Strategy
Trading and Investing Are Very Different
By Henry V. Kaelber
President, Chief Investment Officer, Hoffman, White & Kaelber Financial Services, LLC
Every investor is affected by some degree to trading and the cost of transacting. This refers to trading as a function rather than one’s investment strategy. While it is important, if not very helpful, for investors to understand the rules and operational aspects of executing a securities trade, to make it one’s occupation or base one’s wealth generating strategy on active trading is another thing entirely!
The mindset of an investor is quite different from that of a trader. An investor generally seeks to know plenty of fundamental information about his or her investment. On the other hand, the trader uses other information in seeking quick short-term profits with the hope of earning potentially greater gains. This should be puzzling to some, since the traditional concept of stock ownership is that it's shared ownership in the prospects of a company. Yet the trader has little use for the concept of ownership. Rather, he or she is more interested in the short term dynamics of supply and demand and how to quickly turn a profit.
Sound investing requires thorough fundamental analysis of a security to determine if it is attractive or not. For example, to increase the probability of making a good stock investment, an individual should try to buy that stock at a good price. In order to do that, the investor needs to determine if the current price of the investment is attractive relative to others by studying earnings trends, current and future business environments, interest rates, and many, many other factors. In making the investment, the investor is not concerned with what is going to happen to the price of the stock the next day, because investments are longer term in nature.
Trading is not investing; trading is more speculative. A trader is not trying to predict what is going to happen in the next 10 years. He or she is concerned with price fluctuations immediately after initiating a position. His or her goal is “turn a profit” as soon as possible after the opening trade. The term “opening trade” refers to executing a “buy” (to go long) or “sell” (to go short) transaction after which the person has is at-risk in the market place; a “closing trade” would be the corresponding “sell” or “buy” to end being at-risk on a position. In order increase his or her chances of trading successfully, a trader may study past and current price and volume history to determine what might happen next.
A day-trader trades within the time frame of one day, entering and exiting positions within the day but always closing out trades by the end of the day, win, lose or draw. To be successful, a day-trader must have the discipline of a machine, the instincts of a fox, the emotions of a rock, the skills of a surgeon and the patience of a saint. A little luck wouldn't hurt either.
Large short-term profits can often entice those who are new to the market. But adopting a long-term horizon and dismissing the "get in, get out, make a killing" mentality is a must for any investor. This doesn't mean that it's impossible to make money by actively trading in the short term. But, as we already mentioned, investing and trading are very different ways of making gains from the market. Trading involves very different risks that buy-and-hold investors don't experience. As such, active trading requires certain specialized skills.
Neither investing style is necessarily better than the other - both have their pros and cons. But active trading can be wrong for someone without the appropriate time, financial resources, education and desire. And, most people just don't fit into this category.
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