This is a guest post by Manu Shoker of manushoker.com.
Why Trading and Investing are so Fundamentally Different
There is a popular misconception that trading and investing could be used interchangeably with one another. But as professional traders and investors can attest to, they are both radically different. It’s easy to mix the terms when both activities share the same objective: make money in the stock market.
But their opposite approaches to achieve that objective is what makes them so distinct. To put it in its simplest form, traders trade tickers and investors invest in companies. Let’s break this phrase down in more detail by focusing on three main concepts associated with each activity.
- Primary Philosophy: Although investors could sometimes bleed into what a trader does and traders could bleed into what an investor does, the main philosophy to take away is that one is purely based off fundamentals and the other is based on technicals.
Investors primarily look at the stock market from a fundamental standpoint. When choosing a stock, investors are entirely invested in what a company does and will continue to do. They care more about the bottom line. They look at a company’s financial reports which consist of balance sheets, income statements, cash flow statements, and various other required documents that the company has to disclose to their shareholders.
These reports give shareholders a look at a company’s debt relative to their overall cash flow, their market share compared to their competitors, their growth and projections, and most importantly, how much profit they’re bringing in. These are all things investors care about. They’re thoroughly listening to a company’s conference call during earnings season, the amount of dividend they’ll pay out for the quarter, and any other relevant information an investor would need to decide if they’re willing to buy the company’s stock.
Traders primarily look at the stock market from a technical standpoint. They use various tools that most likely an investor would not. One of those tools is a stock scanner. This is a vital tool that helps traders find their stocks at any given moment by filtering specific settings to their liking. It’ll allow them to choose any stock whether it’s gapping up or down, is a small or large cap, has high or low volume, or has a high or low float. This is all technical jargon you probably wouldn’t find an investor searching for. The point is that traders are looking for these big swings in price fluctuations to make a potential profit and these filters within the stock scanner can help them find that.
While investors are viewing a company’s financial reports, traders are vigorously viewing a company’s stock chart. And within that chart, traders have many study indicators they use at their disposal to figure out entries and exits. They study indicators that could be tools like moving averages to assess whether a stock’s trend is bullish or bearish or a relative strength index (RSI) to determine whether that stock is oversold or overbought.
But before traders even trade a stock, they are watching for certain patterns within that chart. Every trader has a strategy and they’re looking to see if they can find a pattern that falls within their strategy. Traders then look for validated levels of support and resistance. They evaluate a myriad of other factors like the spread between the bid and the ask on the level 2, the kind of transaction going through on the time & sales, and the type of candlestick they’re about to buy into. All of these tools are specifically important for a day trader. More on that later.
- Duration: As any sound investor can tell you, never try to time the market. Investors are not interested in paying attention to daily price movements or even weekly price movements for that matter like traders are. They’re not paying attention to market volatility as much as a trader. Their outlook is substantially longer-term than a trader’s. And that outlook could be at least 5 years and certainly greater than a year. Timing the market is a fool’s errand for an investor.
For a trader, however, timing the market is everything. Swing traders are looking to buy low and sell high or buy high and sell low if they’re shorting multiple times by taking advantage of these price fluctuations where as an investor would typically not care and just sit back. A trend trader tries to buy high and sell higher or short sell low and buy back lower. In other words, a trader will buy a stock short to mid-term where as an investor will buy a stock for the long-term.
It’s also important to distinguish the kind of trader a person is. A day trader will buy and sell a stock on that same day within hours, minutes, or even seconds. And a swing trader will hold a stock for at least a day.
- Skill Level: Spending more time in the market naturally will expose you to more level of risk. A trader’s time in the market can be significantly longer than an investor’s in terms of buying and selling and therefore require a bit more skill level to be successful in making money.
A trader has to cut losses more quickly where as an investor can wait for the company to bounce back if they hit a roadblock as long as their fundamentals remain intact.
Each of these activities require a different kind of mindset as well. Investors need to have some level of belief or intuition in a company that they’re buying. A trader’s approach is a little less emotional. In fact, their decisions should all be based on logic when analyzing the technical setup of a stock.
Regardless of how you approach the stock market, extensive research is undoubtedly required. A trader must check off a multitude of technical conditions to see if a stock is worth trading. And an investor has to study the ins and outs of a company to see if their financial philosophy and overall product or service is sustainable for long-term growth.