There are three major differences between investment and trade. Overlooking them can lead to confusion. A beginning trader, for example, may use the terms interchangeable and misapply their rules with mixed results and unrepeatable. Commercial investments and become more effective when their differences are clearly recognized. An investor The objective is to take long-term ownership of an instrument with a high level of confidence that will continually increase in value. A trader buys and sells to capitalize on short-term changes in value with some 'lowest level of confidence. Targets, timing and levels of trust can be used to delineate entirely two different sets of rules. This is not an exhaustive discussion of these standards, but is intended to highlight some important practical implications of their differences. Long-term investing is discussed first followed by a short trading period.
My mentor, Dr. Stephen Cooper, defines long-term investment as the purchase and possession of an instrument for 5 years or more. The reason for this seemingly narrow definition is that when you invest in the long term, the idea is to "buy and hold" or "buy and forget". To that end, it is necessary to take the emotions of greed and fear the equation. Mutual funds are favorites because they are managed in a professional manner and that naturally diversify your investment over dozens or even hundreds of stocks. This is not just any mutual fund and that does not mean that one has to stay with the same mutual fund at all times. But that does not remain within a class of investment.
First, the fund in question must have at least a 5 or 10 years track record of proven annual gains. You should feel confident that the investment is reasonably secure. You are not constantly watching the markets to take advantage of avoiding or short-term ups and downs. You must have a plan.
Secondly, the performance of the instrument in question should be measured in terms of a benchmark well defined. One of these is the benchmark S & P 500 INDEX which is an average of the results of 500 of the largest and best performing stocks in the U.S. markets. Looking back for the 1930, over any period of 5 years the S & P 500 Index has gained in price by around 96% of the time. This is quite remarkable. If you enlarge the window to 10 years, notes that over any period of 10 years the index has gained in price by 100% of the time. The S & P500 Index has gained an average of 10.9% a year for the last 10 years. So the S & P500 is the benchmark.
If one invests in S & P500 index, can expect to earn, on average, approximately 10.9% a year. There are many ways to enter this type of investment. One way is to buy the trading symbol spy, which is an Exchange Traded Fund that tracks the S & P500 and trades like a stock. Alternatively, you can buy a mutual fund that tracks the S & P500, such as the Vanguard S & P 500 Index Fund with a trading symbol VFINX. There are others as well. Yahoo.com has a mutual fund screener that lists scores of mutual funds have annualized returns in excess of 20% over the past 5 years. However, you should try to find a screener that provides benefits for the last 10 years or more, if possible. To put this in perspective, 90% of the 10,000 or mutual funds so that there do not like the S & P500 each year.
The fact that 10.9% is average market performance for the past 10 years is all the more remarkable when you consider that the average yield of bank deposits is less than 2%, 10 years Treasury yields are about 4.2% and 30-year Treasury yields are only 4.8%. Corporate bond yields approximate those of S & P500. There is a reason for the disparity, though. Treasuries are considered the safest of all investments of paper, supported by the U.S. government. FDIC regulated savings accounts are probably the next safe, while stocks and corporate bonds are considered somewhat 'more risky. Savings accounts are probably the most liquid, followed by stocks and bonds.
To help gauge the safety and liquidity, the long bond holders are comparing bond yields are now receive next year with the expected returns of stocks. Consider that next year expected S & P500 yield is about 4.7% on the basis of mutual average price of its income (relationship P / E) of 21.2. Yet the 10-year annualized return the index was 10.9%. Bond holders are willing to accept half the historical performance of stocks for greater security and stability. In any given year, stocks can go either up or down. The bond yields should not vary much from one year to another, even if they have been able to do so. And 'as if the holders of bonds will be free to invest in the short term, and in the long term. Many bond holders are traders and investors rather than accept a lower yield for this flexibility. But if one has decided once and for all that is a long-term investment, high yield mutual funds or stock'S & P500 Index, in turn, it seems the best way to go. Using the simple compound interest formula, $ 10,000 invested in the S & P500 index to 10.9% a year becomes $ 132827.70 after25 years. At 21%, the amount after 25 years is more than $ 1 million. If in addition to an average of 21%, it adds only $ 100 a month, the total amount after 25 years exceeds $ 1.8 million. Dr C. rightly believes that 90% of its capital should be allocated in a more such investments.
Now that you have allocated 90% of its funds to long-term investing, which leaves about 10% for trading. Intermediate short-term trading is an area that most of us are more familiar with, probably because of its popularity. But it is much more complex and only about 12% of traders are successful. The time for trading is less than 5 years and is more typically a couple of minutes to a couple of years. The typical probability of being right in the direction of a trade approaches an average high of about 70% when an appropriate exchange system is used at less than about 30% without a trading system.
Even at the low end of the spectrum, you can avoid that wiped out the management dimension of business in less than about 4% of its trading portfolio and to limit any loss to no more than 25% of a commercial lease, while your winners until they decreasing by no more than 25% from their peak. These percentages may be increased since there is evidence that the probability of choosing the correct direction of trade has improved.
Intermediate-term trading is based more on fundamental analysis that tries to assign a value to a company's stock based on its history of income, assets, cash flow, sales and any number of objective measures in relation to its current price of Title. It may also include projections of future revenue based on reports of business agreements and changing market conditions. Some refer to this as value investing. In any case, the objective is to buy a company's stock price and wait for the market to realize its value and bid up the price of first sale. When the stock price is enough, the instrument is sold unless it sees a continued growth in the value of the stock, in which case he moves beyond the category of investment.
Since trading depends on the perceived value changes in a stock, the exchange of your time should be chosen on the basis of how well you can detach yourself from the emotions of greed and fear. The best you can remove emotions from trading, the shortest period of time he can commercial success. On the other hand, when you feel waves of emotion before, during or immediately after a commercial, it's time to step back and consider the choice carefully and trading less frequently. An ability to remove emotions from trading takes a lot of practice.
This is not just a moral statement. An entire universe of what is called technical analysis is based on the aggregate emotional behavior of traders and forms the basis of short-term trading. Technical analysis is a study of price and volume patterns of a stock over time. Pure technicians, as they are called, argue that all the news and evaluations were included in a stock's technical behavior. A long list of technical indicators has evolved to describe the emotional behavior of the stock market. Most technical indicators are based on moving averages over a predefined period of time. Indicator time periods should be adjusted to fit the negotiation period. The subject is too large to do justice in less than several volumes of the press. The low level of trust involved in the trade is the reason for the large number of indicators used.
While the long-term investors can use a single long-term moving average with confidence to track steadily increasing in value, traders use multiple indicators to deal with shorter time frames fluctuating value and higher risk. To improve results and make them more repeatable, consider your expectations to change the value your time and your level of confidence in predicting the outcome. Then you will know that set of rules to be applied.
James Andrews publishes the Wiser Trader Stocks and Options Newsletter. Information on selected stock market trading systems, including those of Dr Stephen Cooper, can be found at http://www.wisertrader.com.
© 2004 Permission is granted to reproduce this article, as long as, this paragraph is included intact.
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