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Trading in the middle again: investor thinking

The trading approach to the stock market lies in the middle of the risk spectrum while overlapping the other basic approaches. That puts it between a conservative investing strategy based on profit making companies and aggressive speculative strategies.

For consistency we will refer to all plays that accept high risk seeking significant short term rewards as speculative. There are many trading strategies covering the entire risk spectrum from very conservative to extremely speculative.

The line between trading and speculation

We discussed the more conservative investing approach two days ago and yesterday scratched the surface of high to extreme risk speculation. Typically well managed portfolios have a low to medium risk profile although investing can involve considerable risk. Learning how to manage that risk is part of learning how to invest.

Trading can significantly contribute to the performance of even a conservative portfolio. However, successful trading requires paying closer attention to the markets than is needed to manage a conservative portfolio of large quality dividend paying companies. When the market favors trading in a positive environment, total returns can dramatically outperform a dividend only approach.

For our discussion we will push all insane risk gambles into the speculation category and only consider that trading applies to the remainder of the risk profile. Finding stocks with price movement trends, preferably up, is the key to consistent profitable trading. Naturally we want to pick stocks that will be moving up in price as time goes on so we get to enjoy those gains.

The challenge comes in the ‘will be moving’ part; the foggy future.

Stock Picking

Stock picking combines research, knowledge, a bit of art and when we can get it, luck. Get it right and the returns are sweet. Get it wrong, if you have done your homework, downside can be limited. Still, in a bad trade you book a loss or little, no or unsatisfactory returns. In the weeks ahead we will discuss stock picking in much greater detail.

When looking at the market, consider that it can only do three things. It goes up, down or sideways. It can do it all in one day. More typically the market moves in trends or waves that can last weeks or months. At times big trends can last for years.

Most often traders seek trends lasting at least weeks or months. They take positions or buy shares in companies that they think will give them a long ride. They are an optimistic bunch that does well in rising markets.

The trend is your friend

The market saying, “The trend is your friend” tells us to trade with any established trend to enjoy the best profits. Two more bits of market wisdom, “it takes all types” and “there have to be buyers and sellers” point out the obvious. We can’t buy if nobody wants to sell and we can’t sell if nobody wants to buy.

Ever been unable to find a buyer at the price you want for a property? Ask any realtor near you if they have sellers in that situation. The answer is plain, to move the property, move the price. You must take what a prospective buyer is willing to pay or you remain the owner. The agent or the financial advisor is not the problem it’s simply an unrealistic seller.

When we approach a stock trade we certainly don’t want to meet that issue going in nor do we want it when we need to exit a trade. How to ensure that? Trade liquid stocks. Seeking stocks that are liquid means that they routinely trade in reasonable volume.

We will explore this important issue further in the weeks ahead. For now, know that the decision matrix we build around our work has multiple factors. One of which is we must know and be aware of the share volumes traded by any company we consider or target.

In addition, before trading well you must meet and get to know a cohort that always hangs around any market. Greed, fear, panic, slippage and just dumb show up every single day. Amazingly they are active in many stocks in virtually every market. As we work through the many topics that affect trading this huge factor will be explored in more detail.

There are many myths and games at play in the market. After all this human activity comes with the best and worst human behavior. Don’t make the mistake of thinking someone looks out for you or after you.

The government or regulators including these in the industry don’t. They are looking after themselves first, the market second and generally concern themselves with keeping the game going. That means keeping as many as possible in the game to make the markets work. Looking after you is your job.

I am well aware of the laws and regulations as well as statements made by regulators and industry spokesmen. Don’t count on them. Actions speak considerably louder than words. I repeat, be ready to look after yourself.

Investing is a heads up adult game. Inform yourself, think for yourself and learn how to play it well, safely and profitably.

Day trading

We should mention day trading. As the name implies, day traders sat all day in front of chart and data filled screens seeking trade durations of seconds, minutes or hours and selling out before the market closes. A decade ago there was a day trading trend across North America. But as in all things, times change.

Now computers trade using proprietary algorithms to conduct huge numbers of microsecond trades. This so called machine trading combines with another computer driven phenomenon, high frequency trading, have radically changed the scene. Short term trading, especially individual day trading is largely rendered obsolete.

Don’t even consider day trading unless you like the odds of running the race barefoot against a rocket. Oh yes, did I mention the rocket gets a head start? It’s just a little one, but still, you will experience a severe burning feeling in the most sensitive parts of your portfolio. That’s enough day trading talk.

On trend

Back to trends. Individual stocks also exhibit trends. Riding a market trend on outperforming stocks does wonderful things for your portfolio, ego and no doubt complexion. Get several trending together and repeat multiple times during major market moves produces dramatic portfolio growth.

We will further explore the deep topic of trend trading in the time ahead.

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