Wall Street Hits Air Pocket – Two Trading Lessons (Part 3)

Tuesday, May 11, 2010

Actually, the title should read, “Two 1967 Trading Lessons Confirmed.” Thursday’s stock market gyrations reminded me of those still-valuable lessons learned 43 years ago as a result of one trade…

In 1967, I sat in my stockbroker’s boardroom watching the ticker. At the time, I was actively trading stocks, and the market was heady. One of my holdings was Leasco Data Processing Equipment Corporation, a popular company traded on the American Stock Exchange. It was in a strong uptrend, so I had placed a stop-loss order well below the current price. Mid-day, during a trading lull, I watched Leasco begin to drop on low volume. With each small trade, it gapped down significantly. Within a short period of time, it hit bottom with one trade: exactly my position at my order price. There went my holding, and up went the price.

Now, that pattern showed:

  • The specialist didn’t do his job because he allowed the stock to drop significantly on a few, small trades
  • The specialist acted against regulations – a stop-loss order requires a previous trade at or below my price, so my position should not have been sold

My broker said I should complain, but, knowing the American Stock Exchange’s poor reputation, I decided not to do so. However, I did gain two important lessons from the experience:

  1. Focus my trading on the New York Stock Exchange, where specialists acted appropriately and strong regulations were observed
  2. Do not use stop-loss orders. By accepting the small risk of a sudden, pro-longed decline, I avoided the greater risk of being sold out in a quick drop/recovery move

Both lessons proved to be valuable over the following years.

  1. Until the development of the ancillary exchanges, the New York Stock Exchange proved to be a reliable foundation of trading stability and, importantly, investor protection (*see example below)
  2. Over the years I have witnessed countless “odd” stock price moves – quick, little drops that preceded a major rise. Each time, I thought, “Someone just cleaned out the stop-loss orders.”

Last Thursday’s air pocket was a confirmation of both those decisions.

So… In buying and selling stocks, it’s important to control how we place our orders in order to avoid Wall Street’s little games

(*) An example of NYSE’s investor protection

In 1979 I owned a position in UV Industries. Martin Horwitz, CEO, had decided to liquidate the company to maximize value. The stock moved up, and I placed a sell limit order at a price above the current level. Later, my EF Hutton stockbroker called, saying that Victor Posner had placed a sizable tender offer at a price above my limit order, and would I like to sell? I said, “yes,” but he called back to say the offer had been filled, so I was left out. Except for the tender offer trade, the stock price remained below my limit.

I thought that was wrong and wrote EF Hutton compliance, the NYSE and the SEC. I heard back quickly from Hutton: Sorry, no. Shortly after, the NYSE wrote: Yes, an NYSE rule was broken, under which all limit orders at or below a tender offer price had to be filled – and they were contacting Hutton to make good (which happened and quickly). The SEC? Six months later, I got a terse letter saying I should contact my broker.

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