|by Wes George
Are You a Speculator or an Investor?
August 16th, 1999
"If you don't know the difference between investing and speculating, then for you, there is no difference."
Ken, a portfolio manager, at a recent cocktail party.
Ameritrade runs a commercial on CNBC which features an office boy sporting a Mohawk instructing his balding, middle-aged boss on how to log-on and place a market order for a hundred shares of K-Mart. The spunky office boy says that "buying stocks online is as easy as falling in love". That reminded me of a quote from Edward Chancellor's new book, Devil Take the Hindmost. Fred Schwed, a Wall Street wit, declared that clarifying the difference between investment and speculation was:
...like explaining to the troubled adolescent that Love and Passion are two different things. He perceives that they're different, but they don't quite seem different enough to clear up his problem.
There is some vagueness encouraged by the media and brokerage firms about what the difference between speculating and investing is. One is bombarded by the media with imprecise phrases like, "invest online with E-trade", or my favorite oxymoron, " to invest in the Internet stocks".
Simply put, "the difference between a speculator and an investor can be defined by the presence or absence of the intention to 'trade,' i.e. realize, profits from fluctuation in security prices."1 Your intentions or goals should be very clearly delineated before you purchase any type of security.
Speaking of intentions brings us back to this gem of wisdom, also by Schwed, "Speculation is an effort, probably unsuccessful, to turn a little money into a lot. Investment is an effort, which should be successful to prevent a lot of money becoming a little."2
The majority of people dabbling in the stock market have goals and risk tolerances more akin to investing, yet many are unwittingly speculating like the wildest Vegas gamblers with their hard earned money. Perhaps, most online investors are unaware of the similarities between a crapshoot and a late bull market.
Old-fashioned investors, like my dear dad, "buy companies not stocks."3 They know that historically the markets have returned on average better than 8% a year for the past century, and considerably better than that since World War II.
My dad buys the stock of companies whose business models he understands and believes will be a safe and profitable investment for years. Then he forgets about it, evaluating his portfolio a couple of times a year to take profits here, cut losses there, and stake new positions when there's new information.
Who should speculate?
Today, thanks to the euphoria generated by this glorious market, everyone wants to go online and trade stocks. Anyone can do it. There is no license required, no certification process, and no competency tests.
Imagine what driving in a big city would be like if anyone who could afford an automobile were allowed to just take to the streets. People usually don't die because of their online trading blunders, although this may be changing. However, just as in highway accidents, newbie online speculators can inflict substantial property damage, if only to themselves and their families.
Banks say that deposits into their interest bearing accounts are at record lows. No one saves for the future anymore; everyone is "investing" for his or her future. We have several generations of folks out there who have their life's savings invested in the stock market.
This could be a good thing, and it was in the old days of professional portfolio managers who knew how to ride out market downturns using sophisticated risk management models. Many of today's do-it-yourselfers may lose much of their life's saving by "investing" in high flying stocks with little understanding, and no first-hand experience, of the full range of market cycles.
The market as portrayed by CNBC is a manic roller coaster ride. This image combined with the ability to execute trades with mere keystrokes makes it all too easy for the young brood of online investor-speculators to sell into panics and buy during the euphoria of a bullish top. I'd be the last to suggest government regulations are warranted. However, I would advise extreme caution to anyone considering managing his or her own trading strategies.
One could argue that a new type of market environment has been created with the advent of user-friendly online trading. As in any new environment, players rush in to fill the new ecological niches created. We are still in the early years of the online phenomena, and the natural selection process of weeding out the infirm, undisciplined, and inexperienced traders has only just begun. The combined societal pain will get worse before it gets better.
There are three grave illusions that attract people to online trading like flies to road kill on a hot summer day.
If you think you might want to get involved with online trading because you feel like you are missing out on easy riches, you're wrong. It's not easy to make a buck in the stock market. Remember that for every savvy trader who bought low and sold high, there was a poor schmuck who had to sell low in capitulation and another equally pitiful sucker who bought at the top.
One of the classic signs of a bull market top is that the layman suddenly thinks that stocks are a good way to get rich quick. During recessions, the general public reviles stocks as a fool's gold. Greed is a vice that the old pros count on for that last little 'oomph' of momentum before they close their long positions and go short.
If you want to get involved with online trading because you enjoy the challenge of a steep learning curve, and because you are a student of economics, history, computer science, information management, statistics, human nature, public theater, chaos and folly, plus you have money to burn, welcome.
Before you play the market with your own money for keeps, start off by playing in one of the big stock trading competitions like stocktournament.money.com. They start you off with $500,000 in virtual cash and through a simulated trading interface, which is very much like the real thing at Schwab or Ameritrade, you can find out just how market savvy you are while learning the intricacies of trading rules and online research.
Trading is stressful. Ask yourself while engaged in simulated transactions: how well do you handle stress? Stressing about money is particularly uncomfortable for many people. Try to determine what level of risk allows you to sleep well at night. Start to keep a trading diary to track your emotional responses to various market events. Perhaps, you can use your emotional state as a reliable contrarian indicator. Hey, it works for me.
Finally, if you really do decide that online trading would be fun and profitable for your type of personality, then go ahead and open an online trading account. But do not put any money in that account that you cannot afford to lose. In fact, look at that initial $5,000 deposit as the first installment on your tuition.
Welcome to the School of Hard Knocks.
Your comments are welcomed.
(click number to go back to quote)
1 J. A. Schumpeter, quoted, "Devil Take the Hindmost, A History of Financial Speculation", Farrar, Straus & Giroux, 1999.
2 Chancellor, Edward, "Devil Take the Hindmost, A History of Financial Speculation", Farrar, Straus & Giroux, 1999. Page xi.
3 Huguet, Jim, "Great Companies, Great Return, Based of the Twelve Traits of All Great Companies", Broadway Books, 1999.
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Wes George writes about the financial side of being a Mac nut. Wes has followed Apple's finances for the last 7 years and comes to The Mac Observer every Monday to tell all about his opinions. He is, in his own words, "inordinately fond of money." If you would like to write Wes, make it nice. Someday you might own a company that has something to do with Apple, and Wes will probably still be writing for The Mac Observer...... On the other hand, Mr. George is known to love a rousing, hair-raising debate, so send him your worst!
Disclaimer: This column is for informational and entertainment purposes. While Mr. George may be sage indeed, his writings can not be construed as a solicitation to buy, nor an offering to sell any particular stock. As with any trading in the financial markets, you must use your own judgment to make the best trades that you can. Neither The Mac Observer nor Wes George may be held accountable for trading advice.