What can traders teach investors?
Trading and investing are different disciplines. Traders look at short-term price fluctuations; investors focus on long-term total return. Traders might move in and out of a position several times a day, while investors may only occasionally adjust their portfolios. But both are concerned with financial gains and losses, and the frequent feedback that traders get can help investors better understand their own performance.
One of the most famous equity traders of all time was Jesse Livermore. He started trading stocks in 1891 at age 14, posting stock quotes at one of the many “bucket shops” around Boston. During his lifetime, he gained and lost several multi-million dollar fortunes. He played a pivotal role in the market panic of 1907. His book, Reminiscences of a Stock Operator, is filled with lessons learned from over 50 years of buying and selling.
Stock Market Panic of 1907. Source: Wikipedia
One of his most frequent exhortations is to watch out for losing positions. He calls it cutting your losses—knowing when to get out. “If a trader doesn’t know his exit before he takes the entry,” Livermore writes, “He might as well go to the racetrack or casino.” The principle is watch out for the downside. In trading, this is often done with a stop-loss order—selling a stock if it declines past a certain price. Another trader puts it this way: it’s okay to be wrong; it’s not okay to stay wrong.
Investors don’t need to day-trade to learn from Livermore’s insight. In fact, that would be counterproductive. Transaction costs would consume much of the additional return. For long-term investors, it’s about risk management—using asset allocation and diversification to structure a portfolio and reduce its volatility. Rebalancing when positions get out of line can preserve gains and limit losses.
Markets never stand still, Livermore writes. They’re turbulent or dull, direct or nervous. We shouldn’t fear them, but must always respect them. Every investor makes mistakes. By managing our risks, we can minimize the mistakes that lead to big losses.
Douglas R. Tengdin, CFA
Chief Investment Officer
Leave a comment if you have any questions—I read them all!