- Both trading and investing can lead to satisfying returns, but the important thing is knowing which is best for you.
- Psychological traits of both successful investors and traders are the same: patience, discipline, rationality, sticking to a well-defined, tested and working strategy, and risk reward calculations.
I started off investing as a convinced value investor looking for, and investing in, bargains. My way has brought me extremely satisfying returns that, alongside lots of youthful exuberance, made me, quite often, enter into fierce discussions with traders. I would try to convince traders that trading is too risky and they would try to convince me that holding stocks for a long period of time is even riskier.
Youthful exuberance behind me, I now approach the matter in a completely different way. I’m not as convinced as I used to be that value investing is the only way to go. Let me elaborate on this topic by first defining the two strategies and then looking into the most important determinants of either in order to see what works best for whom and what is the best strategy to use in the current market environment.
Investing means buying assets with the goal of enjoying ownership benefits like dividends, value appreciation, and capital protection over long periods of time. Investors are focused on the price they are paying for an asset and the expected long term return that asset is supposed to deliver. For example, investors in Wal-Mart Stores Inc. (NYSE: WMT) have done extremely well in the last 40 years.
Figure 1: Adjusting for stock splits the price of one WMT share in 1972 was $0.06. Source: Yahoo Finance.
$1,000 invested in WMT back in 1972 would now result in a yearly dividend of $33,000 and a portfolio value of $1.2 million. This is every investor’s dream, finding a stock that will grow for 40 years, with constant dividend increases.
On the other hand, a trader would argue that holding a stock for such a long period of time is extremely risky because various factors can impact the company and most of the capital appreciation usually happens in short periods of time. The bulk of the capital gain for a WMT investor happened from 1995 from 1999 when the stock price went from $10 to $56, and in the 1980s when the stock went from $0.23 to $5.5. In the remaining 33 years, WMT as a stock has underperformed the market.
Sears Holdings (NASDAQ: SHLD) is a perfect example of how owning something for the long term can be extremely detrimental to investment returns. SHLD’s stock price went from a high of $162 in 2006 to the current $13.04.
Figure 2: SHLD has been a terrible investment, but might be a great trade as it is almost 50% up in the last few months. Source: Yahoo Finance.
Trading on the other hand implies taking advantage of market moves like the sharp increases in SHLD’s stock price described above. Trading can take advantage of long term trends like a bull market, called position trading, or it can be done in minutes where currency pair trades, stocks, derivatives, or other financial instruments can be bought and sold several times during short intervals, even minutes. This is called scalp trading.
The debate is everlasting about which is the best strategy, but after years of market analysis and the analysis of its participants, I have come to the conclusion that the best strategy depends on the individual using it, and on the level of knowledge in both fields. Value investing might be better for me, but trading might be better for you and dividend reinvesting might be better for someone else.
The confirmation of the above comes from the fact that there are both traders and investors who have outperformed the market for extremely long periods of time. An example among many are investors Warren Buffet and trader George Soros.
Figure 3: Both Buffett and Soros outperformed the market. Source: Hedge Fund Blog.
All strategies can lead to extraordinary returns over time, but both the investor and trader need to have similar characteristics that allow for investment or trading success.
Important Psychological Characteristics Of A Trader & Investor
The funny thing is that the psychological traits of both traders and investors are almost the same. Both strategies require discipline and patience, discipline in order to stick to a strategy that is sustainable in the long term, and a patient, relaxed attitude that avoids impatient, urgency-driven trades or investments. An investor should invest only if their fundamental and business quality criteria are met, while a trader should engage in a trade only if all his risk reward criteria are met.
Chasing investments or trades just to do something is usually the recipe for bad losses. It’s extremely important that both investors and traders stick to their well-defined, historically tested investing or trading strategy.
The Most Important Factor: Knowledge
“The more you know, the more you see how much you don’t know.”
Whether you’re an investor or trader, the level of knowledge in the field you operate in, alongside the above described psychological traits, is what will determine your investment success.
Most documentaries and comments describe Buffett as the odd investor that spends all of his time analyzing financial statements while others describe Soros as a philosopher and student of human behavior. I think the main reason why Soros’s book Alchemy of Finance isn’t as famous as Graham and Dodd’s The Intelligent Investor is its complexity, however, it is an essential read for every aspiring trader.
Therefore, whether you want to be a successful investor or trader or you just want to increase your investment returns by a few percentage points per year, knowledge is the key.
Trading & Investing In This Market
A trader has to follow trends and put himself in a position that he doesn’t lose when the trends shifts. Last week’s market drop might be the first negative week of a long bear market or just a blip in the everlasting bull market. Knowledge on how to position yourself with minimal risk and maximal return is essential. Even more important is to know when to stay out of the market if the rewards don’t significantly outweigh the risks.
An investor has to be persistent in their search for value at low risk. Thankfully, even at these extreme valuations, market sentiment and a mindless approach to sector or country investing creates amazing buying opportunities. Just think of the commodity slump in January 2016 or the current cheapness of emerging markets.
Investing and trading are simple. If you know more than 95% of the population, there is no way you will underperform if you have the correct psychological approach to the matter.
Keep reading Investiv Daily for insights on how to beat the markets, both from an investing and trading approach.