Dissecting the delusion between stock trading and investment

There is a notion that continuous trading in the stock market is not healthy for an ideal portfolio and that an investor should focus on long term investment rather than getting involved in the day to day trades and market fluctuations. 

Now there are two types of stock market analysis: fundamental and technical analysis. Fundamental analysis tries to get an in-depth understanding of a company through its financial statements and deals with why someone should buy/sell a stock whereas technical analysis basically tells the entry/exit points of stock trade and mainly deals with analysing trends and patterns through charts. 

While it is true that a fundamental analysis would be difficult for someone without any knowledge or background in finance, in contrast, is easier for the average investor to understand at least the basics of technical analysis such as the uptrend or downtrend of a stock, by looking at the graph and act on it based on the trends.

The concept behind holding the stock long term

The duration of time one must hold a stock for long term investing used to be around five to six years (although there was never a fixed period) but has shortened due to the dynamics of technology, the world market and constant innovations. 

A company performing well at the moment might not even exist after 12 months. A good company is worth investing in only when it makes you money. For example, before the pandemic when the whole stock market was drastically down for a couple of years, even stocks with sound fundamentals failed to perform and generate a satisfactory return for their long term investors. 

Moreover, if an investor would hold onto a stock with good fundamentals even when it is going down with the index and not take opportunities in trading small-cap stocks, for example, which is often inversely related to index movement (as seen in the context of Bangladesh market over the years) then he/she is unlikely to make money given that all of their capital tied to sinking positions simply because of the brand value of those positions. 

What the investors fail to notice is the movement cycle. For example, a certain small-cap sector in Bangladesh, performed quite well a few years back when the whole index was down along with blue-chip stocks. 

So a person doing basic technical analysis might be able to understand the upward and downward trend of a cycle and might act upon it rather than keeping his money stagnant in the name of long term investment. 

Owning a good stock might make an investor feel good that he is owning a share of a reputed company but if that share has not generated any substantial return over the course of a few months or even years, then holding down that stock will have absolutely no value. 

Photo: TBS

Systematic approaches to investing

Methods and approaches of investing will differ from person to person. A process-driven style of investing or trading in the stock market is boring but reduces the chance of making fewer errors. Usually, most people join the stock market for the thrill of buying the most promising and trending stocks. 

However, if investors take positions based on rumours, tips or a gut feeling, then such positions can make them lose a substantial amount of money. Even during day trades, a person needs to be in control of how much money he/she can risk booking a profit or loss. The investor may not have control over the movement of stock prices but he/she should have full control of his own trading decisions. 

Stop-loss vs price average 

Often investors would not want to incur or sell a stock at a loss and would either hold the security in the hopes of a small correction causing the prices to either bounce back from a certain point or buy more to lower the average cost of their positions. This often happens when investors try to rationalise their losses. 

So what happens when someone buys a stock at Tk30, for example, and books a loss at maybe Tk28? At that point, he/she is mentally accepting a defeat against his/her stock selection. And by nature, since humans do not easily want to accept losses, they would rather opt to optimistically double down on their positions even when it is losing money. 

As for the option of cost-averaging one's position by buying the stock again at a lower price as it falls, it may not be sustainable for investors with limited capital as it is hard to determine how much further the stock prices may fall. This happens only when the investor refuses to book a stop loss to protect his/her investment and move on to another stock to recover the small loss from the previous purchase. 

Consequently, having a stop-loss position is often better than averaging out the cost of stock with declining prices. Therefore, before making any transactions it is important to gauge both the long and short term risks of such trades.

In conclusion

Trading, as opposed to long term investment, is not as bad as its being portrayed by top fundamental analysts from around the world with their theories and anecdotes of iconic legends like Warren Buffet. Everyone has their own strategy but a strategy is useful only when it is properly implemented and makes money with consistency. 

The author is a Deputy Manager at the Sales and Trading division of BRAC EPL Stock Brokerage Ltd.

Disclaimer: The views and opinions expressed in this article are those of the authors and do not necessarily reflect the opinions and views of The Business Standard.