What’s The Problem with Taking Profit as a Short Term Trader? Understanding The Power of Value Investing
Aug 14th, 2007 by AhYap
The market is very hot in the pass few months. Almost all people are talking about the stock market. The newspaper even make a few headlines for the market plunge last week alone.
Most people don’t understand what is stock and what they are buying. All they know is that there is a counter NAME and then there is a PRICE. And what they need to do is to speculate the movement of price, hoping to buy low and sell high to make some money.
They can use numerous techniques and most of them rely on rumors and tips. Some that are more advanced might use charting techniques which is know as technical analysis. Tips or charts, they are the same gang. They try to speculate on the price movement to make money.
Let’s say you have RM100,000 to invest in KLSE.
You speculate all in 1 counter and your investment go up to RM110,000 in 1 month (you may have used tips or charts in making the buying decision). Speculators believe that stocks are only paper money and only cash is the real money. When they hold stock, they feel risky. They believe that their money is in ‘unsafe’ position. So in order to see the real money and to protect their profit, they need to sell the stock and get the cash. After selling, they think their profit is now ’safe’. This is called ‘profit taking’ or ‘taking profit’.
The problem IS -
What are you going to do with your RM110,000 ’safe’ cash now? It might be safe now, but what do you want to do with it now? You might spend a few hundred or a few thousand to celebrate, but most probably you will still end up having RM100,000+ in cash.
So probably you will have to buy another counter (using another tip or chart). And this is irony because at first, you sell a counter because you believe holding a stock is risky and you must take profit. Now after you sell one, you have to buy another one and put yourself back to the ‘risk’ of holding a stock!
Are you sure you can pick a new one that can make you money again? If you invest based on pure luck, you can still be lucky for a few times but not definitely not forever. If you have to switch from 1 counter to another every month, you have to switch 12 times a year and 120 times in 10 years! Can you have a lucky streak of 120 times based on tips and charts? And most of us have more than 10 years to live!
While you can make money in stock, you can also lose money! You can always lose $10,000 instead of making $10,000.
This is the problem with short term trading. You didn’t reduce your risk in anyway because after ‘taking profit’ you still need to buy another counter. By thinking that ‘taking profit’ make your money safe, you are just lying to yourself. Your money is never ’safe’. You are just transferring the risk to another counter.
What do you need to do with your money after you sell is the biggest problem for a short term trader.
You need to trouble yourself in making new decisions and selections every time after you sell. And you won’t be lucky every time with your new picks. When the market is hot, you might have more luck on picking the next right counter. But in a sideway (now) or bear market, I don’t think you will have much luck speculating.
A long term value investor, on the other hand doesn’t need to do much with his investment. The market is so red on the week I went to Sipadan, and yet I can dive happily without looking at the market.
Long term value investors are buying for the long term. They don’t need to adjust their portfolio daily, weekly or monthly. And because they only buy GOOD businesses at DISCOUNT price, their risk is minimized. They don’t chase price upwards and they will even refuse to buy GOOD businesses that is not selling at DISCOUNT. They will stay away from BAD businesses that don’t have a good future. They don’t speculate on the next BIG thing, e.g. the next Microsoft.
You might argue to me that it is very hard to know the value of a stock. I FULLY agree with you because after I read 20+ books on investing, I still don’t know exactly how to evaluate a business. It does require a lot of work just to understand a business before you can put a value on it.
After reading 20+ investing books doesn’t make me a super investor that can pick and evaluate stocks. But, it let me know exactly what is the RIGHT STRATEGY for investing. It is not tips, not charts, not short term, not speculating. You also don’t need to guess who is in the next Microsoft or Bill Gates. That strategy is called ‘Value Investing’. It can be explained in 1 short sentence -
“Buy wonderful businesses at discounted price.”
People like you and me don’t have much time in evaluating businesses and calculating their value. If we believe in Value Investing, then all we need to do is to find a fund manager who practice value investing, who has a good track record for the pass few years (the longer the better) and have him invest the money for us! They are professionals, they spend all their time on evaluating businesses. Let outsource the job to them and have them work for us!
That explain why most of my money is in ICAP and why I can still dive happily in Sipadan when the KLSE dive 100+ points to below 1,300 last week. It only screws short term traders and speculators, it doesn’t screw value investor. Irony, value investor are more happy when the stock market dive because that’s the time when lots of wonderful businesses are sold at discounted price!
It takes me 4 years to fully adapt to value investing. I have been a short term trader and speculator. I have used tips and charts. I have been an active options trader for 2 years (buy and sell for over 1,000 times). I have attended several seminars and read a few books on trading, options and technical analysis. I have gone thorough a lot before I come to this understanding. For most of you, I don’t think you can understand the power of value investing from this post alone. Most people have to go through things themselves before they can understand. And unfortunately, most will never understand.
Good luck with your money!
Value investing has a lot to do with Price and Earning. Earning let you know the value of a business while the price let you know if it is selling at a discount.