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RichPoorDad

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A tale of two investing styles
« on: May 27, 2012, 12:31:37 AM »
A tale of two investing styles
Personal Finance
By Efren Ll. Cruz

There are many investing styles being practiced in the market today. In fact, some investors even buy into pooled funds based on the investing styles of their fund managers. In my readings on portfolio investments, however, two generic strategies stand out. These are the “trading strategy” and the “buy and hold strategy”.

The acknowledged guru on the trading strategy is Jessie Livermore, the world’s greatest stock trader. Livermore had three major lessons for the investor. First, an investor must look at the pivotal points in the price of a stock or any other investment security for that matter. A reversal pivotal point is when a stock’s price turns upward after falling for quite some time. That is not the price at which to buy the stock as that stock’s price may again reverse direction soon after and continue its downward trek. The price to buy the stock is at the level where there is a confirmation of the upward trend, what he calls the continuation pivotal point.

Livermore also said that time is time, money is money. An investor does not always have to be invested in the markets. If the expectation is for the market to turn sour, the investor should take his profits or cut his losses and get out. More importantly, he says that investors should start cutting losses when such losses already amount to 10 percent of his investment. Livermore says that investors should never fall in love with their investments because these don’t know how to return that love.

Lastly, Livermore said that investors should take hold of their emotions, particularly hope, greed, ignorance and fear. These emotions would only distract the investor in executing his investing strategies.

On the other hand, the acknowledged practitioner for the buy and hold strategy is no other than Warren Buffet, the world’s greatest investor. Buffet had four lessons for the investor. First, once the investor buys a security he should stop monitoring its price movements. Buffet refused to be influenced by the daily gyrations of security prices and interest rates as well as the periodic reporting of macroeconomic figures. He is able to do this because of his second lesson, which is that he buys companies that profit regardless of the economy. This basically means that he buys companies that he thinks are inflation-proof and recession-proof.

Thirdly, he buys a business and not just a stock. To Buffet, stocks are meaningless unless they are connected with the underlying business of the issuer. If the business of a company is lifeless, its stock is also worthless. More specifically, Buffet looks at how well companies practice sound business management, financial and market tenets.

Lastly, Buffet spreads his risks by diversifying his portfolio. He truly believes in the old adage of “not putting your eggs in one basket.” At the same time, he does not believe in over-diversifying.

The proof of the pudding is in the eating as they say. So what happened to the two gentlemen? Jessie Livermore started his career at the age of 14 with just $5 in his pocket. Through his mastery of trading strategies, he was able to earn a cool $1 million in one day in 1907 and another $100 million during the 1929 stock market crash. Yes, crash. He apparently saw that stocks were already too expensive in 1929. As a result, he began to sell stocks short. Other traders at that time knew that Jessie Livermore was a great trader and they followed suit. As more and more people started to sell down the markets, prices fell deeper. Eventually, Livermore was able to buy back what he sold short at bargain basement prices, which earned for him his $100 million.

After that stupendous trade, Livermore lived like a king. $100 million in 1929 was a great deal of money. He was able to buy a mansion. He had a yacht moored behind his mansion. He had a live-in barber and he had women crawling all over him. And eventually he shot himself in the head at age 62 and left just $10,000 in assets and $361,010 in liabilities. He died a poor and broken man.

Contrast that with Warren Buffet who also started his career at a young age but who is still alive and kicking at age 75. At the end of 2005, Warren Buffet’s net worth was $42 billion, only $8 billion smaller than that of Bill Gates’. Buffet earned the title of being the world’s second richest man, and all from investing.

So which is the best strategy? Many studies have shown that the trading strategy just incurs unnecessary transaction costs for a portfolio and in the long run, produces returns that are inferior to the buy and hold strategy. Much more factors will have to be considered though, including investment horizon, risk appetite, investment goals and the like. What is indeed certain is that the trading strategy brings on more risk. Just make sure you get the commensurate return for the extra risk taken.

Happy investing.

Once you have defined these facets of your trading plan, you are in an excellent position to have a strategy to control your emotions when trading. Make sure to review your plan on a regular basis to create effective trading habits
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A tale of two investing styles
« on: May 27, 2012, 12:31:37 AM »

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