Saturday, November 06, 2010

Just What is Trading?

This weekend, I thought I might address the concept of trading and take a look at how I think of it. As you read through this article, I suggest you consider how you think of yourself in terms of whether you might be an investor or a trader and whether or what difference it might make to your approach.

One of the hardest questions I've tried to answer recently is: "How do I define trading?" Dictionary definitions vary. The most common definition seems to be: "The business of buying and selling commodities; commerce." e.g., We can see that definition incorporates no time parameters. On the other hand, adds a time parameter in defining trading as: "Buying and selling securities or commodities on a short-term basis, hoping to make quick profits."

I would tend to agree with the first definition and not necessarily incorporate the "on a short term basis, hoping to make quick profits" language. Setting aside the issue of what actually is a short term trade (is it 5 minutes, 5 days, 5 months?) how might the definition influence our thought and trading action? Of course a quick profit may be desirable to a trader, but not at the expense of cutting profits just to make it a short term trade. For example, what if a directional position is moving in a trend in the right direction? I certainly would not want to pull the plug and end a profitable trade as it is still going my way in exchange for a quick profit and a short term trade. Am I not still a trader even when I refuse to cut profits and stay in such a position?

In my own experience, trades can last from minutes to a year or more. As long as things are going my way and I have no emergency requiring me to close a trade to gain cash, I want to stay in as long as it keeps adding profit. As far as I am concerned, that is still trading.

A subscriber posed the question whether holding a long term stock position and selling covered calls is trading. My answer was yes. Even if the stock is held with a long term outlook, the regular periodic sale of calls constitutes trading in my book and, of course, if the calls are exercised the stock will be sold (assigned).

Why is a discussion about the definition of trading of any value? Many folks seem to think of trading as synonymous with daytrading and seem to have an aversion to trading as a result of that impression. In my own opinion, and I emphasize it is just my opinion, I consider anything short of pure buy and hold as trading. In other words if the trader/investor has any exit plan other than his own death he is trading because he has an established reason to get out of his position(s).

Most importantly, however, I believe the critical part of the definition of trading is that it is a business. I could not agree more with that part of the definition. It is a business, and in order to achieve success whether one styles oneself as a trader or as an investor, the person needs to treat it as a business. He needs to have an education, he needs to formulate a plan, he needs to understand the overall risks and the risks of a specific position, and he needs to have capital. Beyond that, from my perspective, he also should have an exit strategy in place before entering any position.

Maybe the distinction between investing and trading is one without a difference. Or maybe it should be. What do you think?

by Bill Kraft, Editor
Copyright 2010, Makin' Hay, Inc.
All Rights Reserved

P.S. Save $50 PER MONTH on my subscription trading newsletters!
SAVE on my Under $10 Stock Trader Service!
SAVE on my Option Trader Service!
SAVE on my Trend Trader Service!

Technorati tags:

To comment on Bill's article click on the "comments" link below.


Tony"D' said...

Although I think of myself as a trader,exiting my position at the end of the day, your article does make sense by expanding the definition to longer time frames if in your best interest.
Tony "D"

Anonymous said...

Dear Mr. Kraft,
I also share your definition of "trading". As a result of learning many expensive lessons over an extremely long period of time, I eventually discovered that I could not simply buy any security in this fragile world without proper research or an exit plan.

In reading your book, "Trade Your Way To Wealth" you mentioned that you are a multimillionaire and live in Hawaii most of the year. You also appear to have a personal desire to help others... In other words, an accomplished lifestyle and a worthwhile objective that most of your readers would love to attain.

Now, I have to admit although I consider myself a lifetime student of the vagaries of the market, having learned with some rather bitter financial bumps and bruises along the way, that I had already adopted a few of the techniques you currently employ with such success.

What I would like to point out however, is that as much as many potential or experienced traders might desire to join with you by subscribing to at least one of your newsletter services, most of your selections cost over a thousand Dollars a year (with the exception of the $10 Trader at over $800) which makes it a bit prohibitive to join "on faith alone" since presumably most have yet to attain their own aspirations of your aforementioned financial status.

