Lesson 10: Breaking Even

In lesson number two, I wrote about one of my early experiences in futures trading. I had an additional experience at about the same time and I want to tell you about it in this lesson. We will call my two experiences, brokerage house B and brokerage house W. Neither of these firms exist any more, having merged with other firms or gone out of business. Think back to April of 1967.

When I made the decision to learn about the world of futures trading, I simply wandered into brokerage house B and asked if they had any brokers there who traded in commodities. I was directed to a desk and to a particular individual. He introduced himself and said that he really did not handle regular accounts but that he worked with a group of investors who all got into the market at the same time and who all got out of the market at the same time. He was this group's broker but he did not make the decisions for the group. He merely raised the money. Another person, who I never met, but who was reputed to be a member of the group, made the actual trading decisions. This other person did the analysis and everyone in the group followed his buy and sell recommendations.

I asked the broker what this group was trading and he said, "pork bellies". Everyone in the group was in "pork bellies". They were long the July of 1967 futures contract. I was invited to join the group if I wished to but I was told that I would have to follow the directions of the third party and do what everyone else did at the same time they did it. I told the broker I would give it a try and I opened an account and the broker bought me some July pork belly contracts. I am not even sure now how many contracts I initially purchased, probably two or three, possibly four or five. I am sure it was not more than five. July pork belly futures were trading in April of 1967 between 34 cents a pound and 37 cents a pound. I happened to open my account when they were trading near 37 cents and that was the area where my contracts were purchased. The market promptly, in less than two weeks, headed to 34 cents and I had my first margin call. I was off to a bad start.

The margin call forced me to make a decision. Should I put up the margin money required to hold my pork belly position or should I get out and take my loss of approximately 2 cents a contract. You can pretty much tell from this choice that however many contracts I had at brokerage house B, I had the maximum permitted by the amount of money in my account. If I had not invested to the maximum, I would not have received a margin call when the market dropped but 2 cents. It is generally believed that meeting a margin call in futures trading is a mistake. It is not always a mistake, but it can be one. Why is this sometimes the case? It is the problem we looked at of chasing a 5-cent profit with a $3.00 bet or a $20 profit with a $400 bet. Suppose that back in 1967 I was aiming for a $500 profit in my pork belly position and that I had put up $3,000 in expectation of earning this $500. When the market moved against me, I was asked to put up an additional $2000 as margin call money to hold my position. I had $3,000 invested aiming for a $500 profit. If I meet the margin call, I would have $5,000 invested aiming for the same $500 profit (after all, the profit expectations had not changed simply because the market had moved 2 cents against me. If anything, my profit expectations were probably less now then they were before). What if there was a future margin call of $2,000, and another one for $3000 to hold my original position? What if eventually I was asked to put up $10,000 in margin money to hold my original pork belly contracts where the profit expectation had only been $500? This is how the rule that meeting margin calls is sometimes not a good idea came into being. In futures and options and stocks, you have to be careful when adding more and more money to an account chasing after a profit that no longer justifies the additional capital required to hold the position.

I was young and inexperienced in 1967 and unwilling to suffer a loss within two weeks of opening my account at firm B and so I met the margin call and put up the additional capital. But when I did this, I told my broker, "If the market ever moves back up to where I am even, I want out". I was no longer worried about the $500 profit, I simply wanted out of pork bellies and I wanted the money I had invested in pork bellies back in my pocket.

The broker told me that this was not possible. He said that everyone got in and everyone got out at the same time. If I wanted out on my own, then I would have to leave the group. I told him that I would accept this condition if being part of the group meant that I had to meet a margin call within two weeks of opening my account. "Take me out of the group if July pork bellies should ever return to the price I paid". The broker said he would do so and he entered an order something like this, "sell July pork bellies if they ever rise to his break-even point again". It was a little more formal than that, but in essence that was his order in my account.

There is another rule that wise men that trade futures, options and stocks have developed based on years of experience. This is the rule that when a market is running for you, it is not the time to get out. Of course, I didn't know that rule back in 1967, just as I did not know the rule about not meeting margin calls and so I ignored them both. There were two reasons that I ignored these rules. The first was that I didn't want to take a loss in pork bellies and the second reason was that my account at brokerage firm W (which I described in lesson number two) was a great deal more inspiring for me than my account at brokerage house B. I decided to close my account at brokerage firm B when the pork belly market rose to my purchase price and then concentrate all my efforts at brokerage house W. The broker entered my order, I was basically kicked out of the group, and the market rose to just below my purchase price but not quite up to my sell order. It opened the next day sharply higher and I was taken out with a profit. I had violated two fundamental rules of successful futures trading. I had met a margin call and I had offset a trade that was running in my favor and yet I ended up with a profit. Albeit it, not a profit as large as I was making over at brokerage house W, but at least a profit. Was I happy? The answer was yes.

