Is Investing in Stocks Better than Trading Stocks?

Investing and trading are not really two sides of a coin as many people think. They are not opposite things. The only difference in my view is the risk a trader takes for a given trade that determines whether they are investing or trading in stocks. Many people easily fall into the belief that investing is better than trading. Let me shatter this myth in this article and show why the contrary is actually true.

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Investing is a One Time Shot

Investing appears to an outsider to be similar to gambling. But to the investor it is not really so. Though it shares a lot of similarities with gambling and many so-called investors practically gamble with the markets, there is an aspect that makes these people slightly different from gamblers.

Investing is like a one time bet or one time shot. You will make it or break all in your only one attempt. For this reason investors study the markets and stocks and their background companies, economy in general before making their bets. Though this is time consuming task and also full of domain knowledge, this is what makes the investor’s bets better than gambling. Any trade done without a plan or reason is just gambling and returns from that can be attributed to plain luck.

Investing and Trading Both Help Each Other and the Economy

Investing money does not necessarily go into stocks. It can go directly into the business of the companies if not stocks. Even the stock market investments start for a company by investing directly for the growth of the company though initial public offers. Hence investing is more closer to contributing to the economic or industrial activity. It has a direct impact on the companies.

Trading is indirect. It is not a waste thing as many people think, who like to be called as investors. Without traders there cannot be a market as we see everyday. Traders make the bloodline for the market and keep it flowing everyday for the functioning of the markets.

If traders are not there then it will be a hard time for investors. The long term investors from large institutions need enough volume on any day to make a position into stock. Traders help build the momentum or volume for the day so that these investors can buy the stock easily without putting orders lower and lower with every transaction. It is basically the liquidity that traders contribute everyday to the markets.

Liquidity is important for not just stock markets but any business. Even if the economy is not good, enough liquidity can temporarily create rallies and sustain a short term bull market as we see today. Liquidity implies that it will be easy to get in and out of stocks with ease and without moving the price of the stock very much. Highly liquid stocks can be bought in thousands or even millions on single day. This is all due to the presence of traders who generally concentrate popular companies’ stocks.

That is how investors and traders work to create a stock market as we see today. No matter how old or new the technology is there were always traders and investors in the history of stock exchanges. Both contribute not just to create a market but in fact to help the turn-arounds or major growth phases of listed companies in the country.

I saw many people who think that stock market is like a casino and traders and investors are like gamblers without really contributing anything to the society. That is not true. In fact it is a part of our modern culture. It plays a great role in helping the economy and works like a virtual money lender which has more flexibility than banks or finance corporations.

Most of the people who start trading stocks, slowly start their bias towards investors. They think that investing is better than trading because they do not realize that trading is also like any other discipline. It is not just trading even investing does require same kind of study and effort on the part of the market participant as does their other businesses.

Investing is Not Low Risk Option But Trading is!

People tend to move towards investing because they think of the timeframes involved without bothering about how risk changes in the overall equation. There is a general feeling that investing involves low risk where it is exact opposite. Also people flock to investing because it gives them lot of free time to concentrate on their daily business. This is because they do their job only to certain extent as much as their current knowledge tells and get convinced there itself.

In fact investing is far more riskier than trading. It is because you do not have stop loss protections. I saw many traders who call their trades as investments when the trade turns into a loss. Instead of taking the loss they change their mind and plans, to let the stock do whatever it wants. They give more time for it thinking it will recover in a “long period of time”. Hence they name it as long term investment.

It is amazing how people shift their thoughts so easily when it comes to trading stocks. They also shift their identities as a trader to investor without much trouble. But the fact is that all big losses first start with initial small loss. A trader cuts them short and books them. An investor lets it become bigger and bigger until finally selling the stock when it just starts a turn around. How many times can you remember doing this in your own experience? I think many times unless you are learning your lessons.

Such is the risk involved with investing. You may now point out that same will hold true when it comes to making profits. By holding the investment long enough the investor stands to gain bigger. Let me tell that the reality is quite different. The stock can behave like that but not the investor. There are several reasons for this.

First of all many investors book profits soon because they can’t have an idea when to close the trade. That too they do it more often during uptrends much like they let the losses increase during downtrends. If an investor is sitting tight to hold the stock during uptrend it is much like the quality of a trader who does the same thing but with more certainty. Because the trader lets the market gives its signal while the investor looks for things that indirectly affect the market. These indirect things many times go out of phase and make the investor lose sight of the best price to get out of the position.

