Chapter 2
The Margin Call

Don’t trade on margin. Never, under any circumstance, should an inexperienced trader use margin. I like to describe margin as a sexy, busty, blue eyed blond in a short dress who invites you into her motel room and when the door closes a 6′ 5″ thug steps out of the bathroom and bashes your head in and takes your money. When you wake up your head is throbbing, you’re covered in blood and all your money is gone.  At the time, stepping into that motel room with Blondie seemed like a good idea but it didn’t turn out so good in the end.

Week 5 and something is happening but you don’t know why. Your stock is trading at $47 a share. Your green $670 profit is now a big red minus $700. Now you’re panicked and you start Googling your stock symbol to see what you can find. Remember, you’re 5 weeks and $10,100 into this stock and NOW you start doing research. Maybe you should have done some research BEFORE you bought the stock ? Just a thought.

Your Google search comes back with links to about a thousand different things, Yahoo message boards, The Wall Street Journal, Bloomberg, MSN, MarketWatch, NASDAQ, Joe’s Stock Picks, and on and on and on. As you browse through some of the sites you notice a common denominator, analyst ratings. Oh yes, the analyst are back.

Buy, Strong Buy, Neutral, Buy, Buy, 4 Stars, Outperform. You simply can’t find anything bad about this stock so why is it at $47 when just a week before it was at $53.85 ?

Your buddy at work has a sister who is married to a stock broker. If anyone on the planet would know, a stock broker would. After all, that’s what they do for a living, buy and sell stocks and make money for people, right ?
You talk to your buddy, he talks to his sister who talks to her husband the stock broker and the report comes back, BUY ! “I talked to my sister and she said her husband said the stock was a steal at $47.” Whew, thank you God!

You can’t sleep that night waiting for the market to open the next morning so you can buy some more at $47. You’ll buy another 200 shares. That will be 400 shares. You’re not sure what your average price is but what the heck, this baby is going to $75. The market opens the next morning and you place your order for 200 shares at $47 per share. The price shoots up to $47.82 in the first 10 minutes of trading so you change your order to buy at $47.82 but now it’s up to $47.99. Dang ! This train is taking off and leaving you behind. You change your order to “market” and get filled at $48. Now you own 400 shares at an average cost of $49.25 per share. Your investment is now $19,700 plus commissions but even though you don’t remember what the commission fees were it’s not that big of deal, right ?  Your trading platform reads -$500 in big red numbers.

By this time smoke is coming out of your calculator. You have $40,300 “buying power” in your account. You still don’t understand what “buying power” is but it’s free, right ? You could load up another 839 shares and when this baby hits $75 you can tell your boss to kiss your ass and quit that 2nd shift job you’ve been at for the last 11 years. Heck yeah, let’s do it. 800 shares, limit price $48, buy. Your hands are shaking, you have a headache, your palms are sweaty and then you do it, “PLACE ORDER”. 100 shares, 37 shares, 63 shares, 200 shares, 228 more shares, 72 shares, 100 shares. You’re in, you’re filled. You realize you are actually sweating and breathing hard. Wow, what a rush. You now own 1200 shares of a stock at an average price of $48.42 per share, you think. By now the numbers are starting to run together and with the commissions added in and what the heck was all that 100 shares, 37 shares, 228 shares crap about ? You bought 800. Why didn’t you get 800 all at once ? Heck, it doesn’t matter now anyway, come on $75 !!

By the way, your investment now is at $58,100. That’s fifty eight thousand and one hundred dollars. Whew, your hands are actually trembling. You’re not sure if you have a profit or a loss because you don’t remember where it shows that on your trading thing.  Your stock closes the day at $47.60 and you have a loss of -$984.

A loss of $984, dang ! Seems like just the other day you had a profit of six hundred and something. Oh well, you’re starting to see how the market moves up and down anyway so if you wait just a little longer you’re gonna be rich. Man, if you had some more money you’d buy 1200 more shares ! You feel 10 feet tall and bullet proof and your balls are so big you can’t sit down.

