Investing vs Trading?

I’m guessing this board is as good as any to run this post. For the sake of rational, maybe helpful discussion, let’s set aside the virtue-signaling often done by them who self-identify as “investors” --rather than as one of them oh-so naughty “traders”-- and rephrase the question this way.

When does it make better sense to grab an unexpected, windfall profit, as opposed to continuing to own the stock (or bond, or fund, or whatever) in hopes of larger gains?

I’ve been doing this market stuff for three decades, and I still don’t have a good answer. But as markets become more volatile, it becomes increasingly obvious I need one. So permit me --if you would-- to run share some thoughts. But first, some background.

Historically, stocks have offfered an average, yearly gain of around 10%. This is a misleading number, because each individual year is nearly never “average”. The gains (or losses) for any year range widely to either side of that 10% average. But let’s use 10% as a benchmark. If the portfolio you’ve built is offering a yearly return of 10%, you’ve done a journeyman’s job of putting money to work. There are 52 weeks in a year, but markets typically close 10 days a year for holidays. So let’s say there are 250 ‘market-days’ per year. If a 10% yearly return is wanted, then a daily gain of a mere 4 basis point is all that’s needed. But what should you do if a stock you just bought jumps 2%, 5%, 10% on the day? Should you grab the profit and bank the money? (“A bird in the hand…”)

I strongly suspect how that question is answered has nothing to do with math, and everything to do with personality. Some people favor certainty. Some people tolerate a lot of ambiguity. But here’s my take on the matter, with full acknowledgment that others are sure to favor other approaches. I’m now thinking I should grab windfall profits and leave for another time trying to own the stock.

Now for a concrete example. The fundamentalist website I depend on for vetting stocks, SimplyWallStreet, rates MU highly in terms of its ‘health’, ‘value’, and ‘growth’. On a 2-year chart with weekly bars, it can be seen that MU is trading near support, suggesting a buying opportunity. So I did a low-ball bid for shares, and --to my surprise, given that the market had opened ‘up’ for the day-- got a fill at 67.76. I hadn’t been watching a chart. But my trading platform, TOS, rang a bell. Since I had intended my buying of MU to be “an investment”, I didn’t bother to see what happened subsequently. But when I later did look at chart and saw that prices had tagged 69.51, I regretted not having have had an aggressive sell stop in the market. And the reason I didn’t is that I didn’t have a policy of doing so.

Again, let’s go back to the math. A one-day round trip of getting in at 67.76 and out at something close to 68.44 --which the day had offered-- would be a gain of 100 basis points, which is the hoped for gain from 25 market days --or roughly one month-- of owning the stock. Money in ‘the market’ is ‘money at risk’. ‘Money parked’ is money that doesn’t have ‘market risk’. (It has ‘inflation-risk’, but not ‘market-risk’.) So the investorly question --when considering any investment-- is this.

“Does the opportunity seem to offer enough reward for accepting its risks?”

Again, every person is likely to have his or her own answer to that question. I just knew that my regret in not having grabbed a quick 100 beeps was enough to force me to try to salvage the situation, and I was able to exit with 74 bps, but not the 100-115 that later became possible as MU ranged in a channel. But I also know that profit would only have happened if I had gone into the day expecting to ‘trade’ MU, as opposed to buying it for the longer haul. Clearly, I didn’t have a plan for every contingency, and I needed one. So, echoing reformed liberal, Bill Maher, here’s my ‘New Rule’. (Actually, a set of them, many of which I had been following anyway, but not in an explicit, disciplined manner.)

(1) If a stock’s fundamentals aren’t good enough to merit owning it as an “investment”, don’t bother trying to own it short term, either. (Possible exceptions? Trash like BitCoin that have no “investment value”, but make “a good trade”.)

(2) No matter the merits of an individual company, its price performance likely tracks whatever is happening in the board market. (Pick a tell, and cue off of it.)

(2) If a security’s price chart doesn’t suggest that an entry is close to optimal, then look for something else. (This especially applies to ETFs and stock shorts.)

(3) Decide your max position size and whether you will scale in. (Yeah, ‘averaging down’ is a ‘No-No’. But it’s often the best way to repair a less than crisp entry.)

(4) Upon getting a fill, trail a tight loss stop and set a short-term profit target based on the day’s likely price action. (If you get kicked out, you can always buy it back later.)

(5) We’re in a bear market that’s likely to last another 2-3 years. (So plan to sell short more often than betting long, because the Fed has no clue as to how to “manage” the economy.)

Later in the session, MU ran higher. But when its price plot is overlaid on a tell like SPY, it can be seen that MU’s ‘up’s’ and ‘down’s’ were almost entirely driven by what was happening in the broad market. Ditto MOD, another stock I bought. But with that situation, I followed my rules and grabbed a one-day, 2.8% gain. Do the math. 280 bps is 70 market days of “average” gains. The money put at risk on that trade more than made its wages and earns itself a vacation.

So, here’s a follow-up thought. Trading on margin leverages gains. But it also leverages losses. The opposite, ‘deleverging’, does the inverse. It lessens profits. But it also lessens losses. If one thinks Buffet’s ‘Two Rules of Investing’ are sound, and if we really are in a bear market --or at least in a time of exaggerated price volatility-- then deleveraging might be A Good Idea. So a 'Windfall" strategy could be structured like this. If 4 bps per market day is wanted, and if 40 bbs could be gained on just 10% of AUM, then the other 90% doesn’t need to be put at risk, but one’s yearly goal could still be met.

Sharpe Ratios penalize volatility, upside as well as downside, which makes no sense. What matters, as Buffet’s Rule Number One states, is not losing money (which is better captured with Sortino Ratios). For sure, risk-adjusted gains don’t spend any better at the grocery store or gas pump than absolute gains. But they let one sleep at night, which --again- is very much a personality-driven preference, not a matter of math. I HATE ‘risk’. But it has to be accepted, or no gains are made. However, ‘risk’ can be managed and reduced. Putting as little money as possible into markets, for as short a time as possible, is one way to do that, and it’s what appeals to me. I call the approach “Traderly Investing”.

Arindam

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