Learning to trade might be the smartest thing you ever decide to do.
Learning to trade and become a successful trader is hard work – very hard work. Let’s be honest, it takes years. And most never make it. The title of this opinion piece is not meant to suggest that everyone should learn to trade – but, that if you’re on this path, if you’ve decided you want to become a trader, here are 5 good reasons to persist.
“Long-term investing is wounded and may not recover. Everything is going self-directed; the short-term perspective will become the norm. We will see a lot more people taking control of their finances, self-directed investors.” Tom Sosnoff, co-founder Thinkorswim
1. Forget buy and hold
Dow Jones Index 1956 – 2009 (monthly, semi-log scale)
We have just experienced 20+ year bull markets in equity and bond prices. These bull markets started in 1982 at about the same time inflation peaked. For industrial equities (Dow Jones and S&P500 indices) the peak was 2007; for high tech equities (NASDAQ index) the peak was 2000. The peak in bond prices was arguably this year.
The first macro factor contributing to this run up in prices has been the reduction in inflation. US CPI peaked in 1980 at over 14%; the Federal Funds Rate peaked in 1981 at over 19%. As inflation has come down, so have interest rates. As interest rates come down, bond prices go up. And then there’s the equity analysts: lower interest rates means lower discount rates in their discounted cash flow valuation models leading to higher valuations and higher PE Ratios.
The second macro factor in these bull markets has been the additional leverage available. In 1979 I was in an English boarding school. I remember my roommate squirrelling away his weekly pocket money in a bank savings account. When I asked him why he wasn’t spending it on sweets and going to the movies on the weekend (ah, those were the days) he said he wanted to be sure that his bank manager saw him as a good risk when he left university and wanted a home loan from the bank.
As we all know, times changed. The banks gradually got looser and looser with their lending standards – up until it blew up in their faces. And the end result was more and more debt for everyone – individuals, corporations, private equity firms, hedge funds – driving up equity and asset prices around the world.
But now inflation is virtually zero. If you factor in declining rents, CPI in the US is negative. The Federal Funds Rate is virtually zero, long term Government bond yields are between 3.5% and 4.5%. The decreasing inflation part of the run up in markets and valuations has reached the end of the road. And finally consumer and corporate debt levels are starting to come down for the first time since the Great Depression.
Updated thoughts on why Buy and Hold Is Dead … IMHO.
2. You need to take personal responsibility
These 20+ year bull markets in equity and bond prices also had a dramatic impact on the Financial Services industry – it boomed and it boomed all around the world. Corporates raised debt with bond issuances and went public with equity raisings. Mutual Funds bought these securities and Joe Public bought the Mutual Funds.
Along the way, Governments saw an angle, a way out of a sticky problem they faced. In the long run, with ageing populations and declining population growth rates, they couldn’t afford the growing cost of funding state pensions. The Financial Services industry offered them a way out: “mandate employees to fund their own pensions and you’ll be off the hook”. The industry would sell even more Mutual Funds to Joe Public and the Government would throw in a tax break to sweeten the deal.
Now we have Joe Public’s savings plus his mandated pension contributions flowing into the Mutual Fund industry. And here is where you find their dirty little secret. A fund manager has two choices when charging for his service:
- Charge 10% (or so) for performance above a benchmark, or
- Charge 2% (or so) of the total assets being managed
Now, why make life difficult for yourself. Number 1 is hard work – very hard work. Number 2 is easy – buy what everyone else is buying (no need to stick your neck out) then buy a little more when the new monthly contributions flow in and pick up your 2% along the way. Plus Joe Public will like it, because 2% is cheaper than 10%, right?
So, the dirty little secret is that the fund manager has learnt it’s much easier for him to not stick his neck out by trying to out-perform his peers, but just keep taking the 2% of this river of investable funds flowing his way. The end result? He’s forgotten how to invest, how to time the market, how to sell at the top. And here’s a shocking documentary from PBS Frontline about 401(k) fees and the US pension industry.
3. Reduce time-in-the-market risk
Everyone know the story of Pavlov’s dogs? The classic “conditioning” experiment.
