It is always interesting when two broad themes intersect. We can always discuss the perils of aggressive investment techniques. We could also marvel at how technology has so transformed our daily lives, including personal finance. Here is a story that combines both.
Let’s start with the investing part. Joe Campbell, a small-business owner in Gilbert, Arizona, also liked to speculate in his brokerage account. He “sold short” around 8,400 shares of KaloBios Pharmaceuticals (KBIO) at an average price of just under $2. Selling short means that Joe sold shares borrowed from his brokerage firm in the hopes that he could buy back the shares at a lower price to “cover” his short position (replace the borrowed shares) and pocket the difference.
Selling short is risky by definition, because if the stock price goes up instead of down, the trader has to buy the stock at a higher price and will incur a loss. In theory, this loss is unlimited because there is no cap on how high a stock’s price can go. (When the stock price goes up it can create a “short squeeze” because the buying activity of short sellers trying to limit their losses actually pushes the price higher.) KBIO is a very small development company with no actual products, only drugs in clinical trials. Shares of KBIO trade at a very low volume, which makes the price more volatile.
Even though he’d only been trading since March of this year, Joe claims he would normally not hold a short position overnight. But in this case, Joe estimated the stock was worth only $1, and the week before KBIO had announced it was discontinuing work on two of the drugs it had been developing. This trade seemed to be a reasonable risk and Joe was willing to let it ride for a while in hopes the price would fall. Joe had around $37,000 in his account (he wanted to manage risk and “the most I can afford to lose is what I have in the account”) to cover any losses if the stock price went up.
Joe went into a two-hour meeting and when he came out he learned that an investor group had bought half of KBIO’s shares and the price had shot up more than 800%. Joe scrambled to buy shares and cut his losses, and he ultimately wiped out his entire account and still owed E-Trade over $106,000. (Believe it or not, it could have been worse; the stock continued to go up from the high teens, where Joe covered his position, to as high as $45.)
While this was obviously bad for Joe, it would not have been newsworthy if not for the technology part. GoFundMe is one of the largest crowdfunding sites where individuals or groups can raise money and the internet has created a global pool of potential donors. According to GoFundMe, “most people use GoFundMe to raise money for themselves, a friend or loved one during life’s important moments. This includes things like medical expenses, education costs, volunteer programs, youth sports, funerals & memorials – even animals & pets.”
Joe apparently considered his misadventure one of “life’s important moments” and began a GoFundMe appeal. His appeal said that he started it on the recommendation of other traders and although he was hesitant, “what would you do if you were in my situation?” Joe had expected that E-Trade would close out his position when he’d lost the $37,000, and could not imagine E-Trade would not have some stop in place. And E-Trade did not call or alert him when his account went negative. E-Trade’s response was that the stock moved so fast, and had so few shares available to trade, that they were not able to close Joe out. (Yes, managing the trade is Joe’s responsibility.)
Joe’s fundraising goal was $5,000. His plan is now to liquidate his and his wife’s 401k’s and try to work out a payment plan with E-Trade. He raised $5,301 and amid harsh and deserved criticism he ended the appeal. He wrote “also for the record – I will not be shorting low float (volume) stocks ever again!” But he will return to trading, this time with stop losses in place.
High-profile professional traders and fund managers make news when they short a stock because it often leads to public warfare between the company and the investor. William Ackman of Pershing Square Capital Management has had a $1 billion short position in Herbalife, the nutritional supplement company, since 2012, claiming Herbalife is a pyramid scheme. Other major investors have bought shares of Herbalife with the expectation that the price will go up and the stock has had massive price swings. The drama has involved Congress, the SEC and advocacy groups on both sides and it still not resolved.
A casual individual trader has no business shorting stocks. Even a standing order to limit the loss would not have saved Joe because the price moved so fast it would have blown through the stop price. There are readily accessible mutual funds and exchange-traded funds that short stocks if the idea is still appealing. There are also options strategies that will profit from a falling stock price and the maximum loss is the cost of the options.
Of course, the best approach to a stock you think will fall in price is to just not own it.