Investor vs. Trader... Which Are You?

Most market participants consider themselves to be "investors." But if you look at a list of the really big winners on Wall Street, you will see that most of those who make big profits, list themselves as "traders."

By "big profits" we mean doing better than the S&P 500 Index or Nasdaq 100 Index by a substantial margin over any three year period.

Investors

"Investors" put their money into stocks, real estate, etc., under the assumption that over time, the underlying investment will increase in value, and the investment will be profitable.

Typically, investors do not have a plan for what to do if the investment decreases in value. They hold onto the investment in hopes it will bounce back and again become a winner.

Investors anticipate declining markets with fear and anxiety, but usually do not plan ahead of time how they will respond to them. When faced with a declining (bear) market, they hold their positions and continue to lose.

We all know investors. In many cases it was us before we realized how dangerous buy-and-hold investing can be to our savings.

Investors do have some knowledge of trading. But that knowledge is tainted by how it is all too often described in the financial press. "Trading" is risky, dangerous, foolish, bad, involves a great deal of work, etc. On the other hand "investing" is good, reliable and safe.

Investors had a taste of what "buy-and-hold" can do to their capital in the recent 2000-2002 bear market. But many do not realize just how far in the hole that bear market put them. The S&P 500 declined 50% and the Nasdaq declined 80%. How easy is it for the markets to regain those losses?

It will take a 100% gain to make up the losses for those invested in in the S&P. It will take a 250% gain to make up the losses in Nasdaq investments. When a powerful advance is measured in 20% to 30% moves, you can easily see how long it will take to regain those huge losses.

In the last several years of market gains, we have come nowhere near accomplishing this in the typical index fund. It is likely to take investors many more years to get back just to where they were in 2000.

But there is another approach that is almost never discussed. It is used by many hugely successful traders though the financial press seldom mentions it. In fact, many who use it are very quiet about their successes. They do not try to publicly prove themselves right, they just trade and make money.

This approach is the use of price to determine trends. Price does not forecast and it does not predict. Price is always right. If prices are moving up, the markets are advancing. Down and the markets are declining.

At FibTimer we are "Trend Followers." We respond to what "is" happening instead of predicting or forecasting what might happen. We "follow" price and allow the changes in price to tell us when to enter or exit a position.

Using price to determine trend does not allow trend traders to enter at the exact bottom, or to exit at the exact top. Trend traders do not try to forecast the market, but instead let the market tell them when to trade and in what direction.

Trend traders wait patiently for prices to tell them a trend has begun. Then they jump on board. If the trend fails, they exit quickly to control losses. Price tells them when to enter "and" when to exit. If the trend continues, trend traders have no predetermined profit goal. They stay with the trend until it reverses.

Cutting losses quickly and staying with a trend until it ends is how trend traders realize huge profits in the financial markets. The financial markets are trending "about" 80% of the time. That means trend traders are profitable 80% of the time. During the other 20% trend traders keep losses very small so that they are ready when the next trend starts.

Conclusion

Remember that "price" is determined by millions of investors and traders. We discussed this back in the November 7, 2004 commentary, "Market Timing And The Presidential Election" The market's rally leading to the election predicted the outcome. No one else knew what would happen. The election results were a complete surprise.

By using price, trend traders took advantage of the the combined wisdom of all those investors and traders to trade a successful and profitable market timing strategy. Trend traders were long well before the election.

Yes, it takes patience to be a successful trend trader. Yes, it takes discipline to follow the strategy and make the trades which many times go against the prevailing wisdom. This is true of "all" winning market strategies.

But trend traders who use price to determine trends have been quietly "beating" the markets for many years. They will quietly continue to do so for many more.