Navigating Thru a Trading Fiasco

| Nov 12, 2006 | Comments 12

Two weeks ago the Canadian government announced that it was imposing a new tax on income trusts.  This announcement shocked the market and sent the Toronto Stock Exchange S&P/TSX composite index spiraling down 2.4% for the day.  To put that in US terms that was the equivalent to a 300 point drop in the DOW.  Billions of dollars were lost by this announcement.

Unfortunately I had recently taken a position in Enerplus Resources (ERF) the granddaddy of income trusts.  It was the first Canadian oil and gas trust formed in 1986.  Over the past five years, while the DOW was returning peanuts, its return was over 200%.  It has a 9% yield and pays a monthly dividend like clock work.  The plan was for it to become the anchor stock in an income oriented portfolio that I am building.  As I have mentioned numerous times, to be successful in this market you need to be either a trader or a dollar-cost averager.  Most will be far more successful as a dollar-cost averager.  I have written many articles on the topic on this site.  I make use both styles, but primarily I am a trader. 

On the day of the announcement, ERF dropped 14%.  That might have been the largest one day drop that I have experienced in a stock.  If it is not the largest – it is definitely in the top two or three.  Here are the comments from one mutual fund manager, “There is a knee-jerk reaction out there. You got a lot of mutual funds that might be experiencing cash-ins because the media headlines make the masses want to liquidate at whatever the cost.”  Based on his comments, I would presume that he was advising his clients not to sell.  I have been caught in downdrafts such as this before.  So, I was a seller. 

erf.png

Seven days afer the infamous announcement, the calm mutual fund manager’s clients are down an additional 10.5%.  As a trader, I don’t rationalize over this or that – I react.  Perseverance of capital is my number one priority.  Although my intent was to become a long term investor growing old collecting dividends, STUFF happened and my plans were changed.  Many will say, that if it is such a great stock it will come back.  My answer is maybe.  Not everyone sold seven days ago and have since suffered an additional 10.5% loss.  So, now every time ERF advances a few points it will be faced with enormous selling pressure.  Those trapped will want out.  ERF could be dead money for awhile.  Additionally, there is an opportunity cost of being stuck in a stock after such a calamity.  Your money could be put to use in another stock as opposed to languishing in ERF waiting for it to come back.  So, the next day I put some of the money to use into another to stock Hud Bay Minerals (HBM).

hbm1110.png

Over the past seven days HBM has gone up 1.9% versus -10.5% for ERF.  Making this a double win.  I have recovered some of the loss and avoided an additional loss.  Many would have listened to the broker and held on.  Although my original intent was to be a long term investor in ERF, I realize that preservation of capital trumps intent.   This was not my first rodeo, so I sold and moved on.

Filed Under: Energy • Investing • Precious Metals • Trading School

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    ERF gapped down on 3X its average volume on the announcement and then was down huge the next day on 5X its average volume. IMHO, I think that it will take some serious time to recover from that damage. I may reconsider it once it closes the gap, but in the meantime my money is better off somewhere else.

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  • Shawn Murray

    MikeD, was with you on the ERF drop following the announcement. Agree with your rationale that preserving capital is most important. However, time horizon is also important in forming the proper risk assessment. As my horizon is years, I decided to buy more…a lot more. Reasoning was that at approx -22% (~$40/share), weak holders were mostly out of the stock. With 4 yrs until impact and legislation still in discussion, chances seem good that a compromise (extended grandfather period, resource companies exempt altogether, etc) might be possible. If so, upside could be +15-20% when law enacted. Downside seems limited by dirt cheap valuation & 10%+ dividend. Guess my point is that capital preservation can be #1 priority whether selling, holding, or averaging in…depends on time frame and risk assessment. Best of luck.

  • http://www.thetimeandmoneygroup.com miked

    Shawn, I had just initated my position a few days before it crashed. If I had significant profits in it – I might have given it a little more rope. I lost too much money in 2000 by letting small losses turn it to large losses. So, I cut bait much quicker now. Also I don’t like to say never, but I almost never average down. I have been burnt by that too many times. I make the exeception – if I determine before I initiate the position that I will be dollar cost averging into the stock. Good luck with ERF.

  • Shawn Murray

    Mike, thanks. I agree that averaging in is a risky proposition and not cutting away losers can magnify the loss much more than necessary. I got spanked on a number of positions in 2000 where stepping aside, not averaging in was the right move. If I could redo my current position in ERF, would have punched off my initial (and full sized) position like a frustrated load, then waited for a possible re-entry (vice averaging down). While I postured O.K. now, I could have been much better off without an outsized position I currently “enjoy.” Probably would have played it that way if I did not have this pesty distraction known as my job, I’d have picked up the fact that the market gave me a haircut a day earlier and would have reacted quicker. Oh well, one day I will manage my investments and trading full time. Until then, live/learn/improve. Cheers…Shawn

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