The Difference Between Trading and Investing
Contrary to popular belief you do not need to understand high level statistics or even be able to read a balance sheet in order to be a successful investor. Investing isn’t about numbers -- it’s about narrative. How else would you explain a company like Amazon -- a hybrid of Walmart and Federal Express -- which is very good at selling dollar bills for 90 cents. Yet despite never making a dime Amazon’s stock has made its founder Jeff Bezos so rich that he can drop 250M on a vanity publishing project like the Washington Post.
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Apple on the other hand makes more money than the Medici but has seen its stock tumble by 40%. What is the difference? Its certainly not the numbers. Erase both names off the letterhead and set the pair of books in front of an investor and I am sure you would be shocked at what each business will be valued at in a private transaction. The difference is narrative. The Amazon story is all about how they will own the world of commerce, while the Apple story is that after the passing of Steve Jobs they have nothing new to offer to the world.
So narrative, not numbers drives investments -- which is why some of the best analysts on Wall Street come from liberal arts backgrounds with degrees in such disciplines like Comparative Literature rather than accounting and finance. Any moron can build an Excel model whose investment worth is usually less than zero, but few can imagine the future. (see Tesla auto).
As human beings we love narrative. Storytelling is as old as the cave and deeply woven into our DNA. But as traders narrative can be our worst enemy. As traders we operate on a time frame where narrative can change in a heartbeat. Unlike investors who have the luxury of time on their hands to discover if their narrative thesis plays out as imagined, we -- with our levered accounts and day trading focus -- enjoy no such privilege.
Investing may be all about narrative, but trading is all about levels. Trading by its very definition is
the art of profiting from short term movements in price. Value means nothing. Narrative means nothing. Only price matters. And price is ultimately a function of levels. Are they broken? Are they supported? How much do we risk to find out the answer? Those are the only questions that should matter to us traders.
Don’t get me wrong. As a trader you should know your narrative. You should be keenly aware of all the macro and micro themes running through the market, if for nothing else than to know when to stand down. But as traders we cannot make the following mistake. We cannot enter into a trade based upon a price level trigger and then remain in it because we are convinced of its narrative truth.
Yet we all fall into that trap.
In one of the greatest movie lines of all times in The Big Chill Jeff Goldblum challenges Kevin Kline to find anything in life more powerful than rationalization.
Michael: I don’t know anyone who could get through the day without two or three juicy rationalizations. They’re more important than sex.
Sam: Ah, come on. Nothing’s more important than sex.
Michael: Oh yeah? Ever gone a week without a rationalization?
Narrative is what we use to rationalize our losing positions and as traders we simply can’t afford that luxury or we will go bankrupt.
The difference between traders and investors is that we trade levels, not narrative and we constantly have to remember that fact.