I’ve been thinking a lot about this lately. The recent impact of the coronavirus fears on the stock market, like any other fast-moving or high-volatility event arouses my trader’s instincts.
Are those trader’s instincts compatible with fiduciary, long-term investing?
I was a trader before I was ever an investor, at least professionally. Which is to say I was a professional trader before I was a professional investment manager.
I think a lot of people (individual investors or home-gamers as Jim Crammer would call them) are traders before they are investors. Why is that? It is not complicated: Investing is boring and trading gives pathways to large and fast profits. So in a sense, anyone with a touch too much self-confidence is likely to start as a trader. Many traders succumb to being “just investors” as the lessons learned in their losses fail to pace the amount of those losses.
Let’s distinguish between Traders and investors.
- Invest for short periods of time
- Typically trade one single or just a few instruments
- Often seeks Leverage
- They often short sell
- More likely to use Futures and options
- Unlikely to have a financial adviser
- Unlikely to have good diversification
- Usually under-perform the markets
- Generally, volatility seeking
- More likely to be sensitive to execution timing in quality
- Embraced by online trading platforms to generate commissions
- Occasionally chastised or belittled by financial advisers who want to control your assets, Referring to things like real money, play money, and serious money. (isn’t all money the same?)
- Will typically own assets inside a margin trading account
- Typically present a much more lucrative Wall Street client due to commissions, platform fees, data fees, margin fees, and Short Selling fees
- Ideally, pre-plan your exit criteria (for both winners and losers)
- Engaging lost limiting behaviors (such as stop-loss orders)
- May know or care very little about the companies they hold
- They often have a low conviction of trading ideas
- Crucially, traders experience the emotions of gains and losses much faster than investors, allowing one to better master their own investment discipline.
- Usually, invest for the long-term
- Typically hold a broader number of different types of Investments
- Usually not levered
- Usually does not short sell (long-only)
- Seldom holds futures or options
- More likely to have a financial adviser
- More likely to have a financial plan
- Usually happy to replicate the market performance
- Volatility avoiding
- Insensitive to execution quality and timing
- Usually, fee sensitive despite often paying asset-based fees
- High-net-worth investors are coveted by financial advisers
- Seldom have exit criteria for investments
- Seldom have lost limiting tactics in place for the portfolio or for investments
- More likely to have high conviction ideas, and if the investments drop in value she would seek to acquire more
Seems to me that there are good (and bad) behaviors on both sides of this fence. I don’t think that Wall Street has done a good job of accommodating individual investors who are traders or individual traders who have investments. All of the virtuous behaviors of one may work for both trades and investments.
I think someone can be both. This requires a higher level of self-awareness about who you are and the purpose of each investment. Investors are seldom so deliberate. But they should be. The best investors are deliberate 5–10 levels deep.
There’s nothing inherently wrong with being an investor or a trader. Traders do have an additional headwind, stemming from a more constant presence of deleterious emotions. If and when a trader masters this; the benefits will likely accrue to both their trade capital & investment capital.
Behavioral analytics provide that losses sting twice as much as wins give joy. This leads to loss avoidance in investors, which is usually bad. But this same axiom helps traders to develop loss limiting techniques.
Without such discipline, trouble may arise: Traders who take on a trading position, lose and then allow themselves to re-classified the position as an investment are committing a cardinal sin. This is a violation of investing discipline.
Likewise, investors who dabble with trading without a plan are adrift beyond the bay.
The Coronavirus fears of a pandemic created the considerable market movement, volatility, and dislocation this week. If this doesn’t get you going as a trader, take that as a note of caution.
If you are still reeling from your last loss, you might not be on the right mental footing to enter your next position. You have to be emotionally flat. if you take the game-winning shot and miss, you must move on….fast
As a trader, I want to plunge into fast responding opportunities with a big position. Dislocated markets must relocate, right? This instinct butts right against my professional investor discipline of diversification.
As an investor, mostly I just want to weather the storm. If I’m lucky, I might be a little cash-heavy, swallow the pit in my stomach and put that cash to work. The timing is right when I see the panic on the tape starting to look a little illogical and the rays of sunshine begin to peek through the storm of the real world which the stock market reflects.
Investors who trade should have rules. what capital is allocated to investing? What capital is allocated to Trading? What are the parameters for leverage, risk management, and exit in both cases? Systematization is an investor’s best friend.
Now, as a Fintech entrepreneur, the math behind optimality is quite simple. if you properly designate which positions are trades, your digital advice platform could amalgamate a profit-and-loss of your trading activities, with this in hand it would be easy to optimally position size your trading capital in light of its relative performance, relative risk and most importantly it’s relative diversification to your investment positions.
Given that my development team could bang this out in a couple of weeks, I might have to start calling on the banks. Somebody needs to make this.
Financial institutions know that it’s bad business to try to mother do-it-yourself investors even when it might be in the investor’s best interest. DIY investors are strong-willed and independent.
If your financial institution chastises you for your traders’ instincts, or if your trading platform fails to provide the tools for proper portfolio construction: maybe it is time to demand better.
You can succeed as a trader and an investor. Just decide what is what. Decide who you are at that moment. Be deliberate. Systematize.
James’ professional orientation points at the zenith (and sometimes nadir) where technology and investments intersect. He is a Fintech entrepreneur and has served twenty years of a lifetime sentence.
James is a patented inventor, quant pioneer and investment manager. He is the founder of Gravity Investments, a unique investment and technology services firm centered on James’ inventions for diversification measurement, optimization, visualization, and analysis. In the development of the platform, James has pioneered A.I applications, diversification attribution, down-side diversification, portfolio re-optimization, full-lifecycle strategy optimization, programmable investment policy statements and core-satellite optimization techniques.
In working with advisors, funds and money managers as both a strategic sub-advisor and software consultant, James has consulted and trained hundreds of professional investors on portfolio design and optimization. James has a unique ability to look at any investment process and find practical, intelligent and often quantifiable opportunities to improve the investment product.
Inspired by the work of Nobel Laureate Harry Markowitz and the efficient frontier, James has championed and pioneered the science of diversification. James’ technology has advised
or assisted in over 30 Billion dollars of investor capital. His vision of a more perfect investment management system is at the heart of Gsphere ( www.gsphere.net )
His passion for performance, curiosity for the unknown, and drive to excel empower his service to investors.
James is Founder and CEO of Portfolio ThinkTank (the B2C company) www.portfoliothinktank.com, Founder & Chief of Financial Engineering at Gravity Investments www.gravityinvestments.com (the B2B company) and Chief Investment Officer at Gravity Capital Partners, a wholly owned SEC Registered Investment Advisor.