The Speculator and the Investor

Across my social media I have been seeing a lot of posts from friends talking about their “investing”. While I am always elated to find out that my friends are investing, there seems to be an overall concerning trend amongst their style. There appears to be an abundance of talk regarding trading and speculative positions vs investing.

I’ve made mention previously the difference between speculating and investing. In essence, the investor regardless of whether they are looking for “value” or “growth” investments are looking at the future cash flows and profitability of a company and looking to purchase their perceived future value of these cash flows at a discount. Effectively trying to buy a $1 to be paid tomorrow for 50 cents today (obviously this changes from investment to investment but the general premise is the same).

The Trader or Speculator is a little different. Often they have no interest in working out the “real” value of the asset, they use the past price movements of the asset to extrapolate where the price is going to move to next. This process is commonly called Technical Analysis (TA). These traders will use tools like the Moving Average, Bollinger Bands and Volume to try to determine where the price is going to move to next.

The Trader is concerned with trying to take advantage of short term price movements to profit, while the investor is less concerned about the short term fluctuation of a stock price but cares more about the potential long term value.

Often when a TA trader is selling or refusing to buy a stock due to a short term down trend in a stocks price, the investor is the one buying. For example, an investor might find a stock that their fundamental analysis shows has a fair value of $9 trading at $5 today. The speculator buys the same stock, believing that based on price movements the stock is likely to trend higher. Unfortunately, the market starts to behave irrationally (lets say on potential trade war fears hypothetically) and the stock price falls to $4 quickly. Now the short term trader leaves the position, as the momentum as moved from positive to negative. The investor on the other hand, reviews the position and realises that rather than offering an 80% to its fair value, the stock is now worth 125% more than it’s current price. In this scenario the investor despite sitting on a short term loss while allocate additional money to the stock as it now offers greater potential returns.

If you were to offer to sell me a $2 coin for $1 I would buy it. The next day if you were to offer to sell me another one for $0.50 I would mostly likely buy as many from you at that discount as I could afford to. The trader is more likely to be the one selling that $2 coin because the price has gone down.

My philosophy on TA is that while it can be a useful tool to help determine entry and exit ranges for an investment it should by no means be the sole reason for placing a trade. Short term markets are irrational (prices move wildly for no reason), there are hundreds of articles that illustrate this point. A great example is to read the financial news before and after a trading day, 90% of the time what ever reason an expert is giving for short term price movements has been plucked from thin air.

Arguably, the greatest investor of all time Warren Buffett, once stated “over the short term the market is a voting machine, but over the long term the market is a weighing machine”.

This simply means that over the long term, investing based on sound principles and fundamental reasoning will result in better outcomes than trying to guess where the market will move over the next 3 days.