Even the most conservative investor has to own up to some grudging admiration for the successful stock trader. That’s because conservative investors recognize the difficulties that traders face. Before you take up trading, consider the difficulties.
Sometimes we talk with investors who engage in stock trading as a pastime. One such investor, Mr. S, recently told us that he has bought and sold shares of marijuana stocks several times in recent years, and has made a profit each time.
Mr. S is satisfied that he’s doing well and he doesn’t see how he could lose much, even if his luck turned against him. After all, he doesn’t think his marijuana stocks will collapse on him. And even if they did, his trading account never represents any more than 10 per cent of his portfolio. He sees his stock trading as a profitable sideline that is separate from his investing.
Trading and gambling
Stock trading has something in common with gambling. When they’re just starting out, many people believe these activities can’t do them any real harm. But they have their costs.
Many gamblers, for instance, find they need to bet ever-larger sums to get the same jolt. Yet the higher the stakes, the more they’re apt to lose when luck runs out.
Gambling may be worthwhile for some people, provided they keep the financial drawbacks in check. The same may be said for stock trading. If you can afford the losses you risk and control the urge to raise the stakes, it may be worth it. There are subtle risks to trading, however, and you should consider them before you get involved.
When trades go sour
It’s particularly dangerous to view your stock trading as separate from your investments. We’ve spoken to investors who have told us that their short-term trading is coming along splendidly, and their only wish is that their long-term investing could do as well. Often, these investors hold portfolios of 40 or more stocks. When they go back and analyze their actions, they come to realize that an uncomfortable number of their worst losers started out as short-term trades that turned sour—that went down instead of up.
Traders seek high volatility, and this often leads them to stress resource stocks or manufacturing stocks. It also leads them to buy low-quality shares of unproven companies—even penny mines or unprofitable marijuana stocks. This, after all, is where you find the action.
Conventional trading wisdom advises you to sell your losers and hang on to your winners. Yet many traders decide to go against this wisdom after experiencing a whipsaw or two. (A whipsaw occurs when one of your short-term trades falls in price soon after you buy it, so you sell. Then it immediately begins to rise again. So you buy once again, and it starts to fall once more.)
If at first you don’t succeed, change the objective
When a trade goes down instead of up, these traders may decide to keep the investment and simply change the investment objective. They let their short-term trades turn into long-term holds. At best, this skews your portfolio toward excessive holdings of resource and other volatile stocks. But if you delve into lower-quality issues and let your failed short-term trades turn into long-term holds, you can bet that a few of them will continue this costly metamorphosis. Eventually some will emerge as total write-offs.
Note too that stock-market profit comes in unpredictable spurts. Traders often take profits every time a stock rises a bit and then try to buy it back when it dips. But if it’s a high-quality stock, eventually it’s apt to rise and keep going. When that happens, these traders won’t be in it.
Your best bet as an investor is to buy a balanced, diversified portfolio of high-quality investments. This approach makes time work in your favour. The longer you hold such a portfolio, the likelier it is to rise. Holding for the long-term also reduces the impact of commissions. If you pay each time you buy and sell, and you go in and out of the same stock several times a year, your transaction costs start to add up. But if you hold for several years, your transaction costs are negligible. For most investors, short-term trading is at best a hard way to make a profit, and at worst an extremely expensive hobby.
This is an edited version of an article that was originally published for subscribers in the May 3, 2019, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.
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The Investment Reporter •7/3/19 •