Trading vs investing
I have been pondering since yesterday the excellent question from Ron. (It can be found in the comments area of the post immediately beneath this post.)
~~~~~~~~~~~~~~~~~~~~~~~~~~
Hi, Ron,
Thank you for an excellent question. I will provide an answer, which of course is not necessarily the answer. If it proves insufficiently helpful, please ask again...
I believe most traders fail because their objectives lack coherence. Yes, the objective is to select winning stocks, at least in part, but it is not to divine somehow their ultimate high (contra for short sellers) and then sell. The true objective is to make money.
As mentioned in the original post, my trading efforts supplant a zero level of income from no gainful employment. As each calendar year ends, I determine the level of income I require for the coming year to live life (pay bills, travel, etc). Then I [attempt to] envision how the coming year will unfold in the markets. If, for example, I foresee a market that trades flat to down, then I determine the amount of money I am willing to risk in that type of environment. Once I have these two figures -- desired income, risk capital -- I determine the needed rate of return to achieve the objective. For example, let's assume I stipulate hypothetically that I require $50,000/year to live, and let's further stipulate I am willing to risk $50,000. These figures dictate the result of my trading activity generate a ROI (or even ROE) of 100%. Knowing all this, I then recapitalize my trading account for the new year...
Each new trading opportunity must provide a certain level of possibility within the guidelines I set (and broken down into its constituent parts); in the goal above (100%/year) this can be perceived either as 8.5% or $4,167/month. If I share-weight my portfolio into position sizes of 1,000 share lots, I seek only those opportunities whose setups argue for $4 or more of upside points within 1 month. A purchased position then is sold upon achieving its objective. This dynamic equals purchasing 1,000 shares at $20 (or whatever), and then selling at $24+; this does not equal purchasing 1,000 shares at $20, watching it trade up to $24 or $25, and then trying to divine where it finally will stop rising. That effort is inefficacious, I believe. It allows the market to yank your chain rather than vice-versa, and to cause problems (financial losses, emotional anguish, etc), as it creates a grey area most traders are not suited to navigate. At least successfully.
Please recall that my sole mission when trading is to make money -- to displace non-existent income from a non-existent job -- not (to) be correct. (I leave that folly to others.) So I care little what the stock has done before I purchase it (excepting, of course, that it must build a specific setup) or what it does after I sell it. It is this area where most traders get into trouble. IOW, goals and objectives are internally generated; they are not a result of external factors. It is not how high is high, but what satisfies you. (Your decision to seek long term value opportunities is such a decision.)
Because I am human, I am as prone to this failing as the next person. Knowing this about myself, I do not add more impediments to my trading success but instead remove as many as possible. For example, I trade only those stocks for which I have zero long term interest; I find this helps to ease the burden of fretting about the continued success of a stock after I sold it. Who cares?
Indeed, who cares long term about Men's Wearhouse/MW and Telewest/TLWT? Certainly not me. When I first noted months ago the bourgeoning pattern in MW, I asked myself, "Why -- what is so special about MW?" I checked out several stores, and saw little of long term interest to me. (The same truth applies for TLWT.) Really, who can explain the whims and ephemeral infatuations of Wall Street? There comes the moment when the trader shrugs his or her shoulders, and buys. For the trader, the item of sole importance is the profit: buy here and sell there (and stop out there). Note that the professional trader has made these calculations in advance of purchasing the position; he or she does not scurry after the latest recommendation on CNBC, a breakout of a previously non-monitored position, etc. So these two specific trades are ideal for me: the stocks will arrive at a higher price, and then I will sell.
I realize this seems to defy a maxim I just shared -- knowing in advance your objective -- but as the trader graduates through the varying levels of proficiency (tyro to professional) he or she learns the rules. And the professional knows when to ignore them. Just as I do now (real time) with Google/GOOG. I see both through and past the fundamentals (the seemingly stretched valuation) and the technicals (the seemingly funky pattern --"broadening wedge"), etc. I have learned the rules during my decades in the markets, and thus (I) know when to ignore them. Google/GOOG right here, right now is such a 'violation'. Rather than to belabor again Google/GOOG, let's examine instead another opportunity, American Healthways/AMHC...
BI Research (thanks, Allan!) has this to say re the company...
"American Healthways, arguably the leader in the field of disease management, climbed more than $6 since our last Update in a weak market until it banged its head on the $40 level and recoiled a bit to $38.47. There are no company developments that I am aware of and the stock is not rising due to increasing full year FY8/05 estimates as these have remained unchanged for the past 3 months at a consensus of $1.01. By the way, this compares to $.76 last year, so represents 33% growth. The PE on those earnings is 39. It is worth noting that the $1.32 expected for FY8/06 (which has not changed either) equates to a PE of 29 times earnings 16 months out. Perhaps the rise is simply due to new investors flocking to the story of Disease Management and American Healthways, the leader in this field (as evidenced in part by it being the only company to win TWO of the Medicare test projects). However on that front, the Company speculates that some part of the rise may have been the result of new Medicare Advantage rates which recently came out and were attractive in hopes that more HMO plans would have incentive to take on Medicare beneficiaries… and then AMHC could help those plans with disease management. I also wonder if American Healthways, a pure play in Disease Management, benefited from the upbeat nature of Matria’s 4/20 conference call. The Company also continues to win its share of new contracts and contract extensions/expansions. AMHC has the wind at its back and I think if any stock deserves an above PE, American Healthways, which has a PE of 40 on FY8/05 EPS, is worthy. Continue to Hold."
Isolating one specific comment ("There are no company developments that I am aware of and the stock is not rising due to increasing full year FY8/05 estimates as these have remained unchanged for the past 3 months..."), I propound two items:
1) The difference between a company and its stock; and that
2) Different constituencies have primacy at different times.
[click to enlarge]
~~~~~~~~~~~~~~~~~~~~~~~~~~
Hi, Ron,
Thank you for an excellent question. I will provide an answer, which of course is not necessarily the answer. If it proves insufficiently helpful, please ask again...
I believe most traders fail because their objectives lack coherence. Yes, the objective is to select winning stocks, at least in part, but it is not to divine somehow their ultimate high (contra for short sellers) and then sell. The true objective is to make money.
As mentioned in the original post, my trading efforts supplant a zero level of income from no gainful employment. As each calendar year ends, I determine the level of income I require for the coming year to live life (pay bills, travel, etc). Then I [attempt to] envision how the coming year will unfold in the markets. If, for example, I foresee a market that trades flat to down, then I determine the amount of money I am willing to risk in that type of environment. Once I have these two figures -- desired income, risk capital -- I determine the needed rate of return to achieve the objective. For example, let's assume I stipulate hypothetically that I require $50,000/year to live, and let's further stipulate I am willing to risk $50,000. These figures dictate the result of my trading activity generate a ROI (or even ROE) of 100%. Knowing all this, I then recapitalize my trading account for the new year...
Each new trading opportunity must provide a certain level of possibility within the guidelines I set (and broken down into its constituent parts); in the goal above (100%/year) this can be perceived either as 8.5% or $4,167/month. If I share-weight my portfolio into position sizes of 1,000 share lots, I seek only those opportunities whose setups argue for $4 or more of upside points within 1 month. A purchased position then is sold upon achieving its objective. This dynamic equals purchasing 1,000 shares at $20 (or whatever), and then selling at $24+; this does not equal purchasing 1,000 shares at $20, watching it trade up to $24 or $25, and then trying to divine where it finally will stop rising. That effort is inefficacious, I believe. It allows the market to yank your chain rather than vice-versa, and to cause problems (financial losses, emotional anguish, etc), as it creates a grey area most traders are not suited to navigate. At least successfully.
Please recall that my sole mission when trading is to make money -- to displace non-existent income from a non-existent job -- not (to) be correct. (I leave that folly to others.) So I care little what the stock has done before I purchase it (excepting, of course, that it must build a specific setup) or what it does after I sell it. It is this area where most traders get into trouble. IOW, goals and objectives are internally generated; they are not a result of external factors. It is not how high is high, but what satisfies you. (Your decision to seek long term value opportunities is such a decision.)
Because I am human, I am as prone to this failing as the next person. Knowing this about myself, I do not add more impediments to my trading success but instead remove as many as possible. For example, I trade only those stocks for which I have zero long term interest; I find this helps to ease the burden of fretting about the continued success of a stock after I sold it. Who cares?
