"So Why Be a Trader and/or an Investor?"

Neil A Costa

As we get older, we look forward to a happy and healthy retirement. We also look forward to a retirement in which we can afford to maintain a high standard of living.

Sadly for many, however, the dream does not become a reality.

In Australia, for every 100 Australians born, by the time they reach the age of 65 years, approximately one in six will remain in active employment, one in three will have died, and almost one in two will be relying on the government to support them.

Only one in 20 Australians can be classed as having the resources and peace of mind to enjoy their retirement to the fullest.

Money is not everything, and it certainly does not guarantee health or happiness, but it does increase one's options!

The investment industry is a very large and diverse industry, with more than US$4 billion being traded throughout the world each day. Large sums of money have been made (and lost) by people investing in coins, stamps, medals, art, gem stones, precious metals, real estate, stocks, bonds, breeding rare animals and birds, and even tulip bulbs. Stocks, bonds and real estate are the largest and most understood investment vehicles. Clearly, each form of investment has its own advantages and disadvantages.

Investing in the stock market has consistently proven to be one of the most profitable forms of investment available. This is not surprising, given the relative performance of the stock market during the last 50 years. In the period 1950 to 1999, AUD$1 in 1950 would be, in 1999, AUD$18 due to inflation, AUD$26 if you invested in Australian bonds and AUD$369 if you invested in Australian stocks. (Source: Personal Investor, April 2000, page 11.)

Investing in the stock market is also rapidly growing in popularity, with 53.7 percent of Australian adults owning stocks in early 2000, and the number is rising. Australia leads the world, per capita, in stock ownership.

• Allows one to start with a relatively small amount of money.
• Allows one to take almost immediate action to buy and sell stocks, unlike property that takes much longer.
• Allows one to sell part of an investment, whereas real estate requires the full property to be sold.
• Has transaction costs which are much lower than those of an equivalent property investment.
• Allows investments to be monitored easily.
• Allows one to obtain an accurate valuation quickly, at any time.
• Allows one to choose a broker from a large list of reputable firms that offer a range of services at reasonably competitive rates.
• Allows one to choose from a diverse range of stocks, thus maximising one's returns while spreading the risk.
• Is free of blatant outside manipulation, due to the activities of regulatory bodies.
• Has proven to be one of the safest forms of investment, if one knows what one is doing.
• Is free of fund management fees.
• Can have considerable taxation advantages.

The following table illustrates the advances over time made by the Sydney, and later the Australian Stock Exchange All Ordinaries Index, at various periods.

(*Monthly average)

These figures, which exclude the dividends that would have been paid, show you what could have been achieved with a 'buy and hold' strategy, purchasing the stocks that made up the index.

If you only buy the strongest stocks, and sell any stocks that do not perform well, you can expect to achieve significantly better results. These techniques include how to select the higher-potential stocks, and how to enter and exit the market when each stock gives confirmed signals.

As with all types of investments, there are disadvantages associated with investing in the stock market.

The main disadvantages of investing in the stock market include the need to:

• Acquire knowledge of what one is doing if one is to achieve consistently superior returns.
• Have a reasonable capital base to ensure that one is not exposing too much capital to any one investment, and to ensure that one can obtain a big enough return.
• Have the discipline to enter and exit the market when entry and exit signals are given.
• Monitor your investments.

Also, stock markets can be exposed to sudden downward market movements. (This can be an advantage, if you sell stocks 'short' at the time!)

The good news is that, through gaining investment knowledge and experience, you can overcome these disadvantages, or at least minimise their impact.

Of course, you should bear in mind that most of the above disadvantages of stock market investments are also disadvantages of other forms of investment. Also, bear in mind the unique, and often significant, disadvantages of other forms of investment before being too critical of the stock market as an investment vehicle. Gems, for example, can be stolen; property can be extremely difficult to sell at times of recession; gold can spend decades without significant moves in price, and rare breeding animals or birds can be infertile or die! Even money placed in a bank account can lose its purchasing power at an alarming rate during times of high inflation and/or low interest rates.

People are attracted to trading and investing in stocks for many reasons. It is certainly true that there are considerable advantages in living the life of a successful full-time trader. These include:

• Taking control of, and having responsibility for, one's own destiny.
• Not having to tie up large amounts of capital in purchasing a business.
• Not having to be at the beck and call of a 'boss'.
• Not having to endure the constant responsibilities and pressures of running one's own client-service business such as managing staff and maintaining complex accounts.
• Being able to work from almost anywhere - you need little more than access to data and a telephone to place orders.
• Being able to complete one's work in an hour or so per day.
• Having time for other pursuits in order to live a healthier, happier, more balanced and more fulfilling life.

What then, is the difference between an investment and a trade? Some argue that an investment is merely a longer-term trade. Others argue that the difference lies in the intent - whether you purchased the stock primarily for the dividends paid by the company, or for the capital gain.

For the purposes of this article, we will define a stock market investment as one in which the investor intends to buy and retain the stock for a significant period of time in order to obtain income from dividends and any capital gain. Investors therefore try to buy stocks that have a high probability of increasing in value, and of paying increasing dividends, over a period which is usually several years or longer.

We will define a trader, on the other hand, as someone who is primarily concerned with capital gain, and with minimising capital loss. Should a trader receive a dividend, it is a bonus.

Trading requires greater knowledge, preparation and discipline than investing. It is also usually more profitable.

Investors ideally need to have a good knowledge of market cycles, so as to be able to purchase stocks when they are at relatively low prices. They also need to have knowledge of stock selection that will enable them to purchase stocks with a high potential for capital gain and a healthy and consistent dividend stream.

