Danger Will Robinson

One of the final lectures in The SMB Foundation is on risk. Risk as it relates to intra-day trading is not simply evaluating the order book for possible exits if a stock moves against you. It involves understanding the current market environment, the type of catalyst that is the primary driver for a stock on a given day, the price action a stock has exhibited recently, as well as many other factors.

During my 17 years of trading I have seen hundreds of stocks exhibit price behavior that makes it impossible to control my risk. And the first question a trader should always ask is “can I control my risk?” If the answer is “I’m not sure” or “no” then stay away. Now sometimes you may answer this question incorrectly and be caught in a nasty situation and you just have to do the best you can to minimize damage.

When HLF originally traded lower on the news that Ackman had taken a huge short position I chose to stay away. It wasn’t only because of the wild price action that ensued. Several other risk factors immediately come into play. There is the risk that the company issues a statement in response. The NYSE may decide to halt HLF prior to the statement being released or even after. As a short term trader there is no worse feeling than having a position in a stock that has just been halted. There is NO WAY to control your risk at that point. Trading is prohibited. Our broker dealer won’t even allow traders with opposite positions to offset their risk by “crossing” positions.

Take a look at this 15 minute chart in HLF. I’ve highlighted a few different areas. The area that I chose to get involved were the few days after Christmas when it started bottoming and the volatility dropped way down. My thought process went something like this.

  1. Most who wanted to dump the stock had done so prior to the shortened holiday week
  2. There was little chance of news being released between Christmas and New Years as all the players were on vacation
  3. With a quiet market the few pros who were trading might start to buy up the stock with limited headline risk

With this backdrop I started watching the tape closely to spot low risk entry points. My thesis started to play out very well. It grinded higher for two days and on the third day had a nice 2 point Opening Drive. The following day New Year’s Eve it moved up another two points in a fairly steady manner. In four days following Christmas it recovered about six points in a very controlled fashion. It was low stress.

I expected when we got back for the first week of January that the fireworks might start again and although the volatility expanded headlines were pretty quiet. Few on our desk traded it the prior week as most were on vacation. Few decided to trade it when they got back from vacation as well.

Then on Wednesday the craziness was back again with the announcement that Loeb had established a very large long position dismissing Ackman’s short thesis as rubbish (my words not his). The chatter on the desk picked up about HLF but I was not getting involved. The price action was wild and the headline risk was back in play. The conference was scheduled for the next day and big players were moving the stock all over the place. I wrote a few words in our Real Time Chat that this wasn’t the time to get involved. A few hours later the SEC investigation was disclosed (what a bunch of jokers. Why would they release that news during the trading day?) and HLF spiked lower several points hurting several traders on our desk who were long.

The losses our traders suffered were minor in comparison to a scenario where the stock could have been halted prior to the SEC release and then re-opened for trading at the intra-day low which was about 10% lower. So next time you are considering a day trade in a stock that is moving wildly consider what is your real risk. If you cannot answer that question then don’t get involved. It’s a big market. Find something else to trade.

Steven Spencer is the co-founder of SMB Capital and SMB University and has traded professionally for 16 years. His email is [email protected]

No relevant positions



Please follow and like us: