#18. Trading vs. Investing.
Understanding the differences between strategies and how your goals and persona are crucial to shaping it.
Introduction
Finance is not for the faint-hearted. It is a world where fortunes are made and lost in the blink of an eye.
Wealth is usually achieved through two routes: trading and investing. The aim for both is to generate profits, but the roads they travel are vastly different. For anyone looking to be successful in the markets, they must understand their approach.
Let’s deep-dive into the art of trading and the science of investing, splicing each approach with the precision and insight befitting a market master.
The Art of War
“Every battle is won or lost before it is ever fought”. Sun Tzu was of course referring to war but it’s important to understand that trading is a variation of war, with the market acting as the battlefield. Trading requires exceptional speed, intuition, and nerves of steel. It’s the process of buying and selling financial instruments—stocks, options, commodities—within relatively short time frames, often minutes to days. Traders thrive on volatility and exploit price fluctuations to pocket quick gains. This is war; high-speed chess, where every move counts and hesitation can be fatal. Preparation is everything. It is a crucial element to win each individual battle.
There are a variety of trading types, all with differing time horizons and risk tolerance. Examples of these are:
Day traders, enter and exit positions within the same trading day. They work off market sentiment, driven by news, economic data, or corporate earnings.
Swing traders, on the other hand, might hold positions for days or weeks, capitalizing on trends.
Scalpers, work in very low time frames, seconds to minutes. Scalpers look to enter in volatile sessions for hyper-quick profits.
All rely heavily on technical analysis, studying charts, patterns, and indicators to anticipate future movements.
Studies suggest that only about 10% of day traders are consistently profitable in a short period. Less than 5% are successful long term, with average annual returns varying widely. Successful day traders might see returns of 20-50% per year, but these are the outliers. The majority struggle to break even or incur losses. It’s a high-risk, high-reward game where effective risk management is paramount. Tools like stop-loss orders and position sizing are critical to survive the inevitable market swings but they can also be the tools that destroy a trader if used incorrectly.
The Science of Investing
Investing is a marathon, not a sprint. It’s about planting seeds and waiting patiently for them to grow into oaks. Investors focus on buying assets and holding them over the long term, aiming for steady, compounding returns. Einstein famously said the following about compound interest, “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn't … pays it.”
Investing is less sexy than trading. It requires a ton of patience, a vast understanding of fundamental analysis, and the ability to calmly weather market storms.
Investors focus on more on company financials and health, management quality, market position, and growth prospects. Key metrics such as P/E ratios, earnings reports, revenue growth, and dividend yields are the drivers. The goal is to identify undervalued companies early with strong long-term potential. Over time, the value of these investments should increase, driven by the company’s performance and broader economic trends.
Historically, the stock market has delivered average annual returns of about 7-10% after inflation. This might not seem as exciting as the potential windfalls of trading, and it’s a reason why ‘traders’ often find themselves unable to invest, but it’s a reliable path to wealth accumulation. It’s proven and far less stressful. Investing in a diversified portfolio of blue-chip stocks and holding them for 20-30 years can lead to significant wealth, thanks to the power of compound interest.
Mindset and Psychology
The psychological demands of trading and investing are wildly different. Traders tend to possess emotional discipline and mental agility. They need to manage stress, avoid emotional/revenge trading, and maintain a high level of discipline in sticking to their plans even when markets are volatile. It’s a mindset where decisiveness, resilience, and a willingness to cut losses quickly are essential.
Investors, however, require patience and a long-term perspective. They must stay the course despite market fluctuations and resist the urge to react impulsively to short-term market noise. The ability to remain calm and focused on the long-term goal is what sets successful investors apart.
Personalities That Fit
Trading attracts bold, risk-takers who thrive under pressure. Think of the legendary Jesse Livermore, the "Great Bear of Wall Street," who made and lost several fortunes through his daring trades. Traders often have a natural intuition for market movements and an appetite for risk.
Investing, on the other hand, appeals to those with a methodical, analytical mindset. Warren Buffett, the Oracle of Omaha, epitomizes the ideal investor. His approach is patient, disciplined, and grounded in thorough research. Investors value stability and long-term growth over quick wins. At 99 years old, Buffet is regarded as the greatest investor of all time.
Tools and Platforms
Traders need advanced trading platforms with real-time data, charting tools, and quick execution capabilities. These tools allow traders to analyze markets swiftly and execute trades with precision.
Investors require robust brokerage accounts with research tools, portfolio management features, and educational resources. These platforms offer comprehensive resources to help investors make informed decisions and manage their portfolios effectively.
Real-World Examples
Consider a day trader who buys shares of a tech stock at market open based on a favorable earnings report. The stock price spikes, and they sell within hours, securing a quick profit. This rapid, high-intensity trading demands constant vigilance and a deep understanding of market signals. It is or can be a full time job.
Contrast this with an investor who buys shares of Apple in the early 2000s. Over the next two decades, they hold onto their investment as Apple grows into one of the most valuable companies in the world, rewarding shareholders with substantial returns. This long-term approach requires patience and a belief in the company’s enduring potential. It also requires less effort.
Questionnaire
I’ve designed a questionnaire to help you understand if your goals and personality are more suited to being a trader or investor. The questionnaire can be found in the following link: Are you a Trader or Investor?
Feel free to submit your results.