In February 2000, I spotted an irresistible trade. It was a no-brainer – almost as if the guys on the trading floors were holding up signs announcing, “FREE MONEY.”
So, I backed up my wheelbarrow and loaded up.
It was the most profitable trade of my career. But also, the most aggressive.
To the best of my memory, here’s what happened…
PALM, the maker of smartphones and other handheld technology products, was scheduled to go public on March 2, 2000. The company was a wholly-owned subsidiary of 3Com – which was issuing about 20% of the company to the public.
The IPO price was set at $38. Of course, we all knew the stock would open for trading way above that level because of the ongoing dot-com mania.
In January 2000, shares of 3Com were trading at about $50. By the last week of February, they crossed more than $90.
The market was already pricing in the increased valuation of 3Com shares as a result of the PALM IPO. Among traders, expectations had reached purely foolish levels.
I knew the hype would disappear as soon as the stock went public. So, I did the only thing I could do… I bet against the stock.
I placed a trade to take advantage of the stock’s inevitable move down. In fact, since the profit potential was so high, I took a position about three times my normal size.
And the hype continued…
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The next day, just three trading days before the PALM IPO, shares of 3Com rallied to $95, and I was down $400 on every single trade I’d placed. So, I increased my position.
Not only that, I started telling my clients about this trade and encouraging them to take positions. I even put my own brokerage firm’s money into the trade. I was THAT certain it would be a winner.
3Com went higher the next day, too. It was now at $96 per share, and – in a further display of the power of hype – optimistic traders continued aggressively betting on the stock’s rise.
So, I increased my position even more. Sure, the stock was going up – the exact opposite of what I’d predicted – but the probability of the stock rallying above $120 (let alone $130, $140, or $150) was so remote that I rationalized it was OK to keep the exposure.
Then came the morning of the PALM IPO. I hadn’t slept at all the night before. I was sitting at my desk and staring through an assortment of half-empty Pepto-Bismol bottles at the television screen on the other side of my office.
Maria Bartiromo and Bob Pisani were on CNBC. They were talking about the tremendous interest investors had in the PALM IPO. Early indications were that PALM – which was priced at $38 for the IPO – would open for trading somewhere north of $150 per share.
My stomach sank, and I slammed my forehead onto the top of my desk.
If PALM was worth $150 per share, then a quick “back of the napkin” calculation told me 3Com was worth more than $300 per share.
But my exposure betting against the stock was so large that anything above $180 would bankrupt me. It would wipe out my account, put my firm under the minimum net capital requirements, and create huge losses for my clients.
I started to panic. I started typing an order to cover the position and take the loss while there was still time. It would be a tough loss to swallow, but I’d remain solvent, and I’d be around to trade the next day.
Just as I finished typing the order and was about to hit the “send” key, I stopped. A voice in the back of my head said, “It’s all hype. You’ve seen this before and you know how it’s going to end. You used logic and common sense when you got into the position. Now you’re about to panic to get out.”
I erased my order entry screen. Stood up from my desk and unplugged the television. I then left my office for two hours.
PALM started trading about one hour later. It opened at $140 per share, the high of the day, and then began drifting lower.
3Com never traded above $110. And as soon as PALM went public, 3Com started to sell off. It was a typical, and predictable, “sell on the news” situation.
When I returned to the office, 3Com was trading at $85 and the trade I’d made betting against the stock now allowed me to essentially turn every $6 into a minimum of $600.
The trade that had threatened to bankrupt me just a few hours earlier had now made a fortune. My clients were rich. My firm was rich. And my own net worth nearly doubled as a result.
I shut my office door, turned off the lights, sat down at my desk, and closed my eyes. And I swore I would never, ever do that again.
There’s no need to.
The market provides any number of ways to take advantage of mispriced, overhyped situations without exposing yourself to tremendous risks.
And once you identify that fact, you’ll be able to make more money trading in one week than some people make in an entire year.
Best regards and good trading,
Jeff Clark
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