Thursday, 22 November 2018

Are you a trader or an investor?

Source: Stansberry Churchouse Research

Any kind of asset, whether it’s a stock, bond, ETF or commodity, can be held as a long-term investment or can be traded for a short-term profit. For the traders, they will buy and hold it anywhere from a fraction of a second to a few weeks. But, they all have one main objective – to make short-term gains on an investment.

The different types of trading strategies:

Momentum traders look for assets that are making a major move up or down and have a large number of shares trading hands. They hope the momentum will continue, and they hold the asset until the price reaches a pre-set level, which can take minutes or days.

Technical traders look for patterns or trends in stock, bond, index or currency charts. They make trades based on what those patterns have done in the past. They may not know anything about the asset they’re buying or selling. Their decision is solely based on what the chart looks like. There are 2 kinds of technical traders:
  • Day traders look at various charts and indicators before the markets open in the morning. Then, they make trades throughout the day to try to profit from how they hope the chart will look later in the day.
  • Other technical traders will hold an investment for several days or months.
Fundamental investors base their buy and sell decisions on an asset’s fundamentals – like earnings, profits, debt levels, and valuations. Usually, a change in company fundamentals can take time to affect a stock price (although a surprise change in fundamentals – like an earnings disappointment – can have an immediate effect on the share price). So, they are more closely associated with having a buy-and-hold strategy rather than a buy-and-sell strategy.

Trading isn’t for everybody
Waking up in the morning, making $1,000 by noon sounds great. But you could just as easily lose $1,000 by noon if you’re on the wrong side of a trade.

Successful traders have three things in common: 
  • They stick with one short-term trading strategy (like momentum, technical or fundamental)
  • They take a disciplined approach (as discussed below)
  • They have nerves of steel.

Three keys to disciplined trading
Stop losses: A stop loss reflects the most amount of money you’re comfortable losing on an investment. 

Example: if you don’t want to lose >25% of your position, you’d set your stop loss price at 25% below the price you paid for the stock. So, for $20 per share, your stop loss level would be $15 ($20 – 25% of 20). 

As the share price moves higher, you might use a trailing stop to make sure you don’t lose more than 25% on the new higher price. So if that $20 stock has moved up to $25, your trailing stop level would be 25% below that – or $18.75 ($25 – 25% of 25).

Position sizes: Knowing your optimal position size is vital to a well-thought-out investment strategy. The amount to buy should be determined, not by how much money you want to make, but how much money you can handle losing. To help determine your position size, you need to know your stop loss level. 

Example: Let’s say you’re buying the $20 stock above and you set $17 as your stop loss level. Now, consider how much of a paper loss ( how much it’s gone down on paper before you actually sell the position) you can handle. 

With a $100,000 portfolio, you may feel that a $2,000 loss would make you nervous and that’s your comfort threshold.

Asset allocation and risk management. Asset allocation refers to the mix of stocks, bonds, cash, and other assets in your portfolio. Many say asset allocation is the number one factor affecting investment returns. 

For instance, it’s a terrible idea to use all your savings to “play the market” as a trader. Instead, we believe, you should use a portion of your overall portfolio to trade – and leave the rest as a mix of good long-term investments, like dividend-paying stocks, bonds, cash, and some gold.

For the portion of your portfolio, you do want to trade with, make sure you spread your exposure around to a few different sectors. That way, if one sector falls, your entire trading portfolio won’t be blown up.

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