Investing is Not Necessarily Long Term

But there is another little catch here. Apart from the uncertainty of exiting that investors face, they also face the problem in time dimension. People think that investing is good because it is about long term. In fact the long time means either long term gambling or long term trading.

The stocks in reality make their biggest moves in only a short period of time. You can check all of stock markets histories. You will find that stocks spend a lot of time moving here and there. But only a part of the time they spend moving straight in one direction. It is only long term traders that get to catch this portion and make the best killing if not the maximum possible made by those bought at the bottom. Generally those who buy at the bottom fail to call the top at the right time.

The Reality of Long or Short Term When a Stock Moves…

The stocks move in a short period of time with all intermediate trends concentrated in that same time frame. Investors think that by capturing a stock for all its life time will increase the chances of grabbing its golden period of rising. That is actually gambling in the time dimension. Because you may be studying the stock and its company but leaving the timing for luck. Even the most successful investor Warren Buffet made the right timing for his entries and exits. All the principles will go into the ash if timing is not taken care.

Trading is Superset of Investing!

Don’t judge investing and trading based on false beliefs shaped by your trades that went bad. Learn lessons from them. Just take a step ahead and look at the reality. Trading offers more flexibilities than investing. Trading does not only have to be about day trading. It is like a superset of investing when it comes to the time and effort involved!!

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Never Make or Take a Loss: You Should not get Trapped with This Belief

When I took the first loss from the stock market one of my friend with whom I discuss stock trading, had given me this principle. The loss though first, was the biggest loss at that time. He told me that the first rule of Warren Buffet’s investing is to never to take a loss and the second rule is never to forget the first rule. It sounded good at that time until I realized how much blood it will take if I were to stick to this.

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I was initially depressed about the loss because I had taken it out of a logical decision and not a practical decision. The logic does not work well all the time in stock trading. I did not know that at that time and wanted to give it a try. The stock market recovered immediately and I too would have recovered half of the losses in that same week. The loss came as a sudden surprise from Monday to Tuesday.

At first having learned these two rules from a friend and that too to be of a veteran investor, I got trapped for this belief. I thought it sounds good. It seems too appropriate. If had followed the rule 1, I would not have made such a big loss. If I had forgotten the rule 1, the rule 2 would have reminded me. It was a combination of intelligence and principle. But little did I know at that time that it was a ridiculous rule!

What is All This About?

Let me give an insight into what happens when you get trapped with this belief. Those who cannot take or make a loss from their stock trades, have to end up holding the stock whenever it falls below their buy price.

We are not ideal to always make a right decision to buy the stock at its support point so that it always bounces back from there and we do not see a loss. We are also not ideal traders who could avoid their first loss by buying at the support price from the beginning. And even if you do all that, still the support price itself can change over time and it may move just below your buy price.

So that means we are bound to see our stock going below the buy price. When that happens, it is giving a warning that the trend is going to be bad, that we have the best opportunity to cut our losses at minimum. I have seen that the biggest losses always start with this smallest loss where there was opportunity to cut it off.

There are two things that can happen from there on. The stock will bounce back and go make new highs. In this case you will be very happy if you held the stock following this belief to never take a loss. Of course you should have some rule to take profits at the highest point. That is not the topic of this post, so I will not talk much on that.

On the other hand the stock will continue going down in price. Each time it bounces a little bit it is giving another opportunity to close it. By following this belief to never take a loss, you will get trapped in a stock that keeps going down and down and down to the bottom of the ocean.

Imagine how it would be if you had this experience at any time in the last year. In a bull market these things do not happen and so you would appreciate every silly theory about stock trading. It is only a bear market that shatters all myths and exposes the true hidden secrets for trading successfully. These are also the same secrets that help you make the most in a bull market while others just get you along with the bull ride.

When you get trapped there are a lot of bad consequences that can happen in your life other than financial loss. There was an incident in India in the last year that the husband of a stock trader had decided to divorce her after she made a loss of about 30 lakhs in stocks. He did not want to take that burden when she was making losses. But he would have liked the profits though.

There are also a lot of stock traders who have committed suicide due to margin trading failures in January last year. I would heartrending to read their stories. In fact there are many real estate builders who have sold off their properties for cheapest prices and some have committed suicide because they have incurred huge losses in the stock market. These people are the cause for the fall in reality prices at the same time as the stock market is falling in the last year.

There can be more bad things that can happen if you don’t pull the trigger to cut losses when they are small. Apart from this problem there are other things that you should know to become a successful stock trader and never get into these traps.