And then, of course, the pork belly market took off. This is why you generally do not want to get out of winning positions on the first day that you have a profit. The market rose from my break-even point to 45 cents a pound. That was a lot of profit for long traders who still remained with their positions after the 8 cent run. Did I regret my decision to get out at break-even? Of course, it is like the television game show where you are asked to pick door A, B, or C and you pick (A) only to discover that the better pick would have been C. Would I have rather sold my July pork belly contracts at 45 cents a pound than where I sold them?. Yes. Of the group of traders in this exclusive club, and there must have been twenty or thirty members in the group, I was the first and only one to get out and I sold just above my purchase price. Everyone, and I mean everyone who knew of the group and knew the huge profits the group had at 45 cents thought me one big fool for having dropped out of this semi-exclusive club on the very first day when the market closed in my favor. Did I think of myself as a fool? Not really. I had done quite well at brokerage house W and while I would have preferred to sell at 45 cents, I never thought that I had made a mistake by getting out of the group. I have always been kind of a loner and I didn't really feel comfortable being in a situation where I would have no control over my own account, but had to do what everyone else was doing at the same time everyone else was doing it. I was happy with the money that I made at firm W and I sat back and I watched pork bellies to see how high they would go. To 53 cents, to 73 cents, to 93 cents, who knew? I certainly did not. I was willing to miss the big move, I was happy to have my money back. I never traded with this broker again or with the group from which I had been expelled. For the next 30 plus years, I would go my own way down my own path and achieve success or failures based on my own skills and knowledge. In those 30+ years, I would learn a great deal about futures and options trading and stock investing, but it would not be knowledge learned as part of a group. It would be knowledge based on experience, my own experience.

What then happened to pork bellies? It is almost too sad a story to tell, but it is a true story. If you can locate some 1967 charts, you can take a look for yourself. July pork bellies declined from 45 cents a pound to around 38 cents a pound. The group that was trading as a unit had been buying heavily all the way up. When the market dropped to 38 cents, a decision had to be made. When it was made, it was the wrong decision. If any market makes a sharp advance and then sets back somewhat from the recent top, an investor has to decide if the setback is a short-term dip in prices or if it signifies the end of the advance. If pork bellies had moved to 45 cents and then set back to 38 cents on the way to 93 cents, the group of traders at brokerage firm B would have been very happy. But it did not. When the July contract declined in price, this group stopped buying the July contract and started buying February 1968 pork bellies. The number of contracts they bought was very large. When the February contract was at 39 cents, they bought a large position. When February bellies declined to 38 cents, they bought again. When pork bellies were 37 cents, they bought even more. When the February contract declined to 36 cents, the group had a very large margin call. Everyone held with their positions and put up the margin money. It was $3.00 chasing a nickel all over again. The market declined to 35 cents and to 34 cents and the group had another large margin call. Everything still would have been okay if only the market had turned around and advanced, but it did not. The pork belly market in the summer of 1967 wasn't in the mood for making new highs. The February 1968 contract dropped to 31 cents. Everyone at the same time on the same day acting in unison sold their contracts and got out. The losses were overwhelming. The broker who organized the group and who entered the orders never managed another group of traders again. What happened to the third party who was calling the entry and exit shots, I never knew. Of the entire group of twenty to thirty investors, I was the only one who walked away with a profit from the pork belly market of the summer of 1967 and I got out of my position on the first day that the market moved above my purchase price. Except for me, everyone in the group lost money. The moral of lesson ten is this: (A) The meeting of a margin call is often not a wise thing to do. I met my margin call and I was bailed out, but I credit my entire success to luck and luck only. (B) If a market is running in your favor, it is sometimes not wise to get out on the very first day that you have a profit. I did but I missed out on a much bigger profit opportunity that came shortly thereafter. Had I had a little more experience back in 1967, I might have taken a bigger profit out of this market than I did. Of course, I was young and foolish then and breaking-even was enough to make me happy. I wasn't thinking about profit, all I was thinking about was getting my money back.