Editor’s note: Related tickers: Netflix, Inc. (NASDAQ:NFLX)
I’ve made my fair share of bad trades over the years. But with every poor decision I’ve made, I’ve seen it as an opportunity to learn something.
The following is a list of the three worst investment decisions I’ve ever had the misfortune of making, and the resulting lessons I took away from them. Hopefully, readers can avoid making these mistakes for themselves.
Holding leveraged ETFs
A leveraged ETF is a very dangerous thing. While it’s hard to beat the potential returns they offer, the downside can be just as swift and severe.
It’s important for investors to understand that, over a long period of time, leveraged ETFs become worthless. Not every leveraged ETF works the same, but the leverage employed comes at a cost. Like any loan, there’s interest that must be paid.
The cost of maintaining that leverage is ultimately borne by the fund’s holders. Although these funds can have powerful, short-term rallies, in the long run, the cost of maintaining that leverage eats away at the value of shares.
For example, shares of the Direxion Daily Financial Bear 3X Share (NYSEMKT:FAZ) are down nearly 90% in the last five years.
Holding these ETFs for a few minutes, a few hours — even a few sessions — may make sense. While Direxion Daily Financial Bear 3X Share (NYSEMKT:FAZ) is down over the last five year, it staged a powerful rally last September, gaining more than 10% in the span of only a few sessions.
Because they can bounce back so quickly, a trader who has lost money can easily fall into the trap of trying to hold them for “just one more session” in the hopes of making their money back. But the longer you hold them, the more the odds are against you.
If you’re going to trade funds like Direxion Daily Financial Bear 3X Share (NYSEMKT:FAZ), set a strict timetable and follow it.
Shorting Netflix ahead of earnings
Probably the worst individual stock mistake I’ve made was a relatively recent event. Specifically, I shorted Netflix, Inc. (NASDAQ:NFLX) ahead of its earnings in January.
Going into the trade, I was operating under the assumption that Netflix, Inc. (NASDAQ:NFLX) was overvalued. The price-to-earnings ratio was over 300 — many times more expensive than the market.
The company was expected to report a loss, and content costs were increasing.
Netflix, Inc. (NASDAQ:NFLX) had signed a deal with The Walt Disney Company (NYSE:DIS) to give it exclusive rights to stream some of The Walt Disney Company (NYSE:DIS)’s content in the future. Netflix bulls saw this as a positive, but I interpreted it as a bearish sign — Netflix, Inc. (NASDAQ:NFLX) had once had the rights to this content before, through their deal with Starz. The exact details of the The Walt Disney Company (NYSE:DIS) deal were unknown, but most analysts believed that Netflix, Inc. (NASDAQ:NFLX) was now paying more to Disney then they had been paying to Starz originally.
Carl Icahn had raised the specter of a Netflix takeover, but I doubted the possibility. In my mind the most logical buyer was Microsoft Corporation (NASDAQ:MSFT), but since they had hired a former CBS Corporation (NYSE:CBS) executive to create content, it seemed more likely that they would build a Netflix, Inc. (NASDAQ:NFLX) competitor from the ground up rather than buy Netflix outright.
Still, none of this logic mattered. Netflix, Inc. (NASDAQ:NFLX) beat on earnings, and the stock soared. What was an expensive stock became even more expensive.
I took my losses and covered my short (a great move, given that Netflix has continued to power higher). A short while later, I was reading an interview with hedge fund titan Bill Ackman. In it, he explained precisely why my trade had gone awry:
“We don’t short on valuation, but in situations where we believe a company is violating the law, or has misleading or inaccurate accounting, or has a potential regulatory problem.”
In short, it’s a mistake to bet against a stock simply because it looks overvalued. What’s expensive can easily become more expensive.
Not taking money off the table
I bought into silver with the iShares Silver Trust (ETF) (NYSEMKT:SLV) following Federal Reserve Chairman Ben Bernanke’s speech in Jackson Hole, Wyoming in the fall of 2010. A second round of quantitative easing seemed imminent, and I believed that it would prove to bullish for precious metals.
Silver is often viewed by many as the “poor man’s gold.” Both metals trade largely in tandem, but silver tends to have more pronounced moves — both to the upside and the downside. I believed buying silver would be an aggressive way to play the Fed’s continued monetary expansion.
I was overjoyed then, when my thesis played out — silver began to rally notably late in 2010, and gained steam in early in 2011. By April, the metal seemed to rally nearly $1 per ounce per day.
Of course, I failed to fully appreciate what was happening. While silver was carried higher by the second round of quantitative easing, that rally turned into excessive momentum chasing in the spring.
When silver collapsed in May, it was still higher than where I had bought it. But throughout the rally, I held onto my entire position, never taking any winnings.
Lessons learned
Although these experiences weren’t kind to my brokerage account, I tried to take some lessons from them. Specifically:
- Be careful when holding leveraged ETFs
- Don’t short stocks simply because they appear overvalued
- Take some winnings off the table when a position goes on a tear
I hope other investors can avoid these mistakes.
The article The Three Worst Decisions I’ve Ever Made originally appeared on Fool.com and is written by Joe Kurtz.
Joe Kurtz has no position in any stocks mentioned. The Motley Fool recommends Netflix. The Motley Fool owns shares of Netflix.
