While investing and trading involve buying and selling stocks and other financial instruments, their methodology varies greatly. Investors are looking for a larger return over a longer time frame. Investments are purchased and held for several years, and the investor rides out short-term highs and lows. Traders seek to time the market, entering and exiting the market frequently over a short period to procure smaller profits. Traders buy and sell in weeks, days, or even minutes to buy low and sell high. While taking advantage of the market’s volatility, traders care only about micro fluctuations and disregard long-term outlook.
The timeframe an investor and a trader work within is the most obvious difference between the two methodologies. The overall focus is also very different. Incremental value and long-term growth are aspects analyzed by an investor, while the trader will look for anything that will cause a short swing or downturn in the market. Natural disasters and political upheaval cause short-term movement of stock values.
What Is Investing?
Image via Flickr by free pictures of money
The goal of investing is to generate long-term profits. For example, since early 2009, the S&P 500 has increased about two and a half fold. Someone buying in then and holding on to it would have made a nice haul. A long-term investment in the stock market can yield margins many times over a retirement savings account or holding on to cash. A common strategy in investing is to take advantage of any profits made and enhancing further profit by reinvesting the money made from returns and dividends into more shares of stock.
Investments are meant to play the long game over years or decades, using perks along the way like stock splits, interest, and dividends to increase profitability. Over this time, the market will naturally fluctuate. Still, the investor will ride out these short-term ebbs and flows with the expectation that prices will continue to trend upwards over time, recouping any losses incurred in the short term. Market fundamentals like management forecasts and price-to-earnings ratios are what the investor tends to be more concerned with versus short-term volatility.
Retirement accounts such as IRAs and 401(k)s are investments even if the holder isn’t monitoring the day-to-day performance of the various instruments in their portfolios. The objective of a retirement fund is to grow your wealth over many years or even several decades while riding out any short-term downturns with an eye on long-term growth.
If you’re looking to engage in investing, here are some tips for maximizing your returns:
- Make a plan. Ensure you have a solid investment plan for all aspects of your investments, such as selling, buying, and restructuring your holdings. For example, an investor will have goals for their particular portfolio and, as a result, may sell some holdings and buy different stocks if the market moves in such a way that those original holdings no longer serve the overall objective.
- Remember, it’s long-term. You want to be mentally prepared to stick it out for the long haul. It takes discipline and a good deal of patience to ride out any significant short-term downturn in your portfolio and allow the market to recover. While you may be tempted to jump ship, remember that time is your friend when it comes to your investments. It is usually best to stay the course and let the market recover.
What Is Trading?
When you’re involved in trading, you will buy and sell stocks, currencies, commodities, or any other financial instrument with extreme frequency, sometimes in minutes. The goal of the trader is to procure returns that exceed the typical buy-and-hold investments. Investors may be satisfied with a 10 to 15% annual return, while a trader’s goal might be that same percentage in a month.
The goal is simple for a trader, buy at a low point and quickly sell when the market takes an upturn. The opposite also applies as well as a trader can sell short by selling stocks they have “borrowed” at a high price and then actually buying the stocks at a lower price to pay back what was borrowed.
The investor is playing the long game and will ride out the dips in the market, but traders play the short game. They often will utilize a protective stop-loss order to automatically get out of any losing situation at a specified price level. To discover good trading candidates, traders will use market analysis tools like stochastic oscillators and moving averages. These tools do an excellent job of showing trends and allow the trader to jump in and out at the right time.
Within the trading methodology, four primary categories encompass the different styles of trading. The categories refer to the general timeframe in which they will buy and sell the various financial instruments:
- A position trader typically operates in the timeframe of months to years.
- A swing trader will conduct her buying and selling within a timeframe of days to weeks.
- Day trading refers to positions held over a day, with none going into the next day.
- Scalp traders are the ones who operate the fastest, holding on to instruments for mere seconds or minutes, taking advantage of very short-term volatility.
Once you have decided to become involved in trading, some tips will help you be successful:
- Develop a plan and stick to it. Don’t let a minor hiccup derail you from your goal. Often the most challenging part of being a trader is to follow your own rules.
- Assess your risk management. Know how much you can afford to lose and trade no more than that. A rough rule of thumb is to trade no more than 5% of your investable ability. But, again, that depends on your particular risk tolerance.
- Know the tax implications. In some cases, you may be able to use the costs associated with trading as a tax deduction, but you will also owe taxes on your profits. The short-term gains tax rates can be anywhere from 10 to 37%, so make sure you understand your tax implications.
If you’d like more information on investing and trading, reach out to the knowledgeable team at 3D Partners Wealth Advisors. We’ve worked with retirees and investors for over ten years, developing financial plans and investment strategies. Contact us today!