are made infrequently and at a slow pace. Trading, on the other hand, is holding positions for shorter periods of time, looking to make a faster profit, and then exiting. Investment tends to be buy and hold, whereas trading tends to be based on temporary reasons with an exit when those temporary reasons have dissipated.
However, successful investment increasingly recognises that the buy and hold strategy may not work. It may require a more timely response to what’s happening in the markets, since they can move a long way in a fairly short period of time.
Equally, as we will see, many short term trading opportunities in the markets no longer exist, and now the best opportunities may have a time horizon that extends into months and even years.
So, in these Strategies, I will not try to distinguish between trading and investing, and I will use the terms interchangeably.
Fundamentals
I will also use the term market ‘fundamentals’. These are all the factors affecting a market. Anything that influences, or potentially influences, demand and supply is a fundamental, whether it’s social, economic, political or the natural environment.
1.1 Fear the market
My first ever trading experience was a disaster. In 1984, fresh out of university, I started trading futures in my spare time. Futures can be very risky because of the leverage – whereby a small deposit can give you a large exposure to price moves.
I can’t remember why I was ever tempted into trading, but I do remember the result: over a few months I lost four thousand dollars. It was a lot of money to me, which I couldn’t really afford since, as a trainee, I was earning less than twenty thousand a year.
My mistakes
I had no experience and I did all the wrong things:
I started with positions which were way too big.
I stopped and started a new strategy every few days.
I had no long term view.
I didn’t really understand what was driving the market.
I grabbed profits as soon as I could and stayed with losing positions.
I listened to the views of other people who probably had no idea either, including brokers and people with fancy charts.
The result was to scare the life out of me. I had thought you could make money by trading, but I became convinced that it was impossible. I squared all of my positions and decided never to trade again.
Although it did not take long for me to break that vow, I have never forgotten that first unpleasant experience. Even now, when I make investments, I have a fear of the markets, and perhaps an underlying scepticism of my ability to outwit them. However, I am convinced that over the years, the fear I first experienced at that time has saved me a lot of money, and allowed me to stay in the business of trading.
I want you to have that same level of respect. I want to convince you that the market can be a horrible place where your money can just disappear very quickly. You’re throwing dice, tossing coins, whatever. There are no certainties and you don’t know what you’re up against.
“A hard way to make an easy living”
Cleanse yourself of any idea that it’s easy. You’re in for a difficult time. Like me, most traders and investors have had to learn this the hard way, at one time or another, by losing money and agonising over bad positions. By giving you this warning I’m trying to save you from that nightmare.
The market is much more difficult than you think. It acts like a huge super- computer as it effectively absorbs an unbelievable amount of information — more than any human being could fathom.
When you buy or sell in the market you are hoping that the current market price is wrong, that the super-computer is wrong. Now stop for a moment and think how incredible that would be. If you believe that the dollar will fall, what you actually believe is that the current price is flawed, even though it is the result of a huge amount of people dealing in a huge amount of money.
For that reason, when I am asked for my view on a currency or another market, I’m very reluctant to disagree with the price as it stands. I personally give the markets that level of respect — and I’ve been battling them with some success for a long time. Yet many people who lack any experience will happily put forward their view with an astonishing degree of unfounded confidence.
Don’t forget that these days there is intense analysis by funds and banks and that they still regularly get it wrong — often spectacularly wrong. So start with a degree of caution. Be like a lion tamer. The lion can be tamed, but only by maintaining a healthy fear of the lion.
1.2 Markets are more efficient than generally acknowledged
I often think of the market as an opponent, a living being to outwit and defeat. To ‘beat the market’ we need to look for weaknesses in our opponent’s armoury. The problem is that our opponent is nearly perfect. It is very ‘efficient’ at setting prices that offer no opportunities. If we buy and sell on just whims, or on unfounded ideas, we cannot win the battle.
Efficiency in markets is a concept stemming from economics. Quite simply, an efficient market is unbeatable. It sets a price whereby you may as well toss a coin to decide whether to buy or sell. At any time, the price completely reflects all relevant information. There is no point taking the view that because of factor X, a market is undervalued; factor X is already known and factored into the current price.
No opportunities in an efficient market
One consequence of an efficient market is that prices move in a random manner. All current information is already reflected in the current price, which means that the price can only move in response to new (and thereby, as yet, unknowable) news. Therefore there is no trend, and no one can predict what the price is going to do next.
Microsoft shares could be a good example of market efficiency. As I write, their price in New York is $24.91. This is the price that reflects all the known information about Microsoft. As ongoing information emerges about the company, it is disseminated quickly, traders buy and sell on the basis of that information, and the price moves accordingly. Your guess is as good as anyone’s about where the price will go from here.
An efficient market offers us no opportunities. It is an opponent without weaknesses.
Fortunately, markets are not always efficient
Luckily for us, however, the markets are not always efficient. The most likely reasons that a market fails to operate efficiently are that:
All the relevant information is not equally available to all buyers and sellers. An example would be a bargain in the property market which exists because too few buyers are aware of the opportunity.
The buyers and sellers all have the relevant information but do not sufficiently understand the implications of that information. Here an example would
