by David Fessler, Investment U Senior Analyst
Friday, August 5, 2011: Issue #1572
If someone were to ask you, “Are you a trader or an investor?”… how would you answer?
Professional day traders aside, traders rarely make money “trading” stocks. Investors, on the other hand, pay little attention to the day-to-day fluctuations in the market, and often retire early. Most importantly, they rarely lose money. If they do, it’s a small amount.
The distinctions between a trader and an investor are important ones. Investors generally avoid something I like to call “PDOC,” while traders are intimately familiar with it. Let me explain…
“Trade” Your Way to Zero
It’s easy for the average person to fall prey to a trading mindset. They get caught up in the emotion of chasing the latest high-flying, media darling. The financial channels… the daily newsletters… they’re full of them.
More often than not though, they get in too late, pay too much and end up selling at a loss. Repeated over and over, it all too often proves to be their financial undoing.
“Traders” are always looking for the next big homerun stock that’ll propel their portfolios to the moon. A great example is Green Mountain Coffee Roasters, Inc. (Nasdaq: GMCR). It’s up 15,401% over the last 11 years. Another example is Netflix, Inc. (Nasdaq: NFLX), up 3,048% over the last nine years.
The truth is, success stories like these don’t come around too often. But that doesn’t stop many traders from burning up a lot of their net worth betting on the next one.
In this “follow the herd” trading mentality, the focus is squarely on the share price of a company. If the share price goes up, “traders” think they’re right… down, it means they’re wrong.
Every day, the trading floor of Wall Street is littered with the buy and sell orders of “traders” who think they can outguess the market. The old adage, “the market can remain irrational much longer than you can remain solvent,” certainly applies to the herd trading mentality.
Trying to outguess the market by focusing on rarely meaningful stock prices almost never works. It can be a very expensive lesson to learn. Traders end up becoming intimately familiar with “PDOC.” What ‘s PDOC? Permanent disappearance of capital.
“Invest” Your Way to Financial Independence
A more rational, sane and ultimately lucrative approach is to focus not on the share price, but on the company’s business. What about market fluctuations? Just as sure as the sun rises and sets everyday, so will the stock market.
But unlike the sun, the market’s movements are unpredictable. Great investors like Peter Lynch, Warren Buffett and George Soros ignore them. How many times a day do you find yourself looking at your stock prices? Five? Ten? More?
In a sense, you create your own sense of volatility when you look at stock prices that often. The need to constantly monitor prices emanates from our deep-seated need to “be in control.”
News flash: You can’t control the market – or the price of your stock – no matter how many times a day you look at it. Fidelity Magellan’s pilot, Peter Lynch, noted that even though his fund had incredible returns while he was at the helm, most people who owned it actually lost money.
“How?” you ask? Herd mentality: Investors would pile into Fidelity Magellan right after a period of great performance, just in time to catch the next inevitable downturns.
These guys focus on a company’s business, not its share price. They stay away from PDOC. They invest in companies, buying and holding shares for years, as opposed to months, weeks, or days.
They invest in companies like ExxonMobil (NYSE: XOM), Coca-Cola Bottling Co. Consolidated (Nasdaq: COKE), Philip Morris International, Inc. (NYSE: PM), Johnson and Johnson (NYSE: JNJ), or any number of other stocks that increase their business – and their dividends – year in, year out.
You see, Buffett and Soros understand that the currency of ExxonMobil is oil. More importantly, they understand that oil is likely a greater long-term hedge against the depreciation of the greenback… and it pays a nice dividend, to boot.
They understand the “currencies” of the other stocks I mentioned, as well. They hedge their dollar-denominated investments in these other “currencies.” They operate as investors, never as traders.
Time to Take a Look in the Mirror
So which are you, a trader or an investor? Perhaps it’s time review your philosophy, especially in the uncertain times we find ourselves in right now. Many companies are on sale, dumped in a panic by “traders.” A debt deal will get done, and the markets will soar in response.
My guess is that “investors” like Buffett and Soros were bargain hunting all last week. If you’re truly an investor, you probably were, too. Monday may be too late…