I've always been curious about markets, stocks, trading, investments, and crypto. Yes, these are all buzzwords we hear on the news and all over r/wallstreetbets - and to be really frank, there was a time where I would react to these buzzwords on reddit threads out of fomo. But honestly, isn't this the most common, yet most destructive mistake, a rookie can make? I've made those rookie mistakes, and I sometimes still make them. In an effort to make lesser of these mistakes, I've decided to spend time trying to understand what these buzzwords really mean. In this post, I'll go through how I used to invest (more like speculate), how I used to make decisions, and what emotions drove my decision making. I'll spend some words defining and discussing markets, trading vs investments, and my recent lessons on risk management. A blog post will definitely not make me an expert in all these buzzwords, but it sure starts a journey of deliberate learning and understanding.
My journey of learning and mistakes
I grew up hearing about the stock market and stories of how people lose everything on it - homes and families destroyed, debt and financial losses, you name it. So, for the longest time, I've always looked at stock and crypto markets like a gambling venue, a casino per se. Hearing about stories where people lose on the market led me to develop a fear of putting my money on it. Obviously, the fear did not stop me from playing the game, but I realized that I would hold back on investing a large amount or perhaps make bold moves and adopt a YOLO mindset. This lack of knowledge combined with some regretful trades pushed me in the direction of learning more about it. I became motivated to better understand the system and learn how to play the winning game - which, I realized is less technical and more behavioral. I've made mistakes, you've made mistakes, so let's take the time to slowly build our knowledge from the ground up, in an attempt to make fewer and less costlier mistakes.
Trading vs Investing
For a long time, I would use these words interchangeably - I still do sometimes but am more cautious. Although both of these words have been used in the context of stocks, there's one key component that differentiates the two: time horizon.
Investing takes a long term approach to the buying and selling of securities with a focus on the fundamentals of the underlying business/entity. How a business performs, what their 1 or 5 year strategies are, who is running the business, what's their moat, how strong is the business model? These are some questions you should ask when you're trying to invest in a publicly traded company. You're buying a piece of the business and want to make sure that your return on investment is positive and ideally, high.
Trading takes a much shorter term approach. Traders are more focused on short term outcomes that could be daily, weekly, quarterly, etc... The idea is to maximize returns by banking on short term movements. Technical analysis and market trends come to play here as we care less about the business and more about the price movements to maximize profits. Trading is riskier and requires much more skill and time in order to be successful.
Investing focuses on time in the market and trading focuses on timing the market. So... what exactly is the market?
The Market
One of the books I started reading in an attempt to tame my fear and better understand financial markets was The Intelligent Investor by Benjamin Graham. A key lesson that I remember from the book is that: Mr. Market will knock at your door every trading day with the current price depending on his mood. If Mr. Market is feeling fearful, prices are low, and if he's greedy, prices will be high. As participants in the market, we should be emotionally unfazed with the daily pricing of Mr. Market. Obviously, this is easier said than done because don't we all want to make easy money? Anyway, this lesson has stuck with me since, and as a result I've been much calmer in making decisions. I don't care too much about the daily movements as I used to.
To better understand The Market, let's step back and start from the definition:
market a means by which the exchange of goods and services takes place as a result of buyers and sellers being in contact with one another, either directly or through mediating agents or institutions
The first thing that comes to mind when I think about markets is a farmer's market. It is a physical space where farmers and businesses come with their products with the intention to sell and make a profit. In the same space, there will be buyers of all sorts who may be interested in purchasing different products each provided by different merchants. The farmer's market is a place that allows buying and selling of farmer specific products like fresh fruits, vegetables, poultry, dairy, and whatever a merchant wants to sell. Merchants set a price based on what they think buyers are willing to pay for and buyers at times may bargain and try to reduce the price if they think a product is overpriced.
Now to take this idea further, the stock market is a place where the buying and selling of stock happens. A stock could be shares of a publicly traded company, bonds, index funds, and all other forms of tradable financial instruments one can think of. Although at some point in history, the stock market was a physical space of trade, today it is a virtual marketplace that's facilitated over the internet. To keep things simple, let's focus on shares of publicly traded companies for the rest of the article. A buyer looking to purchase a share of Acme Corporation (ACME) would place an order on an online brokerage with a bid price that they think is fair. On the other side of the system, sellers would place ask orders of what they think a fair price is. A buyer may bid for a share of ACME at $10.00 whereas the seller asks for $11.00. At this point the transaction won't happen since both party's requirements are not met.
To prevent deadlocks and facilitate constant trading, market makers would continue to buy and sell shares at various prices so that orders would be fulfilled. In this example, the market maker may already have inventory of ACME and are willing to sell it for $10, which would complete the buyer's order. In order to facilitate the seller's order, the market maker may need to buy ACME at $11 and add it to their inventory until there's someone that bids for a share at $11.5. In this case, the market maker will sell for $11 and make a profit, often known as spread, of $0.5 for that one share. This example is a simplification of a process that happens automatically for millions of transactions within a second. The idea is that market makers create liquidity and allow buyers to fulfil their orders and sellers to liquidate their holdings - creating a happily ever after moment for both parties.
Conclusion
Markets are complex because humans are complex creatures driven by varying desires and emotions. The process of writing this has taught me a bit more about markets, trading, and investing. There's plenty to learn and understand - this is just the tip of the iceberg. To end this I'll leave a few questions for us to think about: what have you learned from your experience in trading and investing? How can you be more intentional and make fewer mistakes? What about markets fascinate you?
These thoughts are entirely an attempt at better understanding the world around me - please don't treat it as financial advice of any sort. Next time I write, I'll dive in on my recent learnings on risk management and trade strategies. Feel free to email me at hello [at] dashvin.com if you've got thoughts. Until next time.