Investors and traders can learn from each other

jeannetteSHOWALTER, CFA

They might be traveling down different roads but traders and investors want to get to basically the same place. They both have making money as their primary purpose.

There are several ways to differentiate trading from investing: length of time an investment is held, the basis for making/exiting the investment decision (either technical or fundamental or a combination), and the means of execution (self-executed, professionally managed, or algorithmic/ computer executed), among a host of other factors.

Each of these various characteristics has a continuum of possibilities. For instance, with regard to the time an investment is held, high frequency traders are often arbitraging-away price differentials between markets and they might hold something for a nanosecond. The other extreme is the genre of investor akin to Warren Buffett who might hold an asset forever, or at least longer than most marriages last.

But, in very broad and general terms, investing is associated with: longer-term time horizons, fundamental analysis, which is most often the process behind asset selection, and human decision-making and execution, albeit with some computerized assistance.

By the very nature of any human process, a range of emotions (fear and greed, complacency, panic, euphoria, etc.) will influence (or even drive) the decision-making process.

A longer-term horizon is often synonymous with a buy and hold approach without any triggers to exit a position on prices drops. Rarely are there price rules, i.e. no hard and fast rules for stopping losses. The underlying concept in this case is that the fundamentals of impending growth, management changes, dividend hikes, etc. will be made manifest or work themselves out. Yes, there can be forms of portfolio diversification (ranging from nominal to true asset diversification) but rules for money management are infrequent.

Now contrast that to trading which is, in broad and generalized terms, shorter-term in time horizon (ranging from a nanosecond to day- to medium-term trading spanning several months). Also, trading is often technical only and has a large set of rules for entries, exits and money management of the portfolio. The larger the set of these aforementioned technical rules, the shorter the time horizon, the greater the exposure to markets trading nonstop, the more diverse the investment positions in a portfolio, then the more probable it is that the trader relies on algorithmic computerized trading. Unlike human decision-making, this trading has no emotion; it is void of fear, greed, panic or other emotions that influence human decision-making or execution. The objective is a consistent application of the rules and tools in the most efficient and objective ways. A lot of computerized programs were birthed by hands-on, very experienced traders who then transformed their trading methods into algorithms.

Now, do technicians disregard fundamental information as irrelevant? No, not at all; they know that behind price movements are the realities of the fundamentals of the market (. and buyer/seller emotions). But, for many traders, price reflects that which can often only be fundamentally explained and articulated after the fact.

I interface with both the trading and the investing worlds. My observation is that while many investors have not allocated a portion of their portfolio to trading strategies or systems, they are leaning and learning that way as they want to get into faster-moving or more leveraged markets needing round-the-clock disciplines. A second observation is that the trading community often embraces fundamental investing with a long-term horizon for portions of its portfolio, though traders are more inclined to bring disciplines of money management, true diversification and stop losses into their investment portfolios as they are less relative and more absolute performance oriented. So, one mindset clearly accepts elements of long-term investing; the other mindset is somewhat reticent to accept trading. I wonder is there a bias, or a fear, or a misunderstanding, etc. of trading? Maybe the problem is that the investment advice being rendered is more narrow in perspective and embraces only those products or services offered by the advisers firm.

The world is changing, the economies are changing, the weather is changing, wars happen, new Presidents get elected, analysts and money managers and investment committees come and go. Yet, the rules of the algorithmic black box are not always changing and consistently applied.

The mindset of the trader is most often: Cut losses and let profits run. There might be some real value to add this type of approach to investing to your portfolio. You might consider the merits of trading systems (directly leased to you by brokers or offered as a money management product by portfolio managers or advisers). Consider that if the hedge fund managers have embraced black boxes for a portion of their portfolios, it might be that you would do so too. Talk to your adviser as to suitability, seek diversity of opinions from multiple advisers and seek counsel from investment experts as pertains to specific asset classes. ¦

There is a substantial risk of loss in trading commodity futures, options and off- exchange foreign currency products. Past performance is not indicative of future results.

Jeannette Rohn Showalter, CFA, can be reached at 444- 5633, ext. 1092, or jshowaltercfa@yahoo.com. Her office is at The Crexent Business Center, Bonita Springs.