You’re watching Michelle Caruso Cabrera on CNBC one morning and she mentions your stock. Yes, you’re still watching CNBC because now you’ve found Jim Cramer and he used to be a hedge fund manager and he’s the best stock person in the world and he even tells you what stocks to buy. Michelle matter-of-factly  tells you that your stock has been halted due to “news pending.” Huh ? Halted, what is halted. You don’t remember reading anything about stocks being halted. You look at your trading screen and numbers are changing and blinking and there’s green and red everywhere but the numbers beside your stock aren’t changing.. You restart your computer. The numbers beside your stock still aren’t changing. You go to the “NEWS” menu on your platform and type in your stock symbol. (For this example, let’s call your stock symbol “RPM”)

Related Symbol: RPM.N
Thomson Reuters Limited.

What in the heck is this ? You’re confused and starting to get a little nervous but keep reminding yourself of all those analyst ratings, BUY, STRONG BUY, your buddy’s wife’s husband said it was a bargain, it’s going to $75 and then another headline appears in your news window. You try to read it but you’re too excited or nervous or whatever the heck you are right now. You take a deep breath and force yourself to slowly read each word.

Related Symbol:  RPM.N
Thomson Reuters Limited.

Ok, what ever the heck that means. Then you see it. The numbers beside your stock are moving again but something isn’t right. The numbers are changing so fast you can’t read them. The chart, where’s the dang chart. Ok, there it is right in front of you. Candlesticks, you remember reading about Japanese candlesticks. Red. Lots of red. This big red line on your chart is getting bigger and bigger. The numbers besides your stock symbol are flying ! You remember when your stock stopped moving earlier it was red and somewhere around -$800. Now it’s -$1118, -$1874, -$2388, -$2556, -$3588.
Your hand is on the mouse but you don’t know what to click and if you did your hand is shaking so bad you probably couldn’t. SELL, BUY, BUY TO COVER, LIMIT, TRAIL STOP, MARKET, SELL SHORT. Your body feels like a block of cement. You can’t move. Your chest hurts. You head is spinning, no really, you’re dizzy. You feel like you’re going to pass out. Your can feel your heart beat in your head. “Oh my God, I’m having a heart attack.”  You feel sick on your stomach. You vomit in the trash can beside your desk. You are sweaty all over, your whole body is trembling, you want to get a drink of water but there’s no way in heck your legs will cooperate.

Now you’re reduced to a spectator. All you can do is watch but you don’t even comprehend what you’re looking at. At this point all you know is your stock has dropped straight down and is still moving down and you have lost a lot of money. Your email alert pops up, it’s from your broker, you can read the subject line in the preview window, IMMEDIATE ATTENTION REQUIRED: MARGIN CALL.  You skim over the email. Your broker has issued a margin call and you need to deposit more money into your account or liquidate some of your position. What ? Your e mail alert pops up again, subject line, POSITION LIQUIDATED. The e mail says something about  equity and your stock has been sold to meet margin requirements.

It’s 11:30 am and you are supposed to be at your job at 3 pm. You try to pull yourself together long enough to call your boss. “Mr. Madoff, I won’t be coming in today, I feel like I’m coming down with a stomach virus” you say in your most puny, sickly voice. It’s not a stomach virus but you dang sure are feeling sick. You’re still not really sure what has happened but you know something has went terribly wrong. You leave your desk and walk outside and sit on the porch. By this time you really don’t care what is going on with your trading account. Heck, at this point, you really don’t care about anything. Your mind wanders off to a day when you were standing on Pa and Nanny’s back steps. It was a perfect fall day, a slight breeze was blowing and you could smell the sassafras. Your aunt Helen had just came from the garden and washed her bare feet off under the spigot fastened to a steel pipe coming out of the ground beside the greenhouse. Sassafras plants grew all around the spigot and the splash of water stirred up the wonderful smell. Aunt Helen had a bucket full of ‘taters and you knew Nanny was going to be making creamed ‘taters and cornbread for supper ! You were 10 years old and everything was perfect.

