What’s the Difference
In short, traders take advantage of price movements in the market, they enter and exit their positions over shorter time periods taking profits along the way.
An investor is someone who seeks larger returns over longer periods of time by following the buy and hold strategy.
How can I make money from this?
The markets are both ludicrous and lucrative. When you are playing in a game of sentiment and psychology then you can take advantage of extreme exuberance and maximum fear.
An obvious mistake I see many traders making is not cutting losses soon enough. They become attached to their trades because they think they are correct.
They experience two main biases here:
Confirmation Bias - Listening to information that only supports their views or their existing beliefs, disregarding any new information that is contradictory to what they believe.
Hindsight Bias - Believing that random events were actually predictable, for example, believing they could have predicated which stocks would become profitable.
Look below, and you’ll see what I mean:
Why cutting losses is important?
A 10% loss needs a 11% return just to break even
A 50% loss needs 100% return just to break even.
For example:
If you invest R100 and it drops 50% - you don’t need a 50% return to break even, you now need 100%.
50% of R50 is only R25 (R50+R25 = R75) - you are still R25 down.
This is why Buying and forgetting is no longer a strategy because the markets are no longer rational. When everyone thinks that “stocks only go up” and “that it’s too easy to make money” - then you should be hearing alarm bells.
I’m here to remind you that valuation is the most important part of the business- not the stock price. There is a huge difference between price and value.
Price is what you pay, and value is what you get
Even quality companies are risky at the moment because they are overvalued. So, yes, even if you buy a quality company you may experience significant drawdowns, but that doesn’t mean sell.
This is why I love to trade - to protect my gains in this psychotic market.
Buying and Holding
Don’t get me wrong, I’m not saying buying and holding is the wrong approach, but it needs to come with conviction. Imagine seeing your portfolio drop by 70%.
Would you have the conviction to buy more?
Would you panic sell?
Would you still trust the company?
Before you buy any stock, you need to research it thoroughly so you know what you are buying. You need to understand the business, identify competitors, learn about the industry, and be aware of the success rate of management. And then after all that, you still need the conviction to back it long term.
If you are confident and the share price still falls between 30-80%, It wont matter to you. Think of it as a discount on your grocery bill - would you not go shopping?
This is why you need to understand what you have invested in because it’s an opportunity to buy it on discount. However, if you just bought to buy without taking the time to understand the business, then you wont know what to do and will most likely panic sell and lose money in the process.
Look at the benefits of staying invested:
Time in the market > timing the market.
Taking advantage of time is the best approach, but it requires doing your due diligence.
R10 invested @10% over 15 years would grow to R417 in that time. That’s a (317% return)
Now, I want to point out that it took 15 years to earn this 317%, and if you go back to my example of losses and gains, if your portfolio dropped by 80% you would then need a 400% return. This is why it is so important to manage risk, because an 80% loss on a share could take 15-20 years just to recover.
Are you prepared to hold a stock for that long just to break even?
Don’t be sacred to cut losses if the economy or the fundamentals of the company changes. This is what is required to protect gains.
I’ll leave you with two principles I follow when it comes to trading:
Add to winners.
Cut losses early.
Watch my latest trade idea below - I talk about JSE trading ranges, and how there is money to be made.
Stay safe, everyone
See you next week :)