The Difference Between Trading And Investing

Author: Dan Norcini
Posted On: Thursday, July 24, 2008, 12:22:00 PM EST

Apparently some of our readers are confused as to the differences between investing in gold shares and trading in gold shares. Judging by some of the nasty grams I have received from a few of you, I thought it might be worthwhile to explain the differences in the two as to the manner in which they approach trading/investing.

Investors generally have a longer term view of the market, attempt to define a macroeconomic trend and position themselves properly for that trend as it develops and ride it until the trend is exhausted and the macroeconomic picture which gave rise to that trend is no longer valid. They do not try to trade in and out of stocks daily or weekly for that matter but look to add to their holdings only on price corrections as they slowly build a sizeable position to take advantage of the move that their macroeconomic view informs them is coming.

Traders are an entirely different lot and approach the markets much differently. Their goal is more one of market timing attempting to catch short term price movements both up and down and profit as they take advantage of those moves. They will move in and out of the market as frequently as they prefer. They are much more active in managing their holdings compared to investors who are generally more passive.

That being said, some of you seem angry with me because I counseled abandoning a trade that goes bad. The notion is that I am now advising selling out on weakness. Unfortunately, those who erroneously think this way do not understand that trading (note – I did not say INVESTING in ) gold shares involves buying them on subsequent price weakness AFTER they form a short term technical buy signal on the charts and SELLING them into a rally after they form a short term technical sell signal on the charts.

Sometimes a TRADE can move against you in which case, as a professional, I will get out of the trade with a small loss and immediately look to move back in after the market moves lower (assuming I am buying) after which it then provides another short term buy signal. I will then take that new trade again expecting it to move in my favor. If it does not, and the market violates a technical support level, I do not argue with the market, but get out with another small loss all the while anticipating yet another entry point at another level at which I get another new buy signal. If the trade then moves in my favor, I will ride it until I feel the current move up runs out of steam at which point I will exit the trade.

The entire point in this exercise is to KEEP MY LOSSES SMALL. Each and every trade I put on has a price point at which I know the trade is either good or bad. Trading discipline then informs me to either exit or maintain or even add to the position. Arguing with a market is a technique employed by losers who inevitably end up busted and broke, just another piece of road kill on the floor of the pit.

By moving into a market as soon as I get a technical buy signal, I am in at a point with a DEFINITE set risk which I define as small. The longer you wait to enter a trade, the more your risk increases because the market has moved further away from that price level at which you know the trade has soured. That is the key to successful trading. Some of you need to lose a lot more money before you learn to RESPECT the markets. Only fools and novices sit there and argue with the market over a losing position all the while their trading capital dwindles into oblivion. You must first learn how to keep your losses small if you are going to survive as a trader. If you can do that, the profits will take care of themselves.

Secondly, some of you are also confused over what it means to “BUY a FISHING LINE” or to “SELL A RHINO HORN”. Neither Jim nor I have ever counseled buying willy-nilly in some blind fashion into a falling market just because you think prices have fallen far enough. How do you know that they have? I can emphasize strongly enough that prices can always fall much further than you ever imagine is possible. As a matter of fact, they can fall far enough that they can wipe out the entirety of your trading capital. Again, learn to respect the market.

Nowadays there is a new phenomenon that did not exist 20 years ago in the same quantity or form that it does today – that phenomenon is the hedge fund.

I have repeatedly tried to inform our readers that hedge funds are almost exclusively technicians in their approach to markets and rely on their computer generated buy and sell algorithms to enter and exit markets. Such algorithms have them constantly chasing prices higher by buying strength or chasing markets lower by selling weakness as all they are interested in is momentum in either direction. IF IT MOVES, CHASE IT – is their motto. Hedge fund activity is of such size that even the commercial traders in the futures pits in which I ply my trade and make my living are fearful of stepping in front of them. Now, if some of the biggest players on the planet decide to unload on a particular market, are you going to be foolish enough to attempt to single-handedly step in front of them and cause them to halt their selling by your own force of will? Try it and see how long you last!

That is why you must have a point at which you know that a trade is not working in your favor and get out of the way of these players so that you do not end up buried by them. Keep in mind that the market could care less what yours or mine or anyone else’s opinion is. It will go where it wants to go when it wants to and will only stop when it is ready or in the case of a hedge fund selling orgy, when their sell programs stop issuing sell signals. That is the point you are attempting to catch when you enter a trade.

