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Rookie Corner: Philosophy 101

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Good Day Y’all! How’s the nerves now? Did you take a new perspective on the markets away from the blog last week? We talked about two of the biggest players in the money game and how they remain focused and calm under all market conditions. I don’t expect that by just reading the blog you became as calm or as focused as Buffett or Jones is but I am hopeful that you were able to see that there is a different way to see things and that part of the trading journey is getting to that place where you are confident that everything will be ok and that with enough skill, knowledge, and experience that you can work through all the challenges that come you way in the game of trading. That brings us to this week’s topic. This week I want to expand on the investor vs trader topic that we briefly mentioned in the last couple of writings. I feel like we can do a better job of preparing ourselves for the eventual ups and downs of the market if we understand that drawing a hard line between the investor and trader mindsets is a wise thing to do. There is nothing to say one can’t be both but blurring the lines between these two things can be very detrimental to the bottom line.

First, let’s talk about the two different mindsets and why we need to keep them separate even if we do both at once. The investor can be thought of as someone whose mission is to build an asset base full of quality businesses that will appreciate in value over time and provide some kind of benefit in the future. For example, if one goes out and buys a portfolio of quality dividend-paying stocks then one is most likely expecting to collect that dividend income for the foreseeable future as a reward for owning a piece of those companies. This is a completely normal mindset and as we discussed last week is akin to what Mr. Buffett does. He seems to have done very well with that philosophy. The trader, on the other hand, wants the reward for their work much sooner and is most likely less concerned about a reward down the road and more wanting more instant gratification.

These two mindsets are quite different but both require similar skills and knowledge but really the only glaring difference might be the end game. So, you may be asking why do we need to draw a hard line between these two things even if we do both simultaneously? The reason, much like everything else in this game is emotions! Let me run a very common scenario by you and let me know if this sounds familiar? A guy named Joe goes out and buys stock XYZ. Joe buys this stock because he thinks it is going to moon because of some new tech device that everyone is talking about? Joe has been told that stocks are driven by supply and demand and he truly believes that this device will revolutionize the world and he is going to make a quick buck on this purchase. Joe buys this stock at $100 per share because he is certain it’s going to $200 per share almost immediately. Let’s fast forward a little while after Joe’s purchase…XYZ stock is at $120 per share and Joe is certain he is right about this company. You see Joe read about this company in an online article and was convinced by some very “credible” sources that this new device was the bomb! Meanwhile, many others had read this same story and thought as Joe did and they too bought some stock which pushed Joe’s price in the direction he thought it should go. Here is what Joe didn’t realize because it wasn’t in the article that Joe read, that device was a new pacemaker type device and it was only in testing when the article was written and had not yet been approved by the health department for full use. What Joe was doing here was a speculative trade, although not a great one for anyone who has a decent financial education. Fast forward a couple more weeks and the news comes out that several patients have died because these devices have failed and therefore the health department has denied use of this new device. As you can imagine the stock price has plummetted down to $50. Now, Joe has an opportunity to chalk this up as a losing trade and move on, however, Joe changes from speculative trader to long term investor, you see Joe reads more about this particular company and learns that XYZ has other medical devices and pays a very small but not necessarily a steady dividend. The reality here is that Joe doesn’t want to take a 50% loss on his position and instead turns into a longer-term investor because he believes he can get back to even if he collects the dividend and waits for the stock to rebound.

Now what Joe failed to realize was that the deaths of those folks from that device were not settled and the company had more challenges ahead stemming from lawsuits. I will say this that no one really knows what exactly will happen to XYZ company going forward but this initial trade loss is now being compounded because Joe has gotten emotional about the loss and now has blurred the lines between trading and investing. If Joe had chosen to either trade this stock and use appropriate measures to prevent catastrophic loss or invest in the stock and do the required fundamental analysis to invest in this company then he would have been able to at least save himself some capital and live to play again. As it turns out in this story the XYZ company couldn’t get out from under the lawsuits and filed chapter 11 and the shares eventually went to zero giving Joe a max loss.

Trading and investing can both work and can be done at the same time but only if one truly understands the proper mindset and skill set that is required to do both. I have seen Joe’s scenario play out so many times and it typically ends the same when the lines get blurred. It is the emotional hit that causes this switch from one discipline to the other and it seldom works out well. The key to being successful in both trading and investing in to have a plan for both that involves exits for worse case scenarios and best-case scenarios alike.

So, if you ever get the urge to jump ship make sure you are prepared and fully understand the ramifications of the two sides of the trading coin.

Trade well,

Coach Holmes

One Reply to “Rookie Corner: Philosophy 101”

  1. MichaelNott says:

    Thanks Greg, That was a great reminder.
    Cheers,
    Mike

Comments are closed.

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