Indeed, who cares long term about Men's Wearhouse/MW and Telewest/TLWT? Certainly not me. When I first noted months ago the bourgeoning pattern in MW, I asked myself, "Why -- what is so special about MW?" I checked out several stores, and saw little of long term interest to me. (The same truth applies for TLWT.) Really, who can explain the whims and ephemeral infatuations of Wall Street? There comes the moment when the trader shrugs his or her shoulders, and buys. For the trader, the item of sole importance is the profit: buy here and sell there (and stop out there). Note that the professional trader has made these calculations in advance of purchasing the position; he or she does not scurry after the latest recommendation on CNBC, a breakout of a previously non-monitored position, etc. So these two specific trades are ideal for me: the stocks will arrive at a higher price, and then I will sell.
I realize this seems to defy a maxim I just shared -- knowing in advance your objective -- but as the trader graduates through the varying levels of proficiency (tyro to professional) he or she learns the rules. And the professional knows when to ignore them. Just as I do now (real time) with Google/GOOG. I see both through and past the fundamentals (the seemingly stretched valuation) and the technicals (the seemingly funky pattern --"broadening wedge"), etc. I have learned the rules during my decades in the markets, and thus (I) know when to ignore them. Google/GOOG right here, right now is such a 'violation'. Rather than to belabor again Google/GOOG, let's examine instead another opportunity, American Healthways/AMHC...
BI Research (thanks, Allan!) has this to say re the company...
"American Healthways, arguably the leader in the field of disease management, climbed more than $6 since our last Update in a weak market until it banged its head on the $40 level and recoiled a bit to $38.47. There are no company developments that I am aware of and the stock is not rising due to increasing full year FY8/05 estimates as these have remained unchanged for the past 3 months at a consensus of $1.01. By the way, this compares to $.76 last year, so represents 33% growth. The PE on those earnings is 39. It is worth noting that the $1.32 expected for FY8/06 (which has not changed either) equates to a PE of 29 times earnings 16 months out. Perhaps the rise is simply due to new investors flocking to the story of Disease Management and American Healthways, the leader in this field (as evidenced in part by it being the only company to win TWO of the Medicare test projects). However on that front, the Company speculates that some part of the rise may have been the result of new Medicare Advantage rates which recently came out and were attractive in hopes that more HMO plans would have incentive to take on Medicare beneficiaries… and then AMHC could help those plans with disease management. I also wonder if American Healthways, a pure play in Disease Management, benefited from the upbeat nature of Matria’s 4/20 conference call. The Company also continues to win its share of new contracts and contract extensions/expansions. AMHC has the wind at its back and I think if any stock deserves an above PE, American Healthways, which has a PE of 40 on FY8/05 EPS, is worthy. Continue to Hold."
Isolating one specific comment ("There are no company developments that I am aware of and the stock is not rising due to increasing full year FY8/05 estimates as these have remained unchanged for the past 3 months..."), I propound two items:
1) The difference between a company and its stock; and that
2) Different constituencies have primacy at different times.
[click to enlarge]
This moment could be that transitioning of constituencies: from investors - who purchase based on fundamentals including earnings momentum, and which offers one type of collar on valuation and thus price - to traders - who purchase in the hope of continuing price momentum (and which offers its own set of collars on price action, thus opening the door to extreme valuation). Thus, the price move for AMHC from $5 to $40 over the past 4 years could be equalled or bettered in less time while traders become the constituency with primacy. Investors seek (and care about) value, traders seek (and care about) price momentum. Savvy investors do not sell until well after the momentum traders come aboard knowing the price gains theretofore will prove as nothing to what is about to occur. (Shrewd investors, however, will - and can - create the environment that brings forth the momentum traders.)
When considering possible opportunities, I study the charts from the greatest periodicity to the smallest unit of intra-day; while holding positions, the reverse is true. I do this seeking the slightest clue of a reversal. Each long term investment begins, in general, as an intermediate term speculation, which, more often than not, begins its life in my portfolio as a short term trade. The sole exception ever to this rubicon is Google/GOOG, but then Google/GOOG is a singular opportunity.
The investor or trader (the denotation for me is a difference of time) knows why he or she buys and sells. Amiguous comments such as "Buy XYZ, it's going up!" are not merely unhelpful but misleading as well to the investor. The immediately-stated rejoinder should be, "Okay, so XYZ is going higher. But what is the objective stated in price, and what is the stop stated as a price or pattern...?" This type of analysis will usher in material changes in your portfolio's ROI.
Vision without action is a day dream,
Action without vision is a nightmare.
I hope this lengthy post cum reply provides a better answer to your questions. And thank you for your kind compliment re this site. If so inclined, please refer as many people as possible; the more here the merrier for all!
posted by David M Gordon | 5:22 AM
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