There are two main schools in stock markets, in terms of one’s attitude to one’s portfolio. There are those who think of themselves as owners in a business and take a long-term approach. They are concerned with the performance of the actual business rather than of its stock on the market. They refer to themselves as investors and tend to believe that short-term stock market movements are manic-depressive, unpredictable affairs that the intelligent investor should ignore. Benjamin Graham, Warren Buffett, and Marathon Asset Management take such a view. Then there are those who believe that it is easier to predict events the closer they are to you. For instance, you can predict with a great deal of certainty what you will be doing in 5 seconds time, but knowing what you will be doing 5 years from now is another matter. They take a short-term view and try to exploit price movements within short time horizons. For them, the stock market is everything. They are constantly trying to figure out what other people will be willing to trade a stock for and whether they have an edge. They are less concerned with the underlying business, indeed, they’ll buy a loss-making company that’s doing well on the market, or which a technical analysis of a chart says will do well, over a profitable one that is doing badly on the market. They also tend to be more active in the market than investors. George Soros, Jim Simon of Renaissance Technologies, and William O’Neil of Investor’s Business Daily, are examples of traders. In this article, we will discuss whether or not you should choose investing or trading.
There’s an apocryphal story that when a manager at Fidelity wanted to find out who the brokerage firm’s best investors were, he found that the best investors were all dead. The moral of that story is that people are often too active in the markets, selling their winners and doubling down on their losers, incurring subtle costs, missing out on rallies and performing all sorts of other inefficient activities. The vast majority of people would be better off as investors and not traders. Yet, the person with the best record of all time, Jim Simons, is a trader. The point is not that it is impossible to make money as a trader, rather, it is extremely hard to do so in the long run.
One of the key differences between the two approaches is how much “activity” each engages in. Traders tend to be “active” investors, with some making hundreds or thousands of trades a day. Investors tend to be passive. Warren Buffett refers to investing with a degree of “lethargy bordering on sloth”. An investor may make only a few investments in any given year. An investor may go years without a single investment. Charlie Munger has just five stocks in his personal portfolio, and many of those stocks have been there for years. Many people don’t realize it, but the index that everyone tries to beat, the S&P 500, is actually a passive investing strategy with its own rules. Few investors ever beat the S&P 500 over the long run. Index funds, ETFs and mutual funds are great examples of passive investment strategies. Investors can be value or growth or growth-at-a-reasonable price (GARP) investors like Peter Lynch.
Active traders trade in and out of the markets, trying to take advantage of changes in the markets. Though it is possible to make money with this approach, the greatest example of this, Renaissance Technologies, used advanced mathematics and computing that few companies can rival. To make money in the markets, you don’t have to be a genius, you need to avoid doing dumb things.
An investor would take the Rare Metal Blog’s conviction that gold is headed for long-term growth, and buy-and-hold, a trader would trade in and out of it using momentum, trend-following, news trading or some other trading strategy.