Autopsy of a Trading Era

— A truck comes to your house. A man installs a line that makes your personal computer work better on the Net. He is presentable and busy. He’s got a million more homes to wire.

Today. You just got into the stock market in the last few years. You have read a lot of articles about how Peter Lynch picked his stocks by personal experience. You are busy opening all of your trading accounts — and we know how easy that is from all of those commercials — and you think, “Hmmm, busy installer, busy company, this digital subscriber line is one fast line, wait till everybody gets one of these!” Voila, next thing you know, you just bought 1,000 shares of Covad . On margin. Why not margin? We know that everything goes up in the end, so live a little, leverage a little.

Six months later, you are gone. Obliterated. Vaporized as surely as if you were the ex-CEO of Covad, who, a few days after a glowing L.A. Times piece about his reign, gets the boot! If this story doesn’t sound familiar to you, that means you are a survivor. Congratulations. You are going to make it to the next bull market. And you will be good at it when you get there. If it does sound familiar to you, I bet you’re are winding down your trading days, whipped by a market that’s as mean and as angry as a trapped and wounded Kodiak.

Same Sorry Endings

When the book on this era is written there will be a massive number of these Covad-to-Lynch-to-poorhouse stories and they will all pretty much have the same sorry endings. What happened here? How did things go so awry? I want to use this Covad metaphor as a quick lesson in what so many newbie investors did wrong in these gilded past couple of years.

First, let’s dispose of one thing. Peter Lynch would never have bought Covad. At least not the Peter Lynch who made me a ton of money when he was at the helm of Magellan. The Lynch style of investing, which has come to be personified by the unfortunate example he used of some school children buying stocks, was never to buy a stock after a good personal experience. That’s like saying that I practice Ted Williams’ style of T-Ball. It was to use the experience as a great starting point for research into an investment. What would you have found if you had looked into Covad? I think you would have found an indebted company that was losing money hand-over-fist. Then I think your research would have ended and you could have waited until the next man came to your house, well-dressed and doing a good job. If it was a UPS man, and you liked him, you could have saved a fortune! Hope it wasn’t the Webvan man. I can’t tell you how many people bought that one after a terrific experience and no research. And be glad Kozmo wasn’t public. You never got a chance to lose a fortune on that one!

Learn From the Past

Lesson No. 1: Research companies. Are they losing money hand-over-fist? If so, accept that you are buying an extremely speculative piece of paper, a lottery ticket, if you will. And where did I get that phrase? From the man who tried to warn us, Alan Greenspan, the Federal Reserve chairman.

Which brings us to Lesson No. 2: Would you ever borrow money to buy lottery tickets? I don’t think so. In fact, I think you would think that was downright stupid. But in the online world, people routinely use margined, or borrowed, money — I wonder how much more could have been saved if we had only called it “borrowed” money instead of the higher-falutin “margined”? — to buy lottery tickets. They did that, I suspect, because they never had to talk to anybody about it or they misunderstood the risks. I wonder sometimes if there had been an intermediary, a human intermediary, the carnage this last year would have been lessened. But a lot of brokers blew their clients up too, so maybe not. I just know that if someone had to ask for a loan to buy lottery tickets the embarrassment cost may have been too high to ponder the request. But not if it was done anonymously, through a computer.

Why focus on the margin? Because while the declines these last 10 months seem staggering, we are actually up year-over-year. So, theoretically, if people hadn’t borrowed to play, they shouldn’t be doing that badly. We know better. The last straw to our Covad-gaffed buyer should have come when the stock started dropping. Like a stone. Like a piece of granite hurled from the top of a 32-story skyscraper right at your cranium. At a certain point, you had to step aside. You had to take a loss. But we are a nation of buy-and-holders. It is all we know. To take a loss is to imply that it won’t come back. That’s un-American. So we held the Covad. Into the valley of the shadow of zero. And it didn’t come back. It won’t come back.

You Have to Have Discipline

To which I say, at a certain point you have to have discipline. Discipline to cut losses. To recognize that you made a mistake. Or just as a way to preserve capital for better times. The markets won’t always be this bad and this unforgiving. They will get better. Then they will get worse again. That’s called the cycle. My hope is that you are still there with me when things get better. (And I am not being arrogant about being there when things get better. I have no choice. This is my profession and I am not going anywhere — in part because I have rules that keep me in the game, perhaps at lower-octane sometimes, and in part because I am flexible. Anything that keeps you in the game in bad times is good.) But that Covad delivery truck got between many readers and me. And many readers and their money.

Anyway, that’s kind of the autopsy for the era. I could flesh it out much more, but it is a barebones post mortem because most of you who are reading it dodged the Covad bullet anyway. It’s too bad. Maybe they should have made it harder. Made it more difficult to open accounts. More difficult to buy. More difficult to buy on margin. But that’s not our way. Maybe it will be next time.

James J. Cramer is manager of a hedge fund and co-founder of At time of publication, his fund was long Cisco. His fund often buys and sells securities that are the subject of his columns, both before and after the columns are published, and the positions that his fund takes may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks.