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Thursday, October 21, 2010

Do you like short-term Trading or long-term Investing?

One of the questions I face most often from readers is: How do I become a trader? I usually answer back with a question: Why don’t you want to become an investor? The answers vary from “I don’t have time to do stock research”, to “I don’t have enough capital”, to “I can’t ever become a Warren Buffett or Rakesh Jhunjhunwala – so why bother”!

New entrants to the stock market usually show up in droves when the Sensex is near an all-time high, thinking that: ‘trading is easy work, and investing is hard work’. The result of such thinking (or is it non-thinking?) is a quick depletion of savings that scares away most would-be traders from the stock markets altogether; or, a transformation of a would-be trader into an investor-by-default, whose quest becomes to somehow recover the trading losses by ‘averaging’ and holding on to the loss-making stocks.

This cycle gets repeated again and again at every market peak that adds to the misery of many newbies and the wealth of a handful of smart investors. I have no illusions that I will be able to change such behaviour akin to financial suicide. But my efforts at repeating this theme periodically is with the hope that a few readers of this blog may see the light.

Let me counter the three most common excuses given by readers to justify their trading ambitions.

I don’t have time to do stock research

Time is at a premium for those engaged in a full-time job or business. When there is insufficient time to complete the tasks at hand, where is the time to perform sector analysis, assess management competence, determine growth prospects, go through annual reports?

There is a simple answer. Delegate the job to a professional fund manager. They are paid (quite handsomely) to manage large funds on behalf of small investors. They have research teams that do all the hard work, and in turn, they charge a fee that is deducted from the fund’s earnings.

I’m not talking about a Private Equity fund or a Portfolio Management System – but an ordinary actively-managed equity mutual fund. Better still, choose an index fund (or index ETF) that is passively managed and charges lower fees. By investing small amounts, one can effectively buy a basket of good stocks or all the stocks that comprise an index.

I don’t have enough capital

Investing in the stock market doesn’t mean that you have to start off with Rs 5 lakhs or 10 lakhs. While such amounts may be necessary to build a strong core portfolio of stocks, you can always build up your capital through regular and systematic investing.

Whatever small amount that you can spare after meeting your regular monthly expenses can be invested in an index fund or diversified equity fund through the ups and downs of the stock market. After a few years of regular and disciplined investing, you may be surprised at the nice bundle you will accumulate.

You can then think of building a core portfolio of individual stocks – provided of course, that you have the time and inclination for doing the hard work involved in individual stock selection and monitoring. Otherwise, continue with your regular investment process.

I can’t ever become a Warren Buffett or Rakesh Jhunjhunwala

This is the lamest excuse of all. Every cricketer can’t be a Bradman or Tendulkar. Does that mean one shouldn’t aspire to be a Laxman or Dravid or Dhoni?

You can be what you want to be – but not without hard work and talent. No one ever became good at anything by taking short-cuts. If you want to become a trader because it involves less work and can give fast returns, you are being naive. You will end up being poor quickly. The majority of traders make their broker’s rich.

Another, often unstated, excuse is: Investing is boring; trading is thrilling. My response to that is – for thrills, visit a race course or a casino. At least the ambience will be enjoyable while you lose money!

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