Everyone has seen how stock charts look like. But have you seen the chart for your investment capital – how your capital rise and fall with time? The way your investment capital moves depend on the type of investor. I have heavily generalised 3 kinds of charts for the Buy-and-Hold investor, Trader and the Clueless investor. This is important because all of us would always monitor our capital time to time to see if it has grown. By doing this, we subject our happiness to it’s rise and dejection to it’s fall. And whether we still have the tenacity to continue investing when we feel dejected. The end point maybe the same, but the journey can be very different. Find out which of the capital movement chart you prefer and you can find out the type of investor best suits you.
The Buy-and-Hold Investor
As a Buy-and-Hold (BAH) investor, you expect your capital rises gradually with time. It is akin to watching grass grow. You probably would not see the effect within a year. You must have the patience to hold on and it is possible to see your friends reaping higher gains than you. At some point you will feel that you may have made a wrong choice. But over several years, you begin to notice the gains. And since you are a BAH investor, you will participate in every rise and fall of the market. When the market crashes big once in 7-10 years, your investment goes down with it. Seeing your capital dropped 50% is heartbreaking, especially when you see the gains which took 5-6 years to grow vanish within days. But it does not deplete all your profits, you actually end up better off than you started. Of course this will depend on when you enter the market. If you keep holding on, you will participate in the next cycle of bull run and bring your capital to higher heights. Hence, the greatest challenge for the BAH investor is patience, and you must be able to take the hit when market plunge. The moment you cash in after the market crash, the game is over.
The Trader
The chart would look something like this if you plot the movements of capital of a trader. Unlike the BAH investor, you can profit as a trader during a crash as you can short the market. Hence, your capital growth does not follow the growth of the market. As long as the market moves, your capital grows. But the problem is that the market does not move all the time. In fact, it moves probably about 90 days or less in a year. Hence, most of the time you lose money as a trader. Looking at the chart, your capital depletes most of the time but grows very fast when the market trends. If you cannot take such numerous small losses, you cannot be a trader. Because you will lose faith in your system and even trading itself. Hence, you would miss the big runs which make the year a profitable one.
The Clueless Investor
Lastly, this chart represents what most people investment capital looks like. I hesitated to call this group of people investors because they do not know what they are doing in the market. But since they call their activity investing, I shall call them Clueless Investor (CI). This group of people usually listen to “experts” who may be their auntie, uncle, brother, sister, friend, brother-in-law, coffeshop talk, analyst recommendation, etc. They buy into “hot” stocks, and their participation actually becomes the self-fulfilling prophecy, pushing up the stock price. Until one day when there aren’t enough buyers, the stock price collapses. The CI does not have enough time to react and exit, and they get stuck with the stock. But they are unwilling to accept the loss and they believe the stock price will eventually recover soon and they can sell. But the stock did not recover, and they would give up and sell the stocks. They end up worse off than they begin (their capital is lesser than they started). But they fail to learn their lesson, when the time is long enough for them to heal the wounds, they get convinced to “invest” in the next “hot” stock. They can never succeed in investing.
I hope that by highlighting the difference for these 3 types of investors will help you understand what it takes to be an investor. It is a rather emotional daunting task. Understand how your capital appreciates/depreciates would give you more confidence and a peace of mind during your investment journey.
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That’s why I stopped being a Buy and Hold investors a few years ago, now I might be called a “Market Cycle Investor”. Basically, I ride the major market trend, buying when market cycle is on the low side and selling out when market is on a high side. By doing this, I made over 200% returns on my stock portfolio from year 2002 to year 2007, cashed out and avoided the stock market Crash and started buying stocks since Oct 2008….by end year 2009, those stocks I bought in 2008 made 40% returns….
On the other hand, the Buy and Hold investor who did not sell out in year 2007, now would be seeing very little gains…and not the cumulative over 240% gains I made.
Maybe next time I should chart the market cycle investor’s capital movement too!
Thanks for your article. This is why I had stopped investing in stocks and focus on forex trading. Now I can buy and sell in different market conditions.
Thanks. All the best in forex!