Which Is Better, Trading Or Investing?

By Ernest Lim


Are there are any stocks to speculate with a 1 - 3 months horizon? How about stocks to buy and hold for up to 2 years? Any recommendations? These are some of the queries, which are posed by readers and friends.

It is noteworthy that the above questions represent two different approaches and views on the stock market. Before I point out some “tips” for the two approaches, I would like to draw readers’ attention to their differences, which are tabulated below.



Differences between the two approaches (Source: Ernest): Table 1

Having appreciated the differences, I will now elaborate on the criteria to pick stocks for trading, as well as, buy and hold approaches.

Criteria to pick stocks for trading purposes

Presence of near term re-rating catalysts

There should be presence of re-rating catalysts in the near term. An excellent example would be dual listing. Typically, this should provide at least a short term boost to share prices, especially if companies are sound and are trading at price to earnings ratio lower than their counterparts in the stock exchange which they are going to list. Z-Obee is a case in point where its share price more than tripled since its announcement on dual listing.

Secondly, the industry in which the companies are operating in should be growing at phenomenal rates. It would be better if the companies’ peers are reporting better than expected results. This would increase the possibility of earnings surprise for the companies for this quarter and upside guidance for the coming quarter from the companies, spurring a re-rating of share prices. To be clear, the industry should be growing at phenomenal rates and not sustainable rates. Thus, it is not required to find companies which are growing steadily at 10% a year, but is required to find companies which are growing at least 30% y-o-y for the current quarter and next quarter.

Thirdly, if one is aware of the contracts bidding from the companies, one should be able to estimate when the contract wins would be announced. If I take Swiber as an example, an investor who is familiar with it should know that Swiber’s contract awarding period in South Asia and Southeast Asia is usually around Dec to Mar. Couple this with the improvements in the oil and gas industry, one should not be too surprised that Swiber announced a string of contracts during that period. Nevertheless, there is a fair level of risk in this prediction.

Fourthly, for companies with blockbuster products which are expected to have significant contribution in the near term may also be considered as stocks for trading purposes. These companies have the potential to enjoy a significant boost to earnings which may result in an upwards re-rating of shares.

Propaganda on the stocks

If readers want to trade, then a prerequisite would be to choose stocks which have propaganda. Examples of such would be plant visits and road shows where fund managers and analysts can get to know the company and company management better. Analysts typically will write analyst reports or some internal notes after such visits. Stocks which are good to trade should also have some “stories or some attention catching ideas” to excite the investment community. An example of such stock is KS Energy where it soared multiple folds when it announced that it would modify its business model from being solely a distributor of consumable oil parts to a rig refurbisher in 2005.

Technicals

This is a colossal topic to discuss here. Suffice it to say that the charts should look strong, indicators well placed, and price movement confirmed with volume and price action. As a result, traders may buy the stock at a relatively high price (as measured by valuation metrics such as high PE ratio against the peers) and sell it higher.

Criteria to pick stocks for investing purposes

For investors who are looking to buy and hold with a horizon of up to 2 years, it would be good to consider the following points:

Competent management - necessity for buy and hold

Management should be competent so as to manage the company well over the medium to long term. Over the short term, management competency can be masked by non recurring items such as executing seemingly earnings accretive acquisitions which boost the company’s results in the short term, or create propaganda so as to create interest in the stock. However, only time will tell whether these actions create shareholder value. Thus, if readers want to buy and hold over a longer period of time, it is pertinent to find a company managed by competent management.

Sustainable earnings and outlook

For this strategy, it is a prerequisite to find companies with predictable financial performance. To have predictable performance, the companies should have the following characteristics.

Firstly, the companies should operate in industries which are growing steadily. They should not be in industries with limited visibility or in cyclical industries. For example, the foundry companies typically have limited visibility and it would be wise to avoid them with a buy and hold strategy. In 2007, the automotive companies’ shares soared at the top of the industry cycle but subsequently fell due to over supply of wheels and lack of demand. Therefore, it is best to avoid industries with limited visibility or in cyclical industries.

Secondly, besides having a stable growing industry, it is important to buy companies whose earnings are predictable due to their business model. Companies whose earnings gyrate widely due to changes in demand should be avoided as these companies involve more monitoring and attention to hold this kind of shares. Nonetheless, if readers can determine that the companies’ lackluster results are once off and they are likely to post better results for the next few quarters, readers can still consider to invest in these companies.

Margin of safety

Buy and hold is typically a more conservative strategy than trading. Thus, it is important to reduce risk by having a good entry price, so as to have a good margin of safety. This is one of the tenets which Benjamin Grahman advocates.

Dividend yield

This is a good criterion to have as it generates income while holding your stocks till they reach your target price. In addition, it creates at least some incentive to continue holding while some of your friends may have obtained quick gains (as well as losses) in the market.

Conclusion - which approach is better?

To decide which approach is better, it depends on the horizon that one has. Different strokes for different folks so which approach suit you? It’s up to the individual reader to decide.

1 For the purpose of this article, buy and hold is synonymous with investing and entails a horizon of 4 months to 2 years. 2 years were chosen as there is considerable difficulty to predict beyond 2 years for the average retail investors.

Ernest Lim currently works as an assistant treasury and investment manager. Prior to this role, he was with Legacy Capital Group Pte Ltd, a boutique asset management and private equity firm, as an investment manager since 2006. He received a Bachelor of Accountancy (Honours) from Nanyang Technological University in 2005. He is a Chartered Financial Analyst, as well as, a Certified Public Accountant Singapore.