“Nicholas, Nich -o- las ! Throw it to me dummy, I’m wide open.”  What ? It’s the neighbor’s kids playing football with an old ragged football that has no air in it that woke you up. You fell asleep sitting on the porch daydreaming about when you were a carefree child all of 10 years old. “Oh my God, my trading account ! ” You run upstairs to your computer. You can’t see anything but the screen saver drawing psychedelic pipes on your monitor.  “Come on dammit mouse, move.” You’re violently moving the mouse around trying to get the screen saver to go away so you can see your trading account and then it appears. “Holy freakin’ cow ! This can’t be real. You want to go back to sleep and dream about aunt Helen and sassafras. “No, No, No, son of a bitch, this isn’t happening.” The numbers aren’t moving again. Why aren’t the numbers moving ? You now realize it’s 4:38 pm and the market has closed. You sit down in front of your computer and try to comprehend what your seeing.
Your platform reads:

  • QUANTITY:  617
  • AVERAGE PRICE: $48.42
  • LAST:  $37.55
  • P&L:  (-13,040.00)

You feel like you are going to cry, literally. It was just a few weeks ago you had a profit of $670 and now you’ve lost $13,040. Heck, you even had a profit of $200 in one week ! (Hint, if you have a profit of $200 in 1 week, TAKE IT !)
You had 1200 shares but now you only have 617 shares and you haven’t sold any. Remember when you were only down -$50 or -$125 ? Heck, right now you’d gladly take the -$900 and something you were down not long ago. You think about calling your on line broker to see if you can get a refund and you swear to God you will NEVER do anything like this again. “Dear God, I promise I will always use stop losses if you get me out of this.”

Well cowboy, here’s the reality. God is not going to give you a “do over”. Your on line broker is not going to give you a refund. There wasn’t a glitch in the system and your money isn’t going to miraculously reappear in your account. Your thirteen thousand and forty dollars (plus commissions and broker fees for having to liquidate your account) are gone. Vanished . Gone. There is no one for you to call. It’s over almost. You now have 2 things to do. First, you have to decide what to do with the remaining 617 shares left in your account. Secondly, you have to suck it up, put it behind you and move on. YOU HAVE NO CHOICE. NONE, Get over it.

Hopefully this wasn’t all for naught, hopefully you learned a lesson here. In Chapter 1, I talked about trading without stop loss orders in place. Chapter 2 showed you what can happen when you don’t take Chapter 1 to heart. Now I know some of you are thinking “no way that would ever happen to me, I’m too smart for that.” Well, I’m a fairly smart guy myself and it happened to me and I’m going to show you the chart and explain how it happened.
But first, my mentor and the smartest person I’ve ever met in my life, Bob Turberville, is going to give you the details of what happened in the trade we just made.

Figures graciously provided by Bob Turberville:
Your margin call is going to come with a total investment of $58,100. You would be $38,100 in to your margin account at the start. When the trading closes at 37.55, your total position is worth $45,060. Using the 30% margin requirement, you would need to deposit $6,558 dollars or so in your account to cover. Otherwise, you are going to see a liquidation of 583 shares to bring the total shares to 617 or so to reestablish to 30% margin requirement based on your equity of $6,960. Your loss is $13,040.
This is all without commissions and fees don’t forget. Some brokers may sell more, and if the price is moving around that much, you would likely see a higher sell off in your account depending on when the liquidation order executed.

