There are lots of differences between trading and investing, some bad and some good. Either way, it is important to weigh up the pros and cons of each strategy, and establish which is best suited for the individual and the current environment.
Investing normally requires a fundamental-based approach, with technical analysis taking very much a secondary role. If your belief is that company profits rise in-line with the share price, thorough research is required to assess whether there is the potential for increased profitability. It is reasonable to suggest that an investing time horizon is longer than a year, so therefore following the company through the launch of new products or over quarterly and annual earnings announcements is imperative to decide whether the company should be included or liquidated from the portfolio.
Investors generally invest for either growth or yield. Whatever the reason, it is important to understand that a small part of the business is being acquired and so therefore theoretically there is a modicum of control in the direction of its business activities. The investment perspective should ideally be that of an owner of the company, whereas traders rarely have any real fundamental or emotional attachment to the company. The interest lies in a quick buck, i.e. the share price either increasing or decreasing over a shorter period of time and a quick exit after a specific price movement.
The real benefit of investing over trading is that as time horizons lengthen, more analysis can be factored into the process of due diligence. This could include future earnings forecasts, anticipated dividends, demographic changes, mergers and acquisitions, political influences and long term charting techniques etc. The idea of investing is that everyday volatility is discounted from the portfolio as a focus on the “bigger picture” is maintained.
The counter argument to investing is that a focus on the long-term picture cannot take into account short-term price movements that drive the daily trade. These can cause significant capital depreciation if market pessimism prevails.
The past two years is testament to this, as the FTSE 100 has come within 1% of the 6,000 benchmark level 5 times now before correcting by at least 5%, and only breaching 6,000 by 103 points since the financial collapse in 2008. This has led to the market being “range bound”, and consequently very difficult to invest into. Tracking the benchmark from the open of 2010 to the open of 2012 would have returned approximately 2.94%, a negligible figure given the risk factors surrounding the capital markets.
It is generally accepted that trading requires more skill than investing, as timing is of the essence. A lot more day-by-day, hour-by-hour attention to the markets is required, as one political announcement or a worse-than-expected macroeconomic reading can rapidly turn profits into losses.
A trader will typically hold a position for no longer than one quarter, but if the trade is trending positively this timeframe could be extended. Technical analysis plays an important role in trading as the trader often seeks to manage risk with entry and exit points based on recent support and resistance levels. The riskreward profile can also be monitored based on the expected price movement.
Although many retail clients believe trading is solely derived from technical analysis, this can be a dangerous and potentially costly assumption. Over the past couple of years fundamental factors have changed rapidly, or developed in new and unexpected ways. With stimulus measures being debated by the major economies and unilateral printing of currencies / QE, markets over recent times have been more reactive to expectations of politics and sentiment rather than from any chart based rationale.
In summary, the main benefit of trading over investing is the opportunity to make money speculating on both sides of the market whether long or short. Since 2010 the FTSE 100 from high to low and low to high has seen 2 bull, 1 bear and 1 near bear market (bull and bear markets are categorised as gains or declines greater than 20%). With unprecedented volatility and the long term horizon looking bleak as major economies try to balance austerity and growth to help deleverage indebted balance sheets, many investors are trying their hand at trading, if not with all their portfolio at least with a percentage of it to try and increase short term returns.