The question I never tire of asking my clients is: “What do you really want to be—a trader or an investor?” For them, and the rest of you, here is my advice this fortnight: find out, and then take appropriate action. It’ll help you sleep better, especially during volatile times like this.
To be sure, you can make money both ways. You can lose it both ways as well. No matter what the Buffetologists or Livermorians tell you, the jury is still out on whether trading or investing is the style that fetches you better and more consistent returns over the long term.
Times change, companies change, people change and so do stocks. It’s possible that what I buy with a trading perspective becomes an investment bet, once I sharpen my focus on its long-term merits and deep-bargain value (should they appeal to my analytical senses).
And, of course, the solid, long-term pick that I accumulate sometimes turns out to be a charmer that offers limited holding value beyond the first 10-20% upswing.
It’s at times like this that I am caught in the trader-investor dilemma. So here’s my seemingly ridiculous proposition: it’s possible (in fact, downright desirable) to be both. Different stocks call for different strategies. Or the same stock requires a different strategy at different times (e.g. in a strongly trending market against a range bound market). So it’s very important for me to know whether I am a trader or an investor in each one of my stocks.
Let’s look at where the differences lie. A trader buys into the price of a stock. He thinks the zillions of buyers and sellers out there (aka the market) will soon enough drive the price up. An investor, on the other hand, buys into a story.
This could be a story about business growth, margin expansion, diversification, capacity addition, corporate actions such as a merger, even country re-rating or some such fundamental trigger that holds the promise of changing the terrain for the business and the way it’s valued.
The trader wishes to make a profit on his trade just as the investor does on his investment. The fun begins when reality takes over. (Although traders and investors do take up short positions, we’ll assume for simplicity that both have gone long on a stock.)
Now both have the same motive (profit), but a significant uptick in the price will evoke a radically different reaction from the trader as compared to the investor. The typical trader may come closer to booking profits as the price rises, while the investor will see the rise as the market’s way of affirming his faith in the stock.
This affirmation will push him to buy more, rather than exit. Of course traders do buy on the way up as well, but that’s when they have a really high price target, which is relatively rare.
The divergence in their behaviour is even more dramatic when the price falls. While the investor will respond to the marked-to-market loss with a measured reconsideration of his original argument to buy, the trader will rev up his radar to actively consider a stop loss, or will get aggressive and average out his position depending on what his charts tell him.
Both of them tend to spread their risks via some diversification, knowing fully well that they cannot hope to be right in every single pick they make. But the basic difference is that an investor will typically buy to hold for a longer duration and will aspire to achieve a larger per cent gain on every item than the trader, who wants to buy, exit and redeploy the ammunition into the next trading opportunity.
So far it sounds like traders are shallow and reckless punters while investors are the studious, committed blokes who will do better in the long run. I’m afraid it doesn’t always work out that way. For all my long-term orientation on stocks, I must confess that traders tend to swim out of losing trades at lower losses than investors.
They also routinely tune in to mega trends pretty early compared to us investor types, who ignore the serious buying that imperceptibly “swings” the charts and catches traders’ fancy. Investors often get married to their ideas. The inevitable lemon gets into their portfolios, often making investors live in denial. Or they might hold on to good ideas for too long. The idea is not just to buy shares of great companies, but of great companies for a great bargain. And to hold on to those shares only as long as they are bargains i.e. till they are sufficiently cheap compared to their intrinsic value.
As an investor, I want to buy a brick in a business, not just a share whose price will go up. This lets me own a real business, run by real managers. It’s an organic entity that grows and prospers, fails and flounders, wins and loses customers, engages employees and delivers goods and services at a competitive price point in a way that maximises value for me in the long run.
Tut tut, says the trader in me. In the long run, we are all dead. Trade your stocks, don’t marry them. Stocks are things you trade, it’s the wives you are stuck with. Now, what do you want to be, an investor or a trader?
Dipen Sheth is Head of Research, Wealth Management Advisory Services
