IN BLACK AND WHITE

 

Trader or Investor

We are emotional beings and fewer events bring a swifter call to action than the possibility or indeed the reality of “losing” money in a market downturn. In fact because we are emotional beings we tend to fear a loss far more than we enjoy a profit - This makes us risk averse and frequently irrational.

Bull & Bear market turmoil

There is a saying which goes “ The bull takes the stairs and the bear jumps out of the window!” This means markets tend to move higher in small increments and over longer periods of time but when the selling starts, panic sets in, and everyone rushes for the same door simultaneously. Downturns are therefore relatively sharp and they can inflict significant emotional distress.

It is at times like these that the calls start coming through about whether to exit exposures (to the stock market in particular). It is always a difficult conversation to have because the equity market by nature does lose ground from time to time. Sometimes it loses a lot of ground. A good long-term investment strategy must by definition take into account these moves as they are a certainty and not a mere possibility.

But nonetheless, convincing a client to stick to the long-term investment strategy when it seems likely that things will get worse before they get better is not an easy task. A lack of action or activity can often be interpreted as failing to pay attention or worse, neglecting a client’s best interest. I believe part of a good advisor/managers role is to try and protect their clients from themselves and more specifically, from making investment decisions dominated by emotions.

A good strategy needs to be clearly defined as either an investment strategy or a trading strategy at the outset. If an investor loses faith (or discipline) in his strategy when the going gets tough, he usually runs the risk of exiting the market once he has suffered significant losses and frequently right at the bottom of the cycle. This activity typically cements previously unrealised losses and most commonly leads to the investor never getting back into the market again, meaning the damage done is permanent.

If you can be disciplined enough to look  past the short-term market fluctuations (volatility), which is the standard definition of risk, and categorise risk rather as the risk of a permanent loss of capital, then you may be less inclined to exit on weakness. 87% of the rolling 12 month periods over the 9 years to the end of August 2015, produced positive returns from the South African equity market.  Considering that this includes the Great Financial Crisis (GFC) of 2008/2009 it seems clear that markets do suffer losses but if you stay the path, the markets tend to recover and ultimately move higher as depicted below.

Graph JSE Top 40 TR Index Long Term

An investor that is considering over-riding or abandoning their long-term strategy (by selling), in favour of protecting themselves from downside risks, should do so at the earliest possible time and not wait for a rebound. Things can always get worse and if your mentality is to sell then best do so as soon as possible to avoid pulling the trigger right at the bottom.  This sort of conundrum implies a lack of faith in the overall strategy. Any discomfort with your long-term strategy should ideally be identified and confronted before any crisis takes place. If it is the crisis or the paper losses themselves that trigger the discomfort then you need to consider whether perhaps your emotions are eclipsing your common sense.

With the benefit of perfect 20/20 hindsight I think one can look at a graph of the equity market index and honestly believe you could have picked the high exit points and low entry levels. Unfortunately on a forward looking basis it is far harder to ascertain when these entry and exit points actually present themselves.

Things to keep in mind if you are considering adopting a trading approach to your investment portfolio:

(i) Exiting or selling a position is often the easy part of the trade - you sell, you lock in a profit and you feel good about it. (at least for a while)

(ii) Re-entering the market or buying back into a position is where things can get a little tricky.

(iii) What if you have not picked the top of the market to sell at and the market goes 10% higher. Do you buy back in? Maybe not. What if it goes 20% higher and everyone is saying it has even further to go – do you buy in then? Quite possibly.

(iv) What happens if your initial trade was right and the market goes lower after your sale. At what level or price do you consider buying back into the market? If things fall by 10% from where you sold do you re-enter? What happens if they fall a further 10% or 20% thereafter? Do you buy more or sell what you already hold believing it is going even lower? Not so clear anymore.

(v) Will you fall prey to the affliction that many succumb to by shifting between being a trader and an investor (Strategy drift)? You claim to be a trader but you land up becoming a long term holder of a position you bought that quickly moves against you and puts you in a position of loss. On the flip side you claim to be an investor who, when faced with a quick 20% profit, decides to sell it to lock in the profits only to see the position double from that point without getting a chance to buy back in at lower levels.

I have said it before and will no doubt repeat it often- Investing is simple BUT it is not easy. Having a good investment strategy in place with clear objectives and expectations can help you to maintain the discipline and the patience required to see your goals to fruition.

If your strategy is to invest for the long-term I would urge you not seek to trade or time the market outside of any tactical ranges that you identified as a part of your overall strategy. This way you will minimise the opportunities of making costly mistakes that can de-rail a good long run investment strategy.

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