Traders, investors… and diets
We hear folks talk about trading: the short term buying and selling of stocks in the market.
We hear folks talk about trading: the short term buying and selling of stocks in the market.
Trading is difficult. It requires a very specific set of tools, commitment, and expertise. Most people are actually better off investing in the medium to long term, with less effort, than trying to profit from frequent trading.
Let’s talk about Bob.
Trying to predict a stock’s movement in the short term is the same as trying to predict the change in Bob’s weight every day.
To predict whether Bob will gain or lose weight we need to monitor Bob very closely and know all the relevant details about his diet, body, activity, and environment.
Similarly, to know whether a company’s stock price will rise or fall, we need to know and have access to all the factors that will impact it’s movement daily.
Putting this into perspective
Overtime, experience helps us develop an idea of what we think will happen. In Bob’s case, we know that when he travels, he usually indulges at client dinners. We know that when Bob is sick, he usually doesn’t eat. We also know that on average, Bob exercises three times a week. Having access to this information equips us to predict the direction of Bob’s weight every day.
This all requires very detailed knowledge not only of Bob but also of exactly what he’s doing at all times, something neither practical nor possible for most people.
Bob’s actions are also sometimes irrational: feeling overconfident one week, he might try a very risky exercise move and twist his ankle; feeling down another week, after breaking up with his partner, he hibernates and goes on an incredible Netflix binge — wishing his healthy diet goodbye. These actions might be impossible to predict, but they are a real setback for Bob’s weight.
Applying the same logic to a company, we can first ask: are we aware of all the factors that might impact the company’s stock price in the short term? And if so, can we guarantee that we are fully informed on these factors at all points in time, and able to make timely decisions?
In regard to unexpected events: If the the news announces a new competitor, or a rumor spreads that the company’s long-time CEO is battling illness, pushing the company’s stock price down — how would you have predicted that?
This is what makes short-term stock picking extremely difficult.
The long term
Instead, you might think about taking a long term approach.
Let’s say you’ve just met Bob for the first time. He’s told you that he’s on a mission to get healthier and has shared information about his plan and lifestyle with you; he’s following a mediterranean diet and doing 3 to 4 hours of intense exercise per week. You know that most people with this type of lifestyle lose weight. You trust Bob’s formula and commitment and decide to check in on Bob in a year’s time.
The difference with this approach is that it makes a long-term prediction of Bob’s ability to succeed using only the most relevant and fundamental factors. If Bob succeeds, you believe he will get healthier. There is no need to obsess and preoccupy yourself with details — that may end up irrelevant — on a daily basis.
So, how did we apply a decision process to Bob’s long-term health?
Can following a mediterranean diet result in weight loss?
Has Bob chosen an effective exercise routine?
Do I think Bob can achieve this given his attitude and environment?
Is one year a long enough time period to see meaningful results?
How might this logic apply to investing?
Can the company’s intended strategy result in success?
Do I have confidence in the company’s approach to the strategy?
Do I think the management team can execute in the competitive environment?
How much time might it take to see a meaningful change?
Summing up
If you’re Bob’s partner, mother, best friend, or psychopath x-partner, you might take comfort in being a trader — watching Bob’s every move, every day, and speculate about what might happen to Bob.
And if you’re an equally confident but less intense fan of Bob’s, you might prefer betting on Bob in the long-term; trusting the direction and actions Bob is taking, without having to worry about the week he’s sick, overindulging at the buffet, or on a Netflix binge.
Are you a trader or investor?