Day 1: Pavlov rings the bell, the dogs don’t know what the hell is going on. Pavlov feeds the dogs. Day 2: Pavlov rings the bell, the dogs stand around. Pavlov feeds the dogs. Day 3: Pavlov rings the bell, the dogs … you get the picture, by the end of the week Pavlov rings the bell and the dogs know they’re going to get fed.
Well, fund managers are just like Pavlov’s dogs. No, that’s not fair. “Investors” are just like Pavlov’s dogs. They have become conditioned by a 20+ year bull market. Their investing behaviour is based on a bull market. Their heroes and mythology (“the Sage of Omaha”) are based on a bull market. Their mantras are based on a bull market.
Like this mantra: “It’s not timing the market but time-in-the-market that counts.” We’ve all heard that one. Probably what stopped your fund manger from taking profits in 2007.
My point is – if the game has changed, the rules you’re playing by have to change. If we’re not in the middle of a bull market any more – then your investing behaviour has to change. All of a sudden being out of the market is not such a crazy idea. Taking small profits consistently makes more sense than holding for Peter Lynch’s “10-bagger” (a stock that goes up 10 times while you own it).
4. Reduce currency risk
I’ve spent my whole life in a currency crisis. For that matter, I’ve spent my whole life in a declining Empire. You see, I’m British – well, half British, my father was American. And we British know what it’s like to have our currency and international standing gradually diminish.
When I was young, my father would occasionally reminisce about visiting London just after the war and tell his version of how he met my mother. “Back then” he’d say “one Pound was worth four Dollars.” While I was growing up the Pound was mostly worth two Dollars. Then in 1985 the Pound went as low as being worth only one Dollar!
I remember at University working with a couple of mates on a software programming contract for a US company. The opportunity of being paid in US Dollars came up – and we jumped at it! Wow, be paid in US Dollars – yeah, now we’d hit the big time.
You see, everyone in England knew it, deep down, kind of instinctively – no one wanted our money. Not the Americans, not the Germans (they had the Deutschmark – impenetrable fortress), certainly not the French. About the only people we had it up on were the Italians – the Lira, now that was just a joke, Monopoly money.
But it’s now 2009 and the world has changed. I don’t know what happened to America but something’s gone wrong. The entrepreneurial engine of the world has turned into ….. (fill in the blank). It seems quite possible that America will suffer the slow ignominious decline that Britain has suffered since the Second World War. And the US Dollar is not as almighty as it used to be.
5. We are witnessing a ‘Golden Age’ for traders
To paraphrase Dickens: “It was the worst of times, but it was also the best of times”. Yes, things are bad after the GFC but the opportunities for traders have never been better.
Frankly, we’ve never had it so good. Here are just a few reasons, off the top of my head:
- Lightening fast online order transmission
- Tiny commissions (less than tick value for the Emini)
- Negligible slippage when entering/exiting
- Very reasonable margin requirements for futures
- High quality research & analysis, available for free
- Ability to trade almost any instrument (equities, FX, futures, options, etc.)
- Sophisticated software that makes even auto-trading possible
- Community of knowledgeable traders available via forums
- Literally thousands of books now available about trading
- Trade from home, office, boat, beach, pool-side, travelling abroad, etc.
We are privileged to live in a ‘Golden Age’ for traders – so take advantage.
This article should have convinced you that:
- Buy and hold is dead. The two key contributing factors that drove the bull market – decreasing inflation and increasing debt – have gone. So forget buy and hold.
- You need to take personal responsibility for your finances. Your mutual fund manager and/or broker are looking after their best interests, not yours.
- You can reduce your risk by reducing your time-in-the-market. While you are holding a position your capital is at risk. Reduce risk by trading shorter term.
- You need to maintain the purchasing power of your capital. Holding your assets in US Dollars may not be the safest bet. Use your trading skills to follow long term Forex trends and move your capital into stronger currencies.
- The opportunities for traders have never been greater. We’re living in a ‘Golden Age’ for traders, with access to everything the Pros have. All you need is a passion for trading and an Internet connection.