Click here for annotated chart of DRYS

“It seems like I get stopped out all the time and then the price goes up” !  Welcome to the stock market. The stock market is always right, always has been and always will be. It’s up to you how you deal with that fact of life. If you’re getting stopped out a lot only to have the price move up then there’s 2 good possibilities of what you’re doing wrong. # 1: You entries are incorrect or # 2: your stop is too tight, or maybe both. Entering a stock at the correct price is like trying to get all the worms back in the can after you’ve spilled them, it’s not easy and you’re gonna miss a few. Here’s a real example that happened to me the week of June 7th, 2010. Here is the ROST chart so you can follow along. (It will open in a separate window)

I bought 50 shares of Ross Stores Inc., ROST, on Thursday, June 3rd at $56.15 with a $2 stop loss order. This means if the price went down to $54.15 my stock would have been sold and my loss would have been -$100 plus commissions. The following day, I purchased 50 more shares at $54.73. Now my average price per share was $55.44 and I owned 100 shares. I moved my stop $53.40 and now my downside exposure was -$204. The following Monday, June 7th, ROST made a low of $53.04 and my stop was triggered and my 100 shares were sold at $53.40 and I took a total loss of $-218 including commissions. As you can see on the chart the price has rebounded very nicely but charts are read left to right, not right to left. Quit scratching your head and think about it for a minute.

Now let’s analyze this trade. You should have the ROST chart open in a separate window.

At 8:30 am on Thursday, June 3rd, ROST reported same store sales, (SSS) were up 9% over the same period last year and 5% for the month. This news caused the stock to “gap up” at the open i.e. buyers were bidding for the stock at a price above the previous day’s close. I waited until after 10 am (one of my self imposed rules) and let things settle down and made my entry at $56.15. I knew there was an extremely high probability that the price would eventually come back to where it had gapped up from but what I didn’t know was when. It could be that day or 3 months from now. This is called “closing the gap.” This is why my initial entry was small (50 shares) and a wide stop ($2).

You’ll see on the chart I had drawn a Fibonacci retracement. “Fibs” are subjective and 10 people will probably draw them 10 different ways. I drew from a recent low where I saw volume to the high of that day. That told me that 50% of a move back down would be at $54.38. As you can see on the chart, the next day price made a low of exactly $54.38 and “bounced at support.” This confirmed buyers were coming in “at support” and I added 50 more shares. Notice I’m adding 50 shares, not 500. Now look at the chart and you’ll see a fib line marked 61.8% at $53.55. The 61.8% is my line in the sand, below that and I’m out. Rather than setting my stop exactly at the 61.8% line I gave it 0.15 wiggle room down to $53.40.

So far, so good and I’m feeling good about this trade. A push above $56.21 and I’m planning on adding another 100 shares. At $57.85 I’ll sell my 200 shares for a profit of $404 less commissions. Then, as the saying goes, “shit happens” and it did. On Monday June 7th, the Dow dropped another 115 points after losing 324 points the previous Friday. The Dow was already below the psychological level of 10,000 and this just added gas to the fire.  So, what did I do wrong ? In my opinion, I didn’t do anything wrong.  Everyone has different risk tolerances. Personally, I was willing to risk $204 but not more. If I was trading with a million dollar account, my risk tolerance would be higher. What I could have done differently was to keep monitoring the stock and re-enter but I don’t like to do that. I’d rather move on, find another stock I like and put my money into it. If you’re not careful, you’ll find yourself “revenge” trading a stock and the 2nd loss is usually a big one.

I want to point out where the figures came from in the last paragraph. The reason I would have added 100 shares at $56.21 is the close on the 3rd was $56.19. A lot of day traders enter “scalp” trades on the 0.20 i.e. they wait til a stock clears the whole number plus 0.20. So if someone was scalping ROST they would be waiting for it to break above the previous day’s close of $56.19 and they would enter at $56.20. I just added another penny. (Some scalpers prefer to wait  until the price clears the previous day’s high rather than close)
My exit target was 0.10 below that days high of $57.90. Daily highs are normally resistance areas so I set my exit just below that. There nothing to stop the price from going through the day’s high like a hooker goes through lipstick but you can’t get it all. I’ll take a $400 profit any day and someone else can have the rest.

Pigs get fat, hogs get slaughtered, remember that.