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How I Lost $33,000 in Less Than 30 Seconds--Know Your Limits

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Most lessons in life are learned the hard way. As kids, we need to burn our hand on the oven, stick a fork in the electrical outlet, and slip while running on the swimming pool deck to make our parents warnings real. As adults, the same principle applies. Our actions have consequences, and many times we must learn the hard way instead of taking advice. On January 22nd, I learned the hard way about the importance of using limit prices.

ALWAYS use a limit price when placing your orders, especially after hours. I cannot emphasize this enough. For those that don't know, a limit price allows you to set the price of a buy or a sell. If the price doesn't reach your limit, the trade doesn't happen. Using limit prices can help with buying entry points and selling exit points, but it also can protect you from a freak of nature. What I am about to tell you is the product of my own laziness coupled with a strange occurrence and a flaw in the Marketocracy trading system. It all added up to the perfect storm, and what a storm indeed.

Since January 4th, I have been trading like a madman testing different strategies. On the morning of the 22nd, before the markets opened, I placed an order for 100 shares of RXD, Proshares Ultra Short Health Care ETF, and thought nothing of it. A position in RXD is part of my long term strategy, and with the price starting to rise from the mid-high 60's into the low 70's, I wanted to increase my position since I think it has some room to run. Previous to this, I had been accumulating a large cash position, around 160,000 at the time. I placed the order, along with others, and then went to work.

When I came home from work, I logged into marketocracy and noticed I was down by almost 3%. It didn't make sense since I had large positions in Ultra Short ETFs, and with the market down, I expected to be up a few percentage points. When I looked at the individual stock page, I noticed something strange.

An order was placed for a buy of 100 shares of RXD at an average price of $400.63 per share.

What the heck? $400 per share? There must be some mistake. I know that this ETF trades at a very low volume and can swing around a bit, but opening at over 570% its previous close seemed insane. I plugged in the symbol into different sites and it looked like RXD opened that morning at $399.99 per share. Once the market opened, it quickly fell to its normal trading range. My market order, placed after hours with no limit price, bought 100 shares at $400.63 per share. In less than 30 seconds, almost $33,000 was wiped out as it started to trade in normal range. (If you go to financial sites to view the price history of RXD, the best record I can find of this is a candlestick chart with an infinite bar upward on the 22nd).

I then proceeded to call Proshares to figure out what was going on. I talked to a really professional and kind analyst (who I cannot name, unfortunately, but excellent nevertheless) that explained to me that during the weekend the Ask price of RXD was $399.99 per share and the Bid Price was $71.28 per share. She said that spreads like that are not uncommon before the markets open, but once they open, the spread closes to a "normal" range. According to the analyst, on the morning of the 22nd, the "books weren't open for trading" for RXD until shortly after the bell, and the first trade executed for the day was 31 seconds into trading at $72.38. No shares in real life exchanged hands at $400 per share. How $399.99 was the recorded opening price is beyond me. This, of course, exposes a flaw in the game. There have been a few days in the past 8 months where RXD opened at a skyrocket price and then immediately plummeted to normal price a few seconds into the trading day. It would be possible, then, to buy shares at market price during the day, and then place a Good Til Cancel limit sale for a price 200-300% the next day. Granted, it would take a while to "strike it rich" since it isn't an everyday occurrence, but it would happen sooner or later. (Maybe I should set a limit order to sell 100 shares for $399.99, yes?) Again, no trades took place in real life at $399.99 per share, but they did in my virtual portfolio. I sent an email to Marketocracy regarding this, but I received no response. If I had only checked the "sell" button when I placed my order instead of the "buy" button . . . that $33,000 loss would have been a $33,000 gain. Regardless, it was a lesson learned here in the virtual portfolio, and though it tore a chunk out of me in the long term game, it didn't affect the short term game. Although a situation like this is extremely rare, it could happen and leave your portfolio hit and your psyche wrecked. Limit orders don't necessarily protect you in a crash since the prices can fall faster than the orders are processed in a panic. However, here in the SLO, always, always use limit orders after hours. Don't learn the hard way, especially now that competition is underway.

So what is all of this business of "bid price", "ask price", "market price", and such? Who is the "man behind the curtain" setting all of these prices at a whim? I'll cover that in a blog next week.

Now for a word for the leaders:

My raise a glass to those of you with the stones to load up your portfolio on Ultra Shorts, after all, I did it last round and I am stilted toward the Ultra Shorts this round. One word of warning, though. While we bask in glory when the market tanks, the Ultra Shorts can reverse course and evaporate paper profits. I know, it happened to me before, and probably will happen several times this round. Let's use FXP, the Ultra Short China ETF from Proshares as an example. I have been lucky enough to be on the winning side of FXP, seeing that in less than a month it has been as low as $70, as high as $105, then back to $85 and now back over $100. I have made some money in the swings, but have been too heavy in FXP. It's fun to play with fire, but sooner or later you get burned, which is why I have trimmed my position in FXP. I plan further reductions until I can get it to a "safe" level, which is between 3-4% of my portfolio. I am spread out into a dividend ETF, bonds, foreign currency, and gold, but the short side is my bread and butter meaning higher risk. I will be interested to see how many of us panic in the next rally.

Speaking of high risk, I have about 5-10 days before I go on a short squeeze buying spree. I have built a large reserve of cash in an effort to execute a short squeeze strategy I practiced in January. Once the buys are made and the blood starts flowing, I'll give detailed updates of the carnage.

---Jonathan