As I search through financial markets looking for opportunities to write about, I am frequently reminded that trading and investing are two very different things that demand two very different approaches. Trading is short term and involves spotting when something has momentum, or has gone too far in one direction. What that thing is and whether it has any value over time is basically irrelevant. Investing, on the other hand, involves a judgment about the long term viability and prospects of what you are buying.
They are, as I said, different disciplines, but once you understand that difference it is quite possible to combine the two. Sometimes both a trading and fundamental investing approach suggests the same thing, making for what I consider to be the ideal trade. Sometimes, however, they are in conflict and the obvious trade is in direct contradiction to your long term view. For those with an investing background who have learned some trading techniques along the way, that is a recipe for inaction; they cannot imagine buying something that they don’t see as a good investment, nor would they sell stock in a company that they liked. Those of us who started out trading, however, have no such compunctions.
Take Tesla (TSLA) for example. From a fundamental, long term basis it is hard not to love the stock. Their cars are amazing and the level of technical innovation behind them is staggering. As many boutique luxury car brands have found in the past, however,…
As I search through financial markets looking for opportunities to write about, I am frequently reminded that trading and investing are two very different things that demand two very different approaches. Trading is short term and involves spotting when something has momentum, or has gone too far in one direction. What that thing is and whether it has any value over time is basically irrelevant. Investing, on the other hand, involves a judgment about the long term viability and prospects of what you are buying.
They are, as I said, different disciplines, but once you understand that difference it is quite possible to combine the two. Sometimes both a trading and fundamental investing approach suggests the same thing, making for what I consider to be the ideal trade. Sometimes, however, they are in conflict and the obvious trade is in direct contradiction to your long term view. For those with an investing background who have learned some trading techniques along the way, that is a recipe for inaction; they cannot imagine buying something that they don’t see as a good investment, nor would they sell stock in a company that they liked. Those of us who started out trading, however, have no such compunctions.
Take Tesla (TSLA) for example. From a fundamental, long term basis it is hard not to love the stock. Their cars are amazing and the level of technical innovation behind them is staggering. As many boutique luxury car brands have found in the past, however, good cars are not enough to protect you once the big boys start to copy what you do. Tesla seems to have the answer there as well. They have built a brand based on performance and quality that sends a particular message. Owning a Tesla says to the world “I am rich and at the cutting edge of technology, but I still care about the planet.” That is the kind of powerful and complex branding that tends to last. In addition, the recently announced home battery system to optimize domestic solar systems is another potential revenue stream that brings welcome diversification.
I could go on with a long list of why owning Tesla stock is a smart thing to do, but I have one problem…the chart.
(Click to enlarge)
It is hard to buy something that has gained over 50 percent in three months and is trading well within range of the all-time high. There are even fundamental, valuation reasons to hold off from buying here; a P/E of over 150 and forecast earnings growth of 25 percent hardly screams cheap.
Of course, in the long term none of that really matters and as long as the expected growth is achieved or exceeded, there is no reason why TSLA cannot just blast through the all-time high and power on upwards. The problem is that the most recent numbers from the company, while setting a record for the number of Model S deliveries, is still not likely to be enough to push the company into profitability and leaves them still needing a big surge to meet their forecast for the year, as pointed out in this Wall Street Journal article.
The numbers were undeniably good on the surface, but the delirious reaction from the market completely ignored the underlying problems and that makes TSLA look overpriced and vulnerable to a sharp move down at any time. In that situation, the all-time high of $291.42 is likely to provide significant resistance, and that makes the trader in me want to sell here with a stop just above that high, say at $295. That would result in risking just a couple of percent of capital on a trade with a lot of upside.
The investor in me wants to own the stock for the long term however, so does selling it here make sense? Yes, it does, so long as it is done as part of a buying strategy. Selling here with the tight stop in place risks only around a 2 percent loss as I said but if, as I suspect will happen, the stock backs off of the high, turns tail and drops to around the $220 support then the potential reward is huge. If you were to sell here and buy back twice as much as your short position at around $230, you would own the stock at an average of $180, the launching point for this run up.
By definition, there is more chance of hitting the stop in the next few days than the perfect scenario unfolding over the next few months, but a roughly 1:20 risk reward ratio combined with the prospect of buying a desirable long term stock at a huge discount makes that a risk worth taking. Selling TSLA, which satisfies my inner trader, in order to buy it later, which satisfies my inner investor, resolves a conflict in my head but also offers the chance of a healthy profit.
