Friday, May 3, 2013

Dow Theory Special issue: Differences between trading and investment

Is trading so different from investment?

For me, everything is the same. They are different ends that lead (or should lead) to the same goal. The goal is to protect your capital (avoid drawdons and paper losses as much as possible) and, if possible, make it grow. If you achieve this goal by day trading: congratulations. If you achieve it by building and operating a chain of supermarkets: congratulations too.

However, somehow we have to draw the line between trading and investment.

LIQUIDITY is the issue. If you are a day trader, you cannot invest 100 million dollars in one security. Maybe you will make 50% a year, but I bet you will not be able to put more than 1 million dollars at work in the market. The shorter your time frame the more liquidity issues will hamper your trading ability and performance.

For me, trading concerns all the investments that, in spite of their profitability are constrained in size.

For me, investments are not subject to such limitations.

Of course, the longer your investment horizon the more capital you can deploy in the markets. First, you have more time to “average in” and average out. Secondly, the longer your time frame, the lower the impact of slippage and commissions.

Here lies the beauty of the Dow Theory. In my opinion, it is clearly “investment," since its “trades” (oops, “investments”) tend to last more than 1 year, hence giving you plenty of room to get in and out of really BIG positions.

So under Dow Theory:

1)     You can “invest” in the sense that you can put big capital to work without being eaten up by slippage and commissions.

2)     You can “trade” in the sense that you are opportunistic, and you will get “in” and “out” according to market conditions. Thx to the Dow Theory you will not be left holding the bag or standing around an occupied chair when the market heads south.

3)     You will be in sync with the longer trend of the market and, thus, you will avoid the whipsaws that plague short-term trading.


The Dow Theorist

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