Four Types of Investors — Which Type Are You?
September 7 2015
Success leaves traces. That’s why studying the different types of investors can be very rewarding. What types of investors are there? How do we recognize them? How successful are they? And more importantly: what type of investor are you?
The 'Momentum Investor'
Sometimes, a word speaks for itself. The momentum investor focuses on 'momentum;' buying when prices are rising and selling when they drop. They ride waves like a surfer; going with the flow. Momentum investors base their investment decisions on the 'greater fool' theory; they are not afraid to invest in highly overvalued markets (bubbles), as long as they believe that the bubble isn’t about to burst yet.
Momentum investors often fail to earn decent returns. Frequently, they’re only a momentum investor because they do not have the emotional strength to swim against the current.
There are undoubtedly some momentum investors who have mastered this investment style. Regrettably, a large portion of all investors unintentionally belong to this group.
Momentum investors often fail to recognize the right moments to buy when asset prices are falling. When the financial markets are crashing, they’ll either say: “I think that the prices will drop even further” or “I’ll wait until prices start rising again.” As a result, a significant amount of momentum investors will outright refuse to buy when prices are low, which often hurts their long-term returns.
If you ever catch yourself thinking or saying the aforementioned quotes, you could unconsciously be a momentum investor. And momentum investing is an art which requires practice.
The 'Chart Reader'
I admit it. I made a serious mistake in the past. I associated 'technical analysis' solely with studying price charts. But technical analysis is more than that. I realized my mistake when I read the book 'Turning Points' by Ruurt Hazewinkel (founder of Optimix). In the book, Hazewinkel provides the only logical definition of technical analysis: 'the study of all market-related factors.'
Consequently, if you (temporarily) do not invest in a certain stock because stocks are 'expensive,' you have made an investment decision based on technical analysis.
That is why the 'technical analysis investor' cannot be an investor type; technical analysis is too much of a common activity to be ascribed to a single investor type.
But we can identify the type 'chart reader' as someone who exclusively uses technical analysis.
Of course, all investors check price charts from time to time. But consulting them is quite different from basing decisions exclusively on the analysis of 'price patterns' and the drawings of trend lines. This is, however, exactly what 'chart readers' do. They try to discover patterns and trends to anticipate future price movements.
I have never been a fan of 'chart reading' and the many technical analyses published in newspapers. They could — if someone would take the trouble to collect all predictions — provide excellent comedy material. I still haven’t found investors who consistently make above-average returns without occasionally going bankrupt. Nevertheless, a large chunk of the investment analyses found in newspapers are based on 'chart reading.'
If double 'head-and-shoulder' patterns, triple bottoms, support and resistance levels — in other words, graph fetishism — are your cup of tea, then you are a 'chart reader.' It’s not clear whether chart readers are able to make high returns over a longer period of time — I am skeptical about it.
The 'Value Investor'
Warren Buffet is probably the most famous value investor ever. In essence, the approach that value investors take is twofold: (1) they estimate the intrinsic value of an investment and (2) they will only invest if its current market price is well below the estimated intrinsic value (applying a safety margin).
Having the perfect 'timing' is not very relevant to value investors (contrary to momentum investors). That’s why value investing is mainly appropriate for investors with a long-term horizon, not for investors chasing quick profits. By definition, day traders cannot be value investors.
But beware! Many investors call themselves value investors; while in reality, they are merely following the market. The Dutch investment fund SNS Nederlands Aandelenfonds is a great example: they believe that their investments are based on the principles mentioned above, but in essence they buy almost all Dutch stocks, regardless of their market price. In reality, it was an 'index hugger;' a fund largely tracking the index, while charging higher transaction costs than a real index (ETF) would.
As a rule, a value investor is interested in all undervalued ('cheap') investments of any asset class.
The 'Gold Bug'
The 'gold bug' solely invests in gold. Often, this type of investor has a pessimistic world view. The world is doomed, and hoarding gold is all there is left to do in addition to the possible preparations on the day of reckoning.
These gold investors are often so suspicious that they will not trust anyone to store their gold for them. They’ll bury their gold in their garden or put it under their mattress, exposing themselves to substantial theft risks. They claim that they no longer monitor 'the gold price,' because gold will prove to be of enormous value when calamity strikes at last.
The term 'gold bug' does not apply to gold investors who question the current level of global indebtedness and the state of the global banking system. 'Gold bugs' are investors who, no matter what happens, believe that the world economy and civilization are headed for disaster.
The term 'gold bug' was used to refer to this group of concerned investors. In the past, I have criticized others for applying the term 'gold bug' to all gold investors. These days, all gold investors are dismissed as 'gold bugs,' even though the word 'bug' has a negative connotation for many people.
Dismissing gold investors as 'gold bugs' is a way to avoid a public debate about gold that many people would like to have. 'Gold bugs' do not represent all gold investors, but is a completely different type of investor instead.
The Four Types and How They Invest in Gold
It is pretty clear which types of investors currently invest in gold. The momentum investors have pulled out. They always desire rising prices, and ultimately they run the risk of missing a large portion of their potential returns.
The chart reader is also particularly pessimistic about the gold market. Almost all 'technical indicators' and 'moving averages' are very bearish.
The value investor should be very enthusiastic about gold. Buying gold is a no-brainer, considering gold is both undervalued and unpopular.
A 'gold bug' is easy to predict: no matter what happens, they will always buy gold.
It’s perfectly possible that I missed other types of investors. Perhaps that’s something to discuss in future articles?