Investing is a term that most people are pretty familiar with, as it involves committing a certain amount of money to a project which is expected to yield results over a longer period of time. Stock investing is a form of investing, at least one looks to hold a stock for a fairly long period.
Stock trading involves both the buying and selling of stocks, called trades, as well as a strategy of buying and selling stocks over a shorter period than investing. There is no set timeframe that distinguishes an investment from a trade. However, when investing you’re looking more toward the performance of the underlying asset, in this case the company, versus just looking to play the market of a stock or the market overall with trading.
Trading and investing have their separate goals and purposes, although there is a certain overlap as well. In both cases, we are looking to make a profit by capital appreciation, whether or not that is on the long or short side.
Investing is also concerned to some degree by earning income, dividends, while trading usually does not involve dividend plays as the time frame for trading is usually not long enough to earn dividends.
The time frames involved in investing range from months to years, or perhaps never selling the stock in your lifetime, and some people just hold a stock until they pass away, with the asset being bequeathed. This is particularly the case with stocks that pay out a fair bit of income, and some people live off of these dividends in their retirement years.
Moving toward retirement also provides a reason for investors to divest their stock positions, with the goal of moving their investments out of growth based assets, as stocks are, and toward more stable and less volatile investments, such as bonds or interest-bearing accounts.
What Does Trading Involve?
Traders are always looking to move in and out of positions, as a matter of strategy, in order to increase their profit over just buying a stock and holding it. Traders have various levels of success with this, with some outperforming a holding strategy by a huge amount, and others doing less well or even very poorly.
Trading involves timeframes which can range from weeks to micro seconds, although individual traders generally don’t enter and exit trades this quickly. Computerized trading programs run by institutional traders do take positions for fractions of a second, and the majority of trades in the stock market are of this sort actually.
Individual traders will hold on to a stock for a few minutes at least, most of the time anyway, although there are situations where they may only hold a position for a matter of seconds if the trade does not go the way they had planned.
Since the price movement of stocks is not random, and proceeds according to the changing influences of supply and demand, there are some discrete patters that emerge that can be taken advantage of if one has the skill.
One must have enough of an advantage here to overcome the trading costs, the spread plus any other trading costs such as commissions or trading fees, and the advantage beyond this becomes the trader’s profits. Over time, over many trades, the goal is to come out ahead, and do so by a greater amount than just buying and holding would deliver.
This is accomplished by looking at both the current situation with the pricing of a certain stock, its recent price action, as well as patters that have developed with both this stock and stocks in general.
Some of this is due to the fact that momentum drives stock prices quite a bit, meaning that a stock moving in a certain direction will influence behavior to cause it to be more likely to continue to move in that direction for a while. There are other factors such as support and resistance points that traders act on and this to some degree becomes self-fulfilling.
Successful trading is both an art and a science, and there’s quite a bit of both involved. Many people get into trading without the proper preparation and tend to underestimate the level of skill involved in being successful at this.
It is therefore very important to acquire the proper education, and while some of the skills that are required with trading are fairly intuitive, to really do well takes quite a bit of thought as well as a good amount of experience. As long as one sets themselves up to keep their risk manageable as they learn the craft, one can start with real money with no prior preparation and get better at this simply by doing and learning from one’s mistakes.
Trading and Investing in Practice
When you’re looking to invest in a company long term, it’s obviously important to be selective with the stocks you buy. This is true in all cases, whether you’re planning on holding the stock for the medium term, the long term, or the very long term, as all of these involve a commitment to the stock, where you will hold it for at least a good while.
A stock’s underlying fundamentals therefore become very important, as you want to pick stocks that are likely to perform well in the future. We base these decisions to a large degree on how the company is doing now, although how it is expected to do should matter a lot too.
We may also be interested in looking at the fundamentals of the market as a whole as well, especially if things aren’t so great and we may be better off waiting to buy a certain stock until things look more favorable for us.
While investors don’t generally rely on technical analysis, using charts based upon historical price and volume data to choose either the stocks they buy or their entry points, this can provide some good insight on the timing of entries and exits.
While an investor may think that the stock’s price now doesn’t matter too much since they are looking to hold the stock for a fairly long period, it always does, as your profits always are a matter of the difference between what you sold it for and what you paid for it. So if it can be bought more cheaply later, as may be the case when the stock is in decline, that can certainly matter.
Investors generally don’t have the skills to use any form of technical analysis very well though, and since being proficient at this does take a lot of skill and experience, it is too much to expect individual investors to time their entries very well, although fundamental analysts who do have the time to hone this craft could perhaps rely on this more than they do. They do base their recommendations on the current price to a certain degree, and will forecast short as well as long term fundamental outlooks, but these outlooks should include more technical analysis than they tend to.
There is sort of a battle of sorts between analysts who rely on fundamental analysis versus those who use technical analysis, and this has all been more polarized than it should be. Technical analysis always can have value, even with very long-term investing, as you still need to pick your entry point and your exit point in any trade. Perhaps the exit is when one gets closer to retirement but that doesn’t mean this is the ideal time, and the price movement of the stock and the movement of the market should at least have some say.
Trading is primarily based upon technical analysis, although some traders do use fundamental data to influence their trading decisions. In this case the relevance is that the announcement of these events can influence momentum and therefore the technical side, and trading always takes the perspective of the market, what it has done, what it is doing now, and what it may do.
This is in opposition to what investing looks at, the asset itself, not the trading of it. It should actually look at both, the asset and the trading, to decide, although it will always fundamentally be driven by perceptions of its underlying value, not what the market currently thinks it is valued at.
Deciding Whether to Trade or Invest
The biggest difference between trading and investing is the amount of time that is required to devote to each. In order to get the most out of trading, one must actually do it full time, and there’s no substitute for the increased opportunities and experiences that full-time trading offers, even with all of the after-market opportunities out there these days.
A lot of traders do it part time though, and there’s no reason why someone cannot be successful doing this for even a fairly short amount of time each day. Trading is a daily affair though, and one must at least monitor one’s trades daily. One can also trade shorter term, day trade in other words, even though their jobs may keep them occupied during normal market hours, by being able to trade forex or contracts for difference, although the opportunity to do this with stocks during off market hours is limited.
One can trade stock indexes this way though, and stock indexes are a great way to trade the market, as this concentrates one’s focus on just a few instruments, which is of benefit generally.
There really isn’t a good way to put yourself in a position to trade effectively while not maintaining daily focus. One must also have a strong desire to succeed at this in addition to the patience required to elevate oneself to one’s desired success.
Investing on the other hand doesn’t really require constant monitoring, and in fact, if anything, investors tend to monitor their positions too much. If one’s goal is to hold long term than it can be counterproductive to track the market value of your positions too much, or put too much stock in the price of recent trades. This is the biggest reason why investors make mistakes by deviating from their plan, and it is also the source of a lot of unnecessary stress, worrying about price fluctuations at a point far away from when they should be looking to sell the stock.
Trading and investing may both be interested in profit, but the means by which they seek this profit are quite different. The separation between them is not cut and dried though and some investors may look to time their investments more than others, and even use techniques to do so that are akin to trading. You can run charts with monthly bars on them, and this is clearly not something that short-term traders would ever be using.
One must find the plan and style that suits them the best, which includes one’s background and experience, one’s skill and talent, one’s level of commitment and dedication, the time one has to devote, and anything else of relevance to this decision. This really is more a matter of fit than what style may be better than another.
John’s sensible advice on all matters related to personal finance will have you examining your own life and tweaking it to achieve your financial goals better.
