CommSec
13 April 2018
This article was written with contribution from Justin Wynne, Investment Adviser, CommSec Advisory
People often use the words “investing” and “trading” to mean the same thing, and it’s true that they both refer to making money on the stock market. But when you get down to the nitty gritty, you’ll find that investing and trading are two distinct disciplines.
In a nutshell, an investor is someone who buys shares in a company with the goal to grow their investment over time. A trader, on the other hand, is someone who buys and sells shares quickly to try and profit from small price changes.
Some people will know whether they tend to use the investing or trading mindset. But if you’re not sure which one’s right for you, it can help to ask yourself a few questions about your investment goals and plans.
What are your investment goals?
Are you looking for long-term growth or a quick win?
Investors generally aim for steady returns and growth over time. They’re not overly focussed on small price changes, because their objective is an overall return over time. For example, an investor might be looking for an investment that delivers a 4% dividend and 4% growth year on year. As long as this goal is being met, they might hold on to the investment indefinitely.
Traders are generally less concerned with long-term returns or a company’s long-term prospects. Instead, they aim for lots of small profits frequently. For example, a trader might buy a stock at $3.50 and sell it a week later at $3.55. It’s a relatively small gain, but if they can do this enough times in a year, they could make a high profit.
Find out more about income vs growth strategies.
How much time do you have to manage your investments?
Do you typically buy a stock, sit back, and hold it through the market’s ups and downs? Or are you more likely to spend hours every week watching your portfolio and waiting for any price movement?
Investors generally don’t spend all day monitoring their portfolio. They might do research on the weekend or after work, and then just check on their investments from time to time.
Because investors typically hold their investments for longer periods than traders, the short term fluctuations shouldn’t have a huge impact on their long-term goals.
Traders typically dedicate more time and attention to monitoring their investments. Because their goal is to take advantage of small price movements, a trader might need to sell quickly and on short notice. Traders also need to spend time keeping records and closely watching their brokerage costs (as frequent trading results in frequent transaction costs).
How much risk are you comfortable with?
Would the thought of losing money keep you awake at night?
Investors are generally less comfortable with risk compared to traders. Some investors manage their risk by diversifying their investments (buying across multiple companies, assets, or sectors). Some investments won’t perform well, but others might pick up the slack. If your portfolio is well diversified, you might still make a profit overall.
Traders are generally exposed to higher risk (along with potential higher returns). Some traders manage their risk by setting clear rules and sticking to them. When they buy a stock, they’ll set an exit price where they intend to sell that stock. If the price goes down, a trader will be disciplined enough to sell and take the loss (rather than holding the stock and waiting for a recovery). It’s their way of doing damage control when a stock takes a dive.
How do you approach investment decisions?
Do you look at the long-term prospects of a company before you invest in it? Or are you more interested in whether a share price will move in the short term?
Investors carefully analyse the stocks they’re interested in buying. They examine the company behind the stock, because they intend to stay invested for the long term.
Traders are less likely to be concerned about the prospects of a company, because they don’t intend to hold stocks for very long. Instead, they’ll probably look at technical factors or trends in share price to try and predict temporary price movements.
It’s not always black and white
Investing and trading aren’t mutually exclusive, and you don’t have to define yourself as one or the other. Some people will use elements from both disciplines at different times, depending on the situation. Being aware of your mindset and recognising that there are different ways to approach the market can help you become a better investor.
