Monday, October 23, 2006
One market, Two types of traders
There is just one market, the global financial markets but there are two very different types of traders. The difference is as clear as night and day, conservatives and liberals, black and white, you get the point. They share one goal, to strike it rich in the financial markets, but utilize two very different strategies to get there.
The first is a fundamental investor. Defined by taking a more age old approach to investing and looking at the core of businesses (leadership, finances, profit margins) to select better built businesses for, usually, long term gains.
A fundamentalist is more interested in who leads the company than who is doing all the buying and selling of the stock. News and analyst studies are very important to the fundamental trader. And fundamentals make sense, a profitable company should go up in value, right?
Not entirely right, but right in theory. See, with stocks, the value of the company could go to $.01 for the entire corporation if there are no buyers and thousands of sellers. As I explained before, the profitability of a company has nothing to do with the way the stock moves. OBVIOUSLY, when a company does well more people will want to invest. But from a standpoint of how the markets work, it really doesn’t work this way.
Don’t get me wrong. Warren Buffett, the second richest man in the world has made a living out of buying undervalued and profitable companies and making a fortune, $40+ Billion to be exact.
Most investors are fundamental investors, I would guess at least 80% to be so. Most people with retirement or long term portfolios tend to be fundamentalists because in the long term a corporation will probably gain value if it is fundamentally a good investment. Wal-Mart is probably a fundamentally sound investment, it has consistent growth and is the largest in its field. Wal-Mart is highly unlikely to go down the tubes any time soon so it should hold its value, making it a good fundamental play.
On the same token however, we have the technical investors. Known for sitting in front of 10 computer monitors and watching a wide array of charts, graphs and confusing calculations, technical investors are usually professional investors more interested in short term trades.
Technical investors are more interested to see who is buying and selling and at what price. If I know that many people are buying ZZZ Corp at $5 a share I could get in at $5.10 and ride the stock up to say $6 where I know there are a lot of people selling.
Technical thinking is studying how the markets move prices of an equity rather than earnings. In my previous article about the Dow reaching 12000 I used more of a technical approach to looking at the DJIA.
Technicals are best when used in short time periods where the market dictates more than long term growth and earnings ratios. Technicals do work over long time periods but not with the same returns or efficiencies as short term. Taking 3-4 short trades a week will yield many hundreds of percent better than 3-4 trades a year over the long term. This is always to be expected because you can capture the best short time period for return rather than waiting five years to see a similar return.
When fundamentals and technicals work:
Fundamentals
Fundamentals are usually best on an equity that can be depleted or is tied to something greater like the economy of a nation. Corn is one of the commodities which fundamental trading would work best. Corn is eaten by people and animals so the market depends on the consumers rather than when people are buying and selling.
A stock is never consumed, it is always available to be bought and sold and always in a specific quantity. Corn supplies, for example, vary from year to year with the weather and whether it is a popular crop with farmers. When supplies drop, a fundamental, corn prices are going to go up. This is simple supply and demand
Fundamentals work best with a product that is consumed and its supply is constantly changing.
Technicals
Technicals work best with fixed supply commodities such as stocks. Technical traders watch the levels at which buying and selling occur most and try to enter the markets at these specific values. Technical investors usually aren’t concerned near as much with the financial stability of the company as they are with how lucrative the stock looks to other investors.
There are two very distinct types of investors but both have proven to be profitable. Decide what kind of investor you want to be and stick to it. Specialize in investing and your profits will explode!