Trading and Investing are two very different methods of attempting to profit in the financial markets.
It can be argued, however, that trading can also be part of the process of investing and can sometimes be used to boost returns over the long run.
The goal of investing is to gradually build wealth over time through the buying and holding of a portfolio of different types of investments. Investments are often held for a long time, with the hopes earning compound interest, dividends and stock splits along the way.
While markets inevitably fluctuate, many investors hold on through the ups and downs and over long periods of time, have usually been rewarded.
Trading, on the other hand, involves the more frequent buying and selling of stock, commodities, currency pairs or other instruments, with the goal of generating returns that can potentially outperform buy-and-hold investing. When you mark something as a trade, you are looking for anomalies in the markets that you can take advantage of to make a profit. Trades are also very heavily driven by news items and susceptible to misinformation.
I always used to like trading around my long-term holdings. If I held a long position in a certain stock long-term and I thought there was a short-term pop on the horizon, I would purchase more shares for a trading position or sometimes pick up another stock in the same sector for a trade. This allowed me to have the action but not do anything with my long-term position. Once the reason for the trade was complete, I would liquidate the trade while continuing to hold my core holding.
If I thought the market was going to correct but I didn’t want to sell my long-term position, I would put on a hedge on the overall market while keeping my stock investment. When it worked, I was able to use profits from that trade to purchase more of my long-term position at a discount.
You can even make trades with your long-term position if it makes sense. Suppose you bought 1000 shares of a stock that moved up much faster than you thought in the short-term. It would certainly make sense to earmark a few hundred of those shares for a short-term trade by using a trailing Stop Loss Order to protect some of your profits and create some cash to buy back in at lower levels.
It is critical that you do not turn a trade into an investment. This is a mistake that costs many investors a lot of money. It happens all the time. You buy a stock because you hear a new product is coming out and the price of the stock goes up and you decide to hold on to it. Or, it goes down because the news was already priced-in or maybe the product isn’t very good. You hold on to the stock thinking that it will rebound or go higher. Usually, the trading profit disappears, you get stuck with a loss and holding the position takes your trading capital off the table. Now you can’t use this money to make other trades.
Once the reason for making the trade disappears, the trading position must be liquidated because the reason you made the trade no longer exists. Good traders often use a protective Stop Loss Order to automatically close out losing positions at a