My suggestion here, as well as commenting on your excellent articles, is to petition you to consider taking just ONE of your services (such as the $10 Trader) and reducing the price to under $100 a YEAR for the first year or two so that people can get to know you better, understand your rationale, absorb your educated views and take on larger roles with you over time. You might even consider throwing in a copy of your first book as an incentive to join with you in educating traders. That, my friend, would tend to assure others join with you...and who knows, I might even become a subscriber myself since it is always wonderful to have company on the path to wealth.
Cordial regards
PS I can imagine that a common rebuttal to my suggestion might be that "If you think education is expensive, try ignorance" take comfort that I have already admonished myself for writing this epistle to you.

Anonymous said...

I've seen people who simply adore the excitment of the market. They're in and out of trades all the time, sometimes in seconds, often in minutes, frequently within a day or days.

But one of these traders (Tim Knight) once had a throwaway remark in his blog in which he noted that an IRA that he left alone and didn't pay attention to (at that writing) was doing as well as any of his actively (not to say madly!) traded accounts.

Knight's comment percolated in my mind for a long, long time. I finally decided to separate my portfolio into an active one in which I "trade" (which few of my trading friends would call trading given, for one example, how far out I buy calls holding them as long as they're going my way) and the balance of my money is in a passive portfolio of index fund ETFs and dividend-paying stocks with the intention of holding all of them indefinitely.

If I find that I'm good at my pokey way of trading (I've learned -- finally! -- to have a near, clear exit in mind and to TAKE THAT LOSS QUICKLY), if I find I'm pretty good, I'll add to my so-called trading portfolio and trade with greater amounts of money. But only after I prove myself.

That said, I think one must always take into account one's personality and what one wants in life. My goal isn't to become rich (which I would like, btw) but to make and have enough money so that I can pursue my true life goals without my (usual and distracting) worries about money.

I know that some people really, really want to make a lot of money. It's a game with them and they want to be WINNERS at that game.

I understand that; I want to be a winner at my game which has little or nothing to do with money.

And my trading, if one wants to call it that, just doesn't happen to be fast-action activity. Instead, it's a combination of long-term investing and some pokey trading in which I can hold, say, a call or put position for months because it consistently pokes along with a slow and steady profit.

Anonymous said...

I also want to add to my above post that taking advantage of your coaching helped enormously, Bill.

Also, I learned (after thinking about matters for a few months) that FOR ME slow and steady appears to win the race.

But I won't know for sure for another year or so!

~ Nona

Bill Kraft, said...

Thanks, Tony "D" I think it helps all of us to look at things from a different perspective sometimes.
Bill Kraft

Bill Kraft, said...

Thanks for your contribution, M. First, let me say that I do not control the price of the subscription services; that is left to the publisher. Second, as you point out, the purpose of the subscription services is education and if $1000 or a little more a year can help someone learn how to cut losses better or achieve more success in letting profits run I would suggest they are a true bargain, particularly when one considers that the cost is quite likely much less than the cost of even a single trade. I also should mention that new subscribers get a month free to check out the Trade Tables showing the successes and failures of the past and to make an informed decision whether the education is worth it or nor before committing any money at all to a subscription.
Bill Kraft

Bill Kraft, said...

Thanks, Nona. Slow and pokey may well win the race for many and frenetic trading can lead to disaster. In my view, it usually comes down to the quality of a trader's plan and the disciplined execution of that plan.
Bill Kraft

Anonymous said...

I've enjoyed reading and learning (I'm ALWAYS learning) from your columns. The suggestion you made a while back to make a copy of the chart when you buy or sell is one I've used ever since. It definitely helps with the post mortems, seeing what I did right or what I overlooked.

I'm a swing trader trying to capture as much of a move as possible. I've made up my own form wherein I enter the indicator values that work for me and at the right-hand side have columns for the highs and lows of the day.

I'm not interested in the closing price as it really is meaningless to my trading. I color code those columns, green if going up, red if going down. I also color code the indicators giving me a very good view of the security's direction and strength.

I enter a long position as soon as I see the indicators turning up and exit when they start to reverse. I then go short if the main trend has changed, otherwise I wait for another good entry on the long side if the main trend stays intact.


Bill Kraft, said...

Thanks for writing, B.C. Sounds like a very interesting approach and illustrates that you have definitely established a plan that works for you. While each of us may have a plan that is unique to us your plan also suggests that we can succeed in diverse approaches. Again, thanks for the illuminating contribution.
Bill Kraft