The Rules of Trading and Investing

The objective is not to buy low and sell high, but to buy high and to sell higher.

By MICHAEL PREISS

AMONG economists and on Wall Street in general there is now an active debate whether the massive stock market rally we saw globally since the mid-March lows is the beginning of a new bull market or whether it is simply a bear market rally that is now running out of steam. Since the March lows some stock markets around the world have risen 30-100 per cent while there was an increasing talk about 'green shoots' and the real economy recovering or at least getting less worse.

As we are entering the second half of 2009, most investors would do well to do a 'reality check' and reconsider their risk exposures and portfolio contents.

Investors are moving in lockstep like never before, driving up stocks, commodities and emerging markets and risking a replay of last year, when they all plunged the most since World War II. The herd mentality threatens to leave investors with no refuge amid signs that the worst US recession since 1958 isn't abating.

The market response to sell stocks now suggests a dose of nerves at the end of one of the best quarters for world stock market returns in history. It took the same nerves to go long and buy in March when everyone or at least most people were maximum bearish among widespread end-of-the-world sentiment.

Evidence on whether the positive economic currents have turned into profits for companies, which will start flowing soon, is needed before the rally can progress further. Stock price gains might be harder to come by as investors search for profit growth to justify the 41 per cent rally in the MSCI World Index. Whatever your view is on the state of the global economy, it pays to consider some truths and rules about trading and investing.

Never, under any circumstance, add to a losing position...ever! Nothing more need be said; to do otherwise will eventually and absolutely lead to ruin! Remember Citibank shares at US$55 less than two years ago, it fell to US$30, when our friends in Abu Dhabi tried to save them with a US$7.8 billion lifeline investment. Many thought Citi was cheap and 'averaged-in' only to see the once largest bank in the world slump to less than US$1.

Trade with an open mind. Still too many people only buy stocks and hope they will rise. We must fight on the winning side and be willing to change sides readily when one side has gained the upper hand.

The same applies to emerging markets. While fundamentally a lot of the emerging markets offer great long-term potential, short-term several countries look over-bought. So in emerging markets, it seems 'Short-term SHORT, Longer-term LONG' might be the best tactical advise.

Capital comes in two varieties: Mental and that which is in your pocket or account. Of the two types of capital, the mental is the more important and expensive of the two. Holding to losing positions costs measurable sums of actual capital, but it costs immeasurable sums of mental capital, not to mention stress.

The objective is not to buy low and sell high, but to buy high and to sell higher. We can never know what price is 'low'. Please remember Citibank. Nor can we know what price is 'high'. Always remember that sugar once fell from US$1.25/lb to two cent/lb and seemed 'cheap' many times along the way.

In bull markets we can only be long or neutral, and in bear markets we can only be short or neutral. That may seem self-evident; it is not, and it is a lesson learned too late by far too many. 'Markets can remain illogical longer than you or I can remain solvent,' according renowned British economist Maynard Keynes. Illogic often reigns and markets are enormously inefficient despite what the academics believe.

Sell markets that show the greatest weakness, and buy those that show the greatest strength. Metaphorically, when bearish, throw your rocks into the wettest paper sack, for they break most readily. In bull markets, we need to ride upon the strongest winds. They shall carry us higher than shall lesser ones.

Try to trade the first day of a gap, for gaps usually indicate violent new action. I have come to respect 'gaps' in my nearly 25 years of watching markets; when they happen (especially in stocks), they are usually very important.

Trading runs in cycles: some good; most bad. Trade large and aggressively when trading well; trade small and modestly when trading poorly. In 'good times', even errors are profitable; in 'bad times' even the most well researched trades go awry. This is the nature of trading; accept it.

To trade successfully, think like a fundamentalist; trade like a technician. It is imperative that we understand the fundamentals driving a trade, but also that we understand the market's technicals. When we do, then, and only then, can we or should we trade.

Respect 'outside reversals' after extended bull or bear runs. Reversal days on the charts signal the final exhaustion of the bullish or bearish forces that drove the market previously. Respect them, and respect even more 'weekly' and 'monthly' reversals.

Keep your technical systems simple. Complicated systems breed confusion; simplicity breeds clarity. Respect and embrace the very normal 50-62 per cent retracements that take prices back to major trends. If a trade is missed, wait patiently for the market to retrace. Far more often than not, retracements happen just as we are about to give up hope that they shall not.

Bear markets are more violent than are bull markets and so also are their retracements. An understanding of mass psychology is often more important than an understanding of economics. Markets are driven by human beings making human errors and also making superhuman insights.

Be patient with winning trades; be enormously impatient with losing trades. Remember it is quite possible to make large sums trading/investing if we are 'right' only 30 per cent of the time, as long as our losses are small and our profits are large.

The market is the sum total of the wisdom...and the ignorance...of all of those who deal in it; and we dare not argue with the market's wisdom. If we learn nothing more than this we've learned much indeed. Do more of that which is working and less of that which is not: If a market is strong, buy more; if a market is weak, sell more. New highs are to be bought; new lows sold.

The hard trade is often the right trade: If it is easy to sell, don't; and if it is easy to buy, don't. Do the trade that is hard to do and that which the crowd finds objectionable. In mid-march that trade was major bull. Now after the second half and a massive rally, common sense would indicate 'book profits' across the board and move into cash if not out-right short, if you are a tactical trader. In the words of a Chinese saying: 'Fortune favours the brave - and the prepared mind.'

The writer is a Chartered Wealth Manager and can be reached at Michael@michaelpreiss.net