Trading and investing can both be effective strategies and they generally agree on a number of major points.
- We want to succeed. Traders will generally define success a bit differently, but we all want it just like we all want to be profitable (thank you, Captain Obvious).
- We need a carefully designed plan and must execute it. As the expression goes, nobody plans to fail but we do fail to plan. Investors and traders who are successful over the long haul rely upon an evidence-based plan rather than luck.
- We must be contrarian. Traders can follow a trend and be successful for a while, but long-term success for traders and investors alike requires going against the flow because the markets are a zero sum game.
- We must remember that “this time isn’t different.” The markets are mean-reverting. Ignore this at your peril.
- There is no such thing as a free lunch. In other words, risk and reward generally correlate.
- We must control our emotions. Impulsive actions based upon emotions, intuitions or one’s “gut” will be costly.
- Most players will not control their emotions. This fact provides tremendous opportunity. As Warren Buffett says, be greedy when others are fearful and fearful when others are greedy.
- Costs matter. Whether these are transaction costs, fees, taxes or something else, overall costs have a huge impact on the bottom line.
- Always consider who’s on the other side of every transaction. As the expression goes, if you’ve been playing poker for 20 minutes and haven’t figured out who the patsy is, it’s probably you. Which leads to…
- Am I a being duped? We all want to be Michael Burry. That starts by not being Wing Chau. Of course, we can all be both (think John Paulson).
But the contrasts between investing and trading can be dramatic, as illustrated by the metric below.
We all have trouble thinking long-term, of course, in part because we tend to discount future value far too much (along with difficulties on account of optimism bias and what Dan Kahneman calls the planning fallacy — we tend to overestimate our ability to control the future). If you doubt me, ask yourself how your diet and exercise plans tend to turn out. So, are you a trader or an investor?