Published On: Sun, Feb 2nd, 2014

Trading or Investing?

If you’re looking for somewhere to put your money so that it may grow month by month or year by year, then you are probably an investor. This is the traditional, some say old-fashioned, way to build up a nest egg for retirement, save for college, or achieve any other long-term financial goal by salting your money away so that it grows in the long-term.

Investing isn’t very exciting, usually, so you may have heard more about trading, which is exciting, usually. Trading is where you buy and sell quite frequently. It doesn’t have to be in minutes or hours, such as a day trader, but trading can be looking at your portfolio and deciding what to buy or sell each evening, which is how many people fit it in with a job.

I have tried to be clear about the difference between investing and trading above, and once you get to know more you will realise they are very different in essence and approach, but inevitably there is a sliding scale that separates them. For instance, if you make buying and selling decisions twice a week, are you a trader? What about making decisions every two weeks? Four weeks? Four months?

You could say that the difference comes down to your intent. An investor usually intends to hold a stock indefinitely, only selling it when there seems to be a good reason to do so. A trader is fairly certain that they will sell the stock soon, possibly even planning the level at which they will do so, and watches the markets to try and make the timing profitable.

The goal for both is similar. No one goes into investing or trading intending to lose money. The goal is to grow your funds, and trading, by its activity, gives you the chance to grow (or lose) your funds more quickly than investing, on the whole, in return for demanding much greater attention and a different approach. Just as the intention is different, so you require different approaches and different mental attributes between the two ways of being in the stock market.

The growth in funds is fuelled by two different engines. With investments, the value of the shares increases as the company expands, does well competitively, produces new goods that are sought after, etc. This is a real growth in value, and arises because other market participants see that the company is doing well, and want to buy into the success to get increased share prices and increased dividends (if offered). This is the way my parents invested, holding on to some Royal Dutch Shell B shares for decades, and no doubt seeing a good return over all that time.

With trading the chance of profits arises more from the daily or weekly market price fluctuations, and not from any basic change in value of the stocks. After all, is a company in the afternoon really worth 2% or 5% more or less than it was in the morning? It is more likely that the money you win when trading is money that another trader has lost, as they took the opposite view to you. The only person guaranteed to win is your broker, who will take his commission regardless.

That is why there are frequent warnings about the risk of loss with trading, and why you need to make sure you are educated and trained in the ways that historically have helped people make a profit. You need to be a step ahead of the trader on the other side of the deal, and not become a regular victim. You don’t want to be on the losing side, simply because someone else took time to learn what you did not.

As the ultimate goal is the same, and both ways of making money use stocks, you may be wondering how you can choose whether to invest or trade, or even if you have to choose. Given that the approach is different, I think it is a good idea to have the two methods distinctly separate in your mind, and better still to have different share trading accounts, so that you never get confused about what you should be doing.

I believe that everyone should have some investments, putting aside money for the long-term, though how much you invest in the stock market compared to other things such as real estate or gold is a matter for separate discussion. Just as you should diversify between companies and market sectors in the stock market, it is also safest to diversify some of your money into other types of investment. Diversification is one of the ways you can avoid catastrophic circumstances, as for example suffered in the 2008 global economic crash by those who were heavily invested in the stock market.

How much you split your funds between investing and trading depends on your intentions, and on your abilities, as well as your emotional makeup. Some people cannot stand the stress of constantly buying and selling, particularly as you are bound to have your share of losses when trading – there is no perfect system. These people would prefer to lock their money away, have a peek at how it is doing every few months, and go about their business worrying about other things. These are the investors.

Traders like an intellectual challenge, are prepared to spend time looking at charts, and will hopefully learn to disconnect their emotions from their actions, if they are to succeed at making money. It is no secret that some people just cannot succeed at trading, as they do not have the discipline and mental makeup to do so. If you study trading, you will see a lot of emphasis placed on the psychological aspect because in reality it is key to your success.

I started as an engineer, as many other traders are, and from an engineering perspective I anticipated being able to apply my analytical and mathematical skills to gain an edge in the market. I was wrong. Technical analysis, the way you find which stocks are likely to rise or fall, is more an art than a science, and doesn’t need mathematical ability at all. Computers easily do all the calculations required, and provide graphical interfaces such as charts with indicators overlaid on them, from which the technical analyst can do his figuring.

But what is really hard when trading is to take decisions and “pull the trigger”. It is a balance. You obviously don’t want to jump the gun, and enter trades willy-nilly before you are sure enough of the way the price is going. But if you wait too long, you will have the pain of regret when you see how much you might have gained if only you had the confidence to open the trade earlier.

Even so, the hardest part is probably closing a trade for a loss. While the trade is open, there is always a chance (your mind tells you) that the price will turn around and make a profit – so you tend to hang on longer than you should in a losing trade.

Sometimes the price will turn around, and you feel vindicated at staying in the position. That just screws you up mentally, as you’re meant to be playing the odds and the odds are that it is a bad thing to stay in a losing position. The fact is that until you close the trade, your mind tells you haven’t lost yet, so you feel much happier.

You can even get it wrong closing your trade for a profit, if you don’t make the best of the situation. Say you had several losing trades in a row, so when you finally make a profit you become more eager to “capture” it and close your trade quickly. Could it be that the signs were telling you that the trade had further to run? You might never know, particularly if you move onto the next trade, but you could have left some money on the table.

If you decide to try trading, make sure that you read and learn all you can about the mental aspects, as that is where the game is won or lost.

To work out which stocks and shares to invest or trade, you need to analyse the numbers. There are two basic types of financial analysis applied to the stock market and similar trading markets, and these are called technical analysis and fundamental analysis. Fundamental analysis is generally associated with investors, whereas technical analysis is widely used by traders.

Whether you are an investor or a trader, as mentioned before it is hard to separate these two. If you want to be successful with stocks, then I recommend that you learn both types of analysis, even if you do concentrate on the one associated with the way you see your stock market action going. Each can give you some insight into the other.

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