling Alibaba a buy.

He decided to buy Alibaba $200 calls. If he was right and shares turned around, he'd make a fortune. If he was wrong... well, how far could this great company fall?

He put all his available cash into the trade. Alibaba kept falling. And as he earned more money, he put that cash in, too – another $100,000. He couldn't even pay his $900 rent until his next paycheck came in.

And Alibaba still kept falling. He eventually sold when his $400,000 investment in BABA calls was down to $20,000... a 95% loss. And since he put on his trade, the company's shares are down more than 50%.

The problem wasn't his investment thesis. He's right that Alibaba is a solid company at a good price. We've even traded Alibaba several times in my Advanced Options service.

In hindsight, he realized his error...

I should have listened to [my mom]. She told me to diversify a little. Don't go all in on one. But I felt like, because she told me not to do it so many times, I actually had to.

As his situation illustrates, everyone and their mothers know you need to diversify. This isn't an insight. It's a platitude or an empty hand-wave to prove that you talked about the risks in an investment. It's an admonition akin to "eat your vegetables"... acknowledging the wiser action without changing anyone's behavior.

That's partly because diversification is a bit boring and it's more fun to go for the big score.

But it's also because diversification is difficult to implement... Sure, putting all your liquid net worth into a single option trade is an extreme example. But diversifying properly involves understanding correlations that vary across time between assets with shifting categorizations. This is an area that human minds – even those of accomplished statisticians – can't fully understand.

Do you diversify across stocks and bonds? Growth and value? Cyclical and acyclical? Reopening and work-from-home? Of course, you can diversify by sector, industry, size, and other features as well.

So instead of "eat your vegetables," giving someone advice to diversify is more like telling them to "eat healthy." Sure, I'd like to... But how?

I will always advocate for you to diversify your assets, no matter what the current market climate is.

It's the smart and prudent thing to do.

And right now, we're definitely in a market climate that calls for smart diversification. That's why I just released three new special reports for my Retirement Millionaire subscribers that reveal...

  • 7 Stocks for the Great Reversal Window
  • 7 Underground Toxic Stocks
  • The Two Most Valuable Assets in a Time of Crisis

If you want to learn more about these reports and how to tap into a corner of the market which could soar higher than the S&P 500 Index, click here.

What We're Reading...

Here's to our health, wealth, and a great retirement,

Dr. David Eifrig and the Health & Wealth Bulletin Research Team
March 23, 2023