Making a Loss is Not Your Choice

Contrary to what many people think making a loss is not same as taking a loss. The stock market’s behavior and its individual stocks’ behavior are not at all in control of any individual trader. As such you can never control whether you are going to make a loss. You can only consider the odds of it before starting any venture.

The stock market behavior is just like a random behavior though there is a pattern in it. It is actually a stochastic behavior. Only people who can understand the statistical nature of this behavior can assess the odds of a situation.

The fact of the matter is that you can control how many losses you may make out of how many attempts by following strong trading principles. But you can never control what will be the fate of a given trade at any point of time.

This is the reason that you can never choose to make a loss. That can happen without your knowing or intention. Then how can you think of rule 1 and then rule 2? You will get irritated about this theory if you really understood what I told so far.

Taking a Lesson By Taking a Loss

I realized that I had done a good thing by taking a loss at my first losing bet. I had only made little profits before that losing trade. Though the loss was big I had taken this loss as I analytically thought that the losses could increase if I didn’t take that.

The losses didn’t increase at that time. But by following this rule to cut loss early on, I had not only saved myself from later even bigger disasters but also learned a lot of wonderful lessons about stock trading.

You should note that by taking a loss early when it is small you are respecting the warning that the market is giving you. It will definitely knock your door when there is a new opportunity. It really happens just like this in stock trading. I had no choice but to accept this as reality.

You will not just cut loss by taking a loss early before it can become big. You will also learn powerful lessons by watching how the stock behaves afterwards and studying all your interaction with the stock since the idea of entering it started in your mind. This is a valuable lesson that is practical and cannot be substituted with any money or training.

A Loss is the Price You are Paying for Your Learning…

Note that every such lesson must be learnt by paying a price. The small losses are indeed the best price you are paying for a lesson. If you don’t do that you are most likely to close a trade by taking loss when it almost hit the bottom. It happens for almost everyone in this business. There is really no point in hanging around with a stock when it lost 95% of its value. Anyone can understand that it is ridiculous to expect a 100% or more turnaround from the same stock. Then the price you paid is too costly.

I did such mistakes again and again but I was glad that I did not do this atleast half of the time. That helped me learn lessons, avoid big losses and what more it also helped me take profits on opportunities that I would have missed if I had hanged around with the same losing stock.

It is Never Late to Learn Stock Trading Principles

Atleast it is not very late to learn this lesson and avoid this belief. You should not worry about taking a loss or making a loss. What you should worry about is its consequences. Assess the varieties of consequences and cut losses early on. Even if the stock were to rebound, it does not matter. You can go immediately for another rising stock that is just delayed.

Note that in the stock market different stocks move at different times. There are some called as laggards that are lazy and some as leaders that are too enthusiastic to be in front of the whole market showing the trend of the market. This helps you get over the small loss you had cut early on.

The right lesson is to learn that it is not in your control to make a loss. But you can take a loss and avoid further losses. You will also not lose another immediate opportunity by doing this. Most importantly taking a loss whether early or late, big or small, means that you are taking a lesson that is practical and unique for your style of trading!

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Buy at the Bottom or Buy When Everyone is Selling: A General Misconception of a Stock Trader

One of the fundamental principles that Warren Buffet had taught and had been accepted by the investors across the world about stock markets, is to buy stocks at the bottom. He does not explicitly talk about the bottom. But he says that one should buy when everyone is selling. I found many people backing up their temptation to buy stocks using this theory. Though I agree with the principle, I find that many traders and investors alike have a misconception about this theory. I will give you a paradigm shift to understand why you may misunderstand this theory.

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Not on the Surface

Many investors and traders take Warren Buffet’s principles without a second thought. No matter who is sharing the stock trading principles it is highly important that you as a trader analyze from your own perspective and learn new perspectives if required. It may happen that certain principles can shift your basic paradigms that you might have had for many years.

There are some principles of Warren Buffet that cannot be applied when trading stocks. Mostly it is to do with the difference between his mindset and a trader’s mindset and fundamental beliefs. The personality traits, emotional behavior, cognitive abilities all differ from person to person. And thus always play a role in influencing a trader and an investor in different ways.

When you buy stocks for the first time you will not know whether it is bottom or top. You will not be able to tell whether it is at a high price or a low price. Because all these are only relative terms. There is a fundamental and unique aspect about stock price movements that makes it difficult to understand than any other phenomenon.

You can Not Tell Till You can Tell!

You can never tell when a stock has made a bottom until it conclusively proves by moving much further up away from a certain lowest price. There can be bottoms in intermediate time frames, short term trends, and long term trends involving 5 or more years of time period. For example, the present market (Sensex at 15K) has moved much farther away from its lowest value in the past few years of 8K. Of course all this happened in only five months of time. But nevertheless you could not tell that 8K for Sensex was the bottom conclusively till now.