Traders need to understand market cycles and how to select stocks with the greatest potential for capital gain. They also need to have a proven system for buying and selling stocks so as to maximise the capital gain and minimise the number and size of losses.

Many people are attracted to trading, in preference to investing, as a means of generating additional income. Indeed, many system vendors market intra-day trading systems on the basis that you can trade many small market moves per day with very little risk. The thought of sitting in front of a computer screen, watching the market activity only seconds after it happens, and telephoning a broker with an order to "short the hell out of BHP", can be very alluring. Indeed, add the mobile phone and the Porsche, and the image is complete.

I am an intra-day trader, a position trader, and a longer-term trader. To the beginner, short-term trading seems exciting and longer-term investing seems staid. The reality is, however, that I know many very wealthy longer-term traders, but few people who have made their fortunes from intra-day trading, or from taking trades which run for only a day or so at a time.

To intra-day trade properly, that is to have a reasonable chance of competing with full-time, professional intra-day traders, you need 'live' data, preferably in a form which displays it as charts. This can cost from around AUD$200 or even up to AUD$2,000 per month.

Although you should be able to negotiate reduced brokerage, bear in mind that the frequency of your transactions will be much greater than for a longer-term trader/investor, and overall your brokerage and associated costs will be much higher. For example, if one's average trade length is two weeks; one will pay one 'round trip' brokerage, on average, every two weeks. If one's average trade is two hours, it is possible you will make, say, 20 or more trades in two weeks. Even if you have negotiated brokerage at half the normal rate, your brokerage expenses will still be 10 times more than the one-trade-per-fortnight trader.

Intra-day trading using, say, a 15-minute chart can be quite stressful; forcing you to have to make a decision every 15 minutes while the market is trading. The chances of making a trading decision based on emotion, and not according to the rules of your proven system, is usually much higher when your trading decisions are made when the market is still trading.

A trader using a daily chart only has to make a similar decision once per day, and a trader using a weekly chart only has to make the decision once per week. These traders make their trading decisions when the market is closed.

W.D. Gann, who is reputed to have made $50 million prior to his death in 1955, had this to say about intra-day trading:

One great mistake the man makes who watches the ticker all the time, is that he trades too often. He gets in and out several times during the day, and each time he pays commission.

(Truth of the Stock Tape, page 8.)

(The 'ticker' was a device that printed stock prices on a narrow tape, called the ticker tape. Tickers were popular in the early 1900's. Today traders obtain their live data from a range of electronic devices such as live screens and portable pagers.)

Another important fact traders overlook is that the more times a man gets in and out of a market, the more times he changes his judgement. Therefore, the percentage of his being wrong increases.

(Truth of the Stock Tape, page 9.)

Gann concludes by saying:

The best way to read the tape correctly is to stay away from it.

(Truth of the Stock Tape, page 76.)

This is powerful advice, given Gann's documented success at intra-day trading.

It is up to you to decide the time frame you want to use for your trading activities. My strong recommendation, however, is that you should commence with a longer time frame. In this way your costs will be much lower, you will only need to spend a fraction of the time on trading-related tasks, and you will have much more time to gain the necessary knowledge and to make trading decisions in a calm and disciplined manner. Most importantly, the chances of you making money are much higher.

Later, as your level of knowledge and expertise increases, you will develop the skill to enter and to exit the market closer to bottoms and tops, and thus gain more profit per trade. Ironically, as mentioned earlier, the most successful traders I know have tried intra-day trading, and taken shorter-term trades, and have concluded that the big money is to be made from longer-term trades! They also conclude that the longer-term trader has a much better quality of life!

Trading or investing for a living has numerous advantages over simply placing your money in large investment funds. As smaller traders, we have the advantages of being able to make and implement quick decisions; we can select strong stocks from a bigger pool of liquid stocks; we can buy and sell our stocks in a company at a moment's notice without affecting the market, and we can operate with an extremely low cost structure. In a sense, we are like a small speedboat competing with a big, slow ocean liner. We should therefore be able to outperform the various investment funds by a good margin!

It is vitally important that you understand what is involved in getting to the stage where you can do this with security and comfort. You must have, for example, the commitment, discipline and time to take control of your own stock market trades.

Those who trade and invest without a plan, that is, 'by the seat of their pants', are the group most likely to be disappointed and disillusioned. This is because they are doing little more than gambling.

Trading without a plan is like travelling in a boat without a rudder - you may end up where you want to go, but a lot of damage can be done on the way. Even if you are lucky enough to get where you are going, you can never be sure what you did correctly in order to arrive at your destination. If you have a written plan, you can trade within the framework of that plan, thus knowing that you are steadily moving towards your trading goal, and that any successes you have are not purely due to chance.

You must do the work required to learn how to become a consistently profitable trader. You also need, or must develop, the self-discipline required to follow your rules if you are to make consistent profits from your trading.

In conclusion, you can become a consistently profitable trader and/or investor, and enjoy the lifestyle and the financial security that it brings. You must, however, invest the necessary time preparing yourself - just as you would in preparing for any other business endeavour. You must:

• Design and test your own trading system, or purchase a proven trading system that yields consistent profits without you having to take undue risks. (Trading system design requires a detailed knowledge of the components of a successful trading system and of how to rigorously test such a system to ascertain whether the system is likely to remain consistently profitable.)
• Ensure you have sufficient capital to allow you to trade your system and to follow your all-important money management rules.
• Purchase data, and if desired, appropriate computer software to allow you to display charts.
• Have a comprehensive trading plan that documents all key aspects of your trading.
• Have, or quickly develop, the self-discipline required to follow your rules in order to make consistent profits from your trading.

"For more information on how you can maximize your trading profits while strictly controlling your risk, click here..."