Sometimes, in spite of all the caution and research and analysis, the market simply does not cooperate. So what – that is life as a trader – just get out of the trade and wait for another opportunity. You will ALWAYS get another opportunity to trade that market but if you end up losing all of your capital in a hedge fund dump because you wanted to play the bold defender of the faith, you WILL NOT last long enough to get that opportunity. Keep that in mind and do not ever forget it. It is coming from more than 2 decades of trading experience.

Back to the issue at hand vis-à-vis Fishing lines and Rhino horns – in a falling market you DO NOT jump in and buy weakness because the market is falling. You buy it at a level in which you EXPECT support to develop or at which you have ascertained that downside momentum is ebbing. That level is determined by examining the price charts. When Jim states a level at which he is going to buy it is because he is making an informed decision based on an analysis of a price chart. I will do the same thing but I do not publicly state price levels. That is just a difference in our trading styles but we both mark our buy in points after careful analysis, not by arbitrarily picking some random number out of the air.

Before you buy in however, you should note a price point that you are willing to risk your trade to before exiting. That will vary for each and every trader depending on their temperament, their capital and their conviction. I personally HATE losses so I cut them short very quickly. That is why I get out of a trade that is not working and quickly forget about it and move on to the next trade. No one likes to lose money on a trade but how you handle a loss as a trader says a lot more about your potential to survive in this business than how you handle your winners. Anyone can do the latter (although some gloat entirely too much) but only a rare few can handle the former.

I will be the first to admit that there are times in which I will violate one of my trading principles and stick to a trade that has gone bad and even add to it but I only do that in those few cases that I KNOW BEYOND A SHADOW OF A DOUBT, that the technicians are simply wrong and that price is too cheap or too expensive. Keep in mind that knowledge comes from 2 decades of knowing the markets that I trade and even at that I rarely do such a thing so I do not recommend this as something that most should even think about doing. It should be noted that the futures world is completely different than the equity world. In the case of futures, one has to know the supply and demand picture and the nature of the particular product they are trading – in the case of the equity world a host of things could take place that could completely justify a stock sinking into the toilet. One of the cases that comes to my mind was the case with Crystallex a while back when the government of Venezuela announced that it was basically going to nationalize the mining industry in that country. I wonder how many traders ended their careers right then and there on account of that out of the blue occurrence. Taking a small loss in that would have been far preferable to getting wiped out, would it not?

I hope this clarifies some things for you all. I wish I could answer all of your emails but I simply cannot. Those of you who write to me in a civilized fashion can expect a civilized answer if I do find the time. Those of you who write to me in the spirit of a horse’s ass, can expect an appropriate reply, assuming I want to waste time answering your email.

Lastly, please do not blame Jim, myself or Monty for that matter because you might happen to own some junior mining shares that are going down. If you are looking to blame someone, blame the naked short sellers or the management that does nothing to protect its shareholders’ interests or whatever. Even better, look at the shares of the mining companies that are the leaders in the sector and move some of your money into those stocks at the appropriate points.

Do not get married to a stock. Successful traders learn to optimize their trading capital and move it where they can get the best return on their money. Some of you are still pining away at the poor performance of some of the South African miners. Try to be objective – if they are not moving up as gold moves higher and there are other issues that are, then get rid of them and buy the better performing issues. At the very least, if you still think that they will turn around, then at least lighten up on them and move some of that money into the sector leaders. The name of the game is to make money – to do that you need strong performers that maximizes your investment. There is a reason why some of those stocks are not performing. We may not ever know what it is but the blunt truth be told – who cares? You will be much happier and self-fulfilled to see a stock that you have purchased moving strongly higher in a favored sector than sitting there mumbling, frustrated, angry and bitter because yours is going nowhere, especially after doing all the research and analysis that convinced you to own a gold mining company to protect and grow your wealth. Besides, your wife will think you are a veritable genius especially when you can buy her a new car or take her to a fancy restaurant with your earnings! In the case of you gals, you can always remind your husband that you treating yourself to a shopping binge or the works at the local beauty salon with your own money so he can leave off nagging you about going overboard spending.

I sincerely wish you all the very best of success.

Dan