June 22nd, 2008

Investor or Trader? What are You?

I attended a wedding this weekend and, during the dinner afterwards, I was telling a friend about this blog and my upcoming book, “Running with the Herd” when he unexpectedly hit me with, “Are you an Investor or a trader?” He quickly followed up with a question that sounded like skepticism in his voice “How long do you own stocks, a year or less than a year?”

With what sounded now like derision, he quickly said that he “usually holds stocks for three years or more”, clearly implying that anyone who didn’t do the same was somehow a gambler and not truly worthy of any sort of objective consideration.

So what are the differences between investors and traders?

  • “Investors” put their money into stocks, real estate, etc., under the assumption that over time, the underlying investment will increase in value, and the investment will be profitable. Investing is normally a passive activity after the initial purchase of the stock or fund. Typically, investors anticipate declining markets with fear and anxiety, usually not planning ahead as to how they will respond. Instead, they hold onto the investment in declining (bear) markets and absorb the loses in the hope the investments will bounce back sometime in the future and they will again be winners.
  • “Traders” take a proactive approach to their investing and invest with one goal, to put their capital into the market to make “profits.” They “trade” with a plan that tells them what to do in any situation. When to enter and when to exit. They never allow large losses. Trader don’t necessarily move in and out of the markets frequently; this is a common misconception. Traders simply have plans for when they will enter and exit investments and/or the market. They know what to do if their trade goes against them, and they know what to do when their trade is profitable.

In short, 1) “investors” have no exit plans from either a stock or the market while “traders” do and 2) “investors” take a passive approach while “traders” are active investors.

So how will “investors” and “traders” actually have fared as the S&P 500 Index declines 10.4% since the beginning of the year and 15.8% since October 9. If I’m a “trader”, then I know what my strategy has been and will continue to be. Friday’s abysmal performance (down 1.85% with significantly higher volume due to quadruple-witching), only confirms my Market Timing Indicator and clearly continues to signal that the market should be avoided.

The strategy still includes taking only small opportunistic (trading) positions, closing out questionable or losing ones, taking some hedging positions (gold, silver, etf’s that short, puts or any combination) and maintaining significant cash positions. For frequent readers, the chart below is familiar and clearly indicates that there’s no prospect for any sustained upside movement for the market in the foreseeable future. I’ve been comparing this year’s market to the 1973-74 bear market crash since March 1 and seeing eerie similarities:

The next test will be at the lower boundary of the horizontal trading range made earlier this year or 1380, a further decline of 3.8%.

“Investors” remain clearly nervous and take dubious comfort in the thought that they’re “in it for the long-haul”, “own good companies”, or “own stocks paying good yields”. But how long might it take for them to recoup, through a combination of dividends and capital appreciation, the 15% or greater losses if the market goes to that support level? What if the support doesn’t hold and the market continues it’s decline into bear market territory?

Quite a while but if they had acted like “traders”, they would be able to sleep at night knowing they were protected by being in cash. They also would be in an excellent position to take advantage of the distressed prices offered whenever in the future that the market does finally make a bottom and begin to form a base. I’m confident that my Market Timing Indicator will signal a return to the market only when the opportunities significantly outweigh the market risks.

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