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Investing “versus” Trading—Points Along A Spectrum, Not Mutually Exclusive
This article explains why the usual dichotomy between "trading" and "investing" can be misleading. It doesn't matter what you call yourself. You invest in stocks to make money.
Recently, have you run across a growing number of references to the virtues of being a “committed” investor instead of a “speculative” trader? I know that I have.
Here is a typical statement: “You cannot succeed if you trade a lot. You can only succeed by being an actual investor. You must realize that by owning a share of stock, you are in fact a partial owner of a real business. No business owner wants skittish investors. Corporations want committed, interested investors who are going to look to the long term, support the company through thick and thin, and not sell the stock at the first sign of short-term problems or bumps in the road.”
Well. As they say in The Godfather, “It’s business, not personal.” Let’s look at a few facts.
First, many of the points in the statement above are true. If you buy a share of stock, you are, in fact, part owner of the business. Corporations generally would prefer committed, long-term shareholders. A long-term view does look beyond mere bumps in the road.
But other ideas are false or misleading. For one thing, many active traders are, in fact, successful. You can succeed or fail if you trade stocks. It is probably true that the majority of hyperactive individual traders do not beat the market, but that simply means they have faulty strategies, or that they execute their strategies poorly, or both. Many traders do beat the market, handily and consistently. Poor traders are often people who have insufficient knowledge, don’t do their homework, do not have a strategic approach that suits their goals and personality, and are impatient.
The “trading versus investing” dichotomy sets up a false premise, that there are only two ways to participate in the market, by being a “buy and holder” or by being a “trader.” “Trader” often carries a negative connotation while the “investor” wears a halo (as in the quotation in the second paragraph of this article).
Where does one cross the line from being a “trader” to an “investor”? Must you only buy—but never sell—to be an investor? If I turn my portfolio over ten percent per year, does that make me a trader? Twenty percent? One hundred percent? If I buy a stock and then sell it ten days later because its CEO just got indicted, does that make me a trader rather than an investor? Or does it make me a smarter investor? If I hold most of my stocks at least a year, does that make me an investor? Three years? Five years?
The fact is, there are places all along the spectrum between the extremes of “buy and holder” to “trader.” It does not advance the analysis to force any person into one category or the other. And reckless investment decisions are not limited to traders. Sometimes the most reckless thing you can do with an investment is hold onto it. The dot.com bubble proved that.
To me, the most sensible approach to being an investor is to establish a set of rules and principles that are intelligent and fact-based, and then execute them according to plan. Every so often, take a step back to re-examine your goals and strategies to see whether they still make sense. So I take a long-term view, but that sometimes leads to short-term activity. There is no logical contradiction in that.
The net result is that the Sensible Stock Investor holds some stocks for a relatively short time (measured in days or weeks) and other stocks for years. What label should be put on that? I would suggest a label like “sensible.” Or “buy-to-hold,” meaning that the intent when purchasing a stock is to hold it for a long time, but that I will sell it when it stops achieving the goals I set for it. The main goal is to follow Warren Buffet’s Rule #1, “Don’t lose.”
From the corporation’s point of view, what I (as a small investor) do with my shares of stock is irrelevant. Owning a tiny share of a business is not the same thing as having an influence on the business. If I buy 100 shares of AT&T, I own .00016% of the business. My ownership of those shares gives me zero control over how the business is run. I don’t have a seat on the Board, and management doesn’t listen to anything I say.
Now if I were just starting out my own business, and I had five angel investors, of course I would want them to be committed to my business, stand behind me, and not pull their investments out at the first sign of trouble. They would want me to do well, and they would recognize that the best chance for me to do well is for them to help me.
But with a large public corporation, the trading of their shares in the stock market does not affect the running or financial foundation of the corporation in the slightest. The corporation got its capital at the IPO, via secondary offerings of its stock, or by borrowing. If you and your neighbor trade the shares back and forth, the corporation isn’t affected and shouldn’t care. There is nothing morally virtuous about being a buy-and-holder. Trading is morally neutral. The question whether to trade or not is a business decision that you make for your own purposes, pure and simple.
Each party in a stock trade acts in his or her best interest as each perceives it. It is true that many investors who trade a lot, or who react emotionally to short-term “noise” in the market, do worse than others who hold their investments longer. But so what? That does not mean that you have to make those mistakes. Neither approach is inherently better than the other.
The fact is, “investing” is the buying of a security. Or, to quote Buffett again, “Investing is laying out money now to get more money back in the future.” No more and no less. If my security serves my purposes for a long time, I may well hold it for a long time, for years. But if the security fails to meet my reasonable expectations for it, or if the corporation that issued it screws up and starts to hurt me, I owe no obligation to continue to hold that security. I can sell it and look for a better place for my money. In fact, my fiduciary duty to myself demands that I do so.