This is where the stock market behavior differs from other disciplines. Stock trading involves the fundamental and fourth dimension of time. It is its time varying behavior that makes it so tough to decode its Da Vinci Code. You cannot tell so and so not only until it happens but also after enough time that the opposite happens.

When traders buy stocks as they fall they say that they are buying the stock at the bottom. They also refer the name of Warren Buffet to indicate the authenticity of their action. But they do not think once that there can be misconceptions as to any successful theory. If something is obvious in the stock market, then even before you can act there will be so many people already acting on that.

It is not something that is obvious but we need to read behind the lines. When it comes to buying a stock at its lowest price or when it had hit bottom, it is truly to buy a stock at its best possible price for a buyer. But it means the worst possible price for a seller. Then why in the hell a seller will sell the stock when so many buyers are so eager to buy it at the bottom?

Why is This Misunderstood?

The theory is not as simple as it sounds. Many traders and investors alike build misconceptions about it. The same reason holds for the seller that holds for the buyer as well. If buyer thinks it is bottom, then seller too can think so. But if seller thinks that it is not bottom then buyer too can think so. When they think opposite, that is when a transaction or a trade happens.

Now what makes two people or traders who are so similar in their professions, to differ in their thoughts, perceptions etc.? It is the need to take action and not the luxury or proactive nature. A desperate seller or a buyer makes a move for the market but not those traders who think that it is an opportunity. When those traders do act, that does not affect the market much unless the desperate actors have done with their task.

A popular reason why this is misunderstood by many involves the fact that every trader shares similar goals and thus similar thoughts. This results in the theory going into a paradox. Let us take a closer look at this principle.

“Buy when everyone is selling”

I will ask you a serious question, can you really buy when everyone is selling? Think about it. There is a paradox in it. Remember every trader is in the market for the same end goal, that is to make money by making profits, taking opportunities. If you are able to find an opportunity as to buy at bottom, unless you are a very unique individual out of tens of thousands, it is most likely that another trader too is able to find the same opportunity.

If you are willing to buy when others are selling, then there are some traders who are willing to buy similar to you. Then how it is true that you are buying when everyone is selling? The true meaning of Warren Buffet’s statement is that it is not when others are selling that you can clearly see, but it is when you yourself feel like selling even while others are selling.

Unless you too are in the mode of selling, it does not become a situation where everyone is selling. So Warrant Buffet explores a wonderful philosophy here. When you can see your reflection instead of getting trapped by the circumstance like everyone else is, that is when you can successfully control your need or urge to sell and turn around to buy the stocks at the right opportunity.

This is in fact very hard thing to do. That is the reason why Warren Buffet gives away his solid principles for free. It is not just enough to know something. When it comes to stock trading you need to live in the time when the event is happening to fully understand a theory in its true sense.

There is a Paradox in This Principle

As the stock market involves time varying behavior, your emotions, psychology, thoughts, beliefs and behavior too very with time. You feel that a theory fits well with stock market in static state when markets are closed and you are studying. But when markets start moving and the actual scene arrives you will not necessarily feel the same thing.

Now is it not hard to see why this principle is kind of a paradox. If everyone is selling how can there be any person willing to buy? Warren Buffet is referring to the kind of scene that happened in 1930s Great Depression times when everyone including rich, poor were selling stocks. It was a situation where there was no hope for the future. Even the people who normally think steadily and are safe with diverse income streams still go for selling during these times.

That is the time when you should understand that the markets have hit bottom. That is the time when you will not able to find a way to buy stocks even though everyone is selling. It happens on auto pilot. You will feel that you don’t have control over your decisions, but you have to do what everyone is also doing. Can you just imagine such a situation?

Where is the True Bottom?

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In the present market scenario, I truly believe that such a situation hasn’t yet happened. The simple fact that the markets made a sharp come back by 73% in just two months time from March to May illustrates this truth. People still have the money to buy stocks, they still have the luxury to buy stocks, even in the midst of a recession, there are so many that still have jobs to be able to think of buying stocks rather than thinking about long term future. The bottom is far from visibility.

A true bottom occurs when you, even after knowing what to do at the bottom, will not be left with any choice but to go against this principle. In such a situation to go with this principle is not a simple thing to do. It is a risk that you have to take by sacrificing some important thing from your life or possessions or relationships. But it will be worth doing and only few get the courage to apply this theory at the right time!

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