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  • Oct 24, 2014
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STRATEGY

Spelling out the difference between investing and trading

There is a thin line between trading and investing. A veteran adviser spells out what differentiates the two approaches

PUBLISHED : Monday, 25 March, 2013, 12:00am
UPDATED : Monday, 25 March, 2013, 3:30am

Investors are often thrown glib phrases like "Let winners run!" or "Kill dogs early!" or "Markets can remain irrational longer than you can remain solvent!" There are too many to list and whenever I hear one of these phrases I try to mentally file them into one of two investment categories: Investing or Trading. But what is the difference between trading and investing, or between a trader and an investor? There is, of course, no exact definition but here are some thoughts that might help clarify:

Value

If you are going in because something has an attractive value, most likely you are investing. Traders often do not care much whether something is cheap or expensive.

Relative value

If you are shorting one stock against another long stock, you are most likely betting on a "reversion to the mean" - in other words you are a trader betting that the value spread between the two stocks will revert to some previous average level. Investors usually do not care about the value spread between two stocks.

Timing the market

If you believe you have the skill to time market entry and exit you best start trading immediately. Why worry about long-term investing when you can simply trade in and out of markets to profit from their impending rise and fall? Many believe they can time the market but, strangely, I have heard of very few who have built fortunes timing the market.

Let winners run, cut the losers

This is the traders' mantra. If something is losing money how could one possibly wish to add to it? Yet continuous portfolio rebalancing to take profits from the winners to feed the losers is the essence of successful long-term investing.

Technicals vs fundamentals

If you are more concerned about the 200-day moving average of a stock price than a company's financial statements, clearly you are trading, not investing.

Time frame

If your investment horizon is any shorter than three years in the stock market, you had best set yourself up as a trader and not as an investor. Short time-horizons are useful for speculative trading, not long-term investment.

Leverage

Patient long-term investors are familiar with the danger of over-borrowing: if they were not, they would not be around to tell their long-term investment stories. On the other hand, traders believe they can swiftly lever up and down as circumstances dictate and, obviously, they need to continuously monitor their positions.

Patience

What trader worth his salt has time to talk about patience? If something is going wrong, kill it and move on, would be their position. Unfortunately, long-term investors require almost inhuman quantities of patience. As companies with sound financials and great prospects are met with utter contempt by the market, their long-term investors must find a way to keep their sanity while all of their friends are making money trading the latest "investment" fad.

Contrarian

When investors and traders are risk-averse, markets tend to be relatively cheap and long-term investors courageously go against the crowd to hunt bargains with their elephant guns, as Warren Buffett would say. When greed returns to the market, long-term investors generally pull back exposure, to lock in hard-earned profits.

Although not exhaustive, the above list clarifies key differences between traders and investors. When setting one's goals for portfolios and mandates, it is good to clarify whether a mandate is investment or trading oriented. Without clarifying this, it is like a journey into the unknown without a compass.

 

Robert Jones is head of FCL Advisory, which advises family offices and wealthy individuals

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