What can Long-term Value Investors Learn from Traders?

1. A few years ago, I was invited to speak at a conference where both the organisers and the audience were hugely dominated by traders.
2. And the topic that I chose for my talk revolved around one question: What can long-term value investors learn from Traders?
3. The talk was a long one and it continued till the wee hours of the morning. I spoke about many things but there was one key idea about this talk. That investors can learn to be more detached from traders.
4. While I believe that the success rate in trading is less than that in long-term value investing (and this belief is debatable), I also feel that good traders are far more detached than value investors.
5. What do I mean by “detached?” By the term detached I mean the willingness to be objective about the situation. This means first acknowledging that all trading is probabilistic and there are no sure things and what should work often doesn’t. The same, by the way, is true about investing.
6. Recognition of this reality makes it easier for a trader to quickly change his mind when evidence tells him that he is wrong.
7. For successful traders, this means that the willingness to readily acknowledge about their being wrong and acting accordingly will preserve their capital.
8. When they think they are wrong and they act in accordance with that belief and they turn out to be wrong, they will their protect capital from impairment.
9. Sometimes they will be wrong about their belief that they were wrong too but the consequences of that type of error would typically be opportunity losses. And real losses matter more than opportunity losses.
10. For a trader, the mindset of capital preservation first, makes him far far more detached than a typical value investor who tends to fall in love with his ideas and cling to those ideas even when evidence warrants a change of mind.
11. We may give many names to this tendency – confirmation bias, commitment bias, endowment effect etc etc, but it turns out that successful traders do not have these tendencies.
12. Nor, you will say, do value investors. But traders makes far more decisions than value investors. And for them the need to change their mind in light of disconfirming evidence is far more than for long-term value investors.
13. It is for this reason why people who want to make living from value investing have much to learn from successful traders. Those successful traders, have had far more practice in changing their minds! And over time they become really good at it. And moreover they don’t sulk about going wrong either.
14. Successful traders are true Baysians – they routinely think in terms of probabilities and their “systems” allow them to change mind slowly as well as quickly as the situation warrants.
15. The value of your network is a function of its diversity. This means that if you are a budding value investor, you should have in your network, a few successful traders. Observe them. See how they think. How and why they change their mind. How they truly practice “detachment” – a trait that’s necessary for success whether you are trading or investing.
16. This type of fertilisation of, not trading ideas, but methods of thinking, has great utility, in my view.