Investment and Trading!

There are only two ways to participate in the market - Investment and trading. But the definition of these approaches is not what is usually believed.

A long-term investment strategy is to buy and forget. Invest in a particular business, review that BUSINESS periodically, and don’t track your investments regularly.  There are successful investors who follow this approach and create wealth over a LONG-TERM. They have sat through bear market cycles and significant drawdown but have remained disciplined investors. They don’t track their portfolios daily; they track the business and exit only if there is anything wrong with the business. Otherwise, they remain invested in it irrespective of the price movement. There are many people who have generated significant wealth by following that method, even with a moderate success ratio.

You can either follow the above approach or adopt it for a portion of your portfolio.  Even systematic investment plans, PMS, and other investment products fall in this category. Returns are generated over the long-term and there is no way to know HOW LONG.

All other formats of investment can be called trading:

• Long-term trading
• Medium-term trading
• Short-term trading
• Very short-term trading

People often want to invest for a certain period. Usually, investment for 1-3 years is considered long-term!  But what is the logic behind this 1-3 year duration? Is it based on the availability of funds or tax requirements or some other arbitrary rule?

The other aspect is that the market doesn’t work based on our tax profile, fund availability, or fund requirement. Investment is a long-only approach. Market cycles are random or complex in nature; they will perform well and generate great returns when the market is in an uptrend. They will not perform if the market remains sideways or in a downtrend.

There is no tool in any branch of analysis that can tell you how the market will behave over a period. Yes, there can be high probability models to predict movements but remember it is still a probability. You need to have a rule where the view will no longer be valid, and you need to liquidate the investment. This rule must be based on price behavior and not on time.

Irrespective of whether you are a short-term, medium-term, or long-term investor and the approach to trading or investment, it is imperative that you have a clear EXIT rule in place.

In a nutshell, if you are not going to buy and forget - you need to have an exit strategy.

Exit rules can be based on any criteria such as company performance, maximum acceptable risk in a trade, violation of some moving average on the price chart, or any other logical objective measure.

There is no perfect method of exiting the trade. It is not about being right or wrong, it is more about risk management. Like the entry method, every exit method has its pros and cons. But a clear rule of exiting the trade is the most crucial aspect of successful trading.

You can keep the portfolio churning in control by developing laggard exit methods. But churning will be higher and it is possible that you have to exit and re-enter during a strong uptrend which will not happen in the case of buy and hold strategy. The process may incur some impact cost, but I would say it is a premium we pay for minimizing the drawdown that occurs during severe downtrends.

By exiting on investment, you can analyze the situation again and consider investing in some other themes or stocks that are outperforming. Market leaders may change during the next leg up and by getting rid of underperforming stocks, we get an opportunity to invest in such new stories and outperforming stocks. I believe it is a better business than keep praying and hoping that the stocks in which we are stuck, would recover

A good driver is not known by how well he or she can accelerate but on their control over brakes. Similarly, a good trader is someone who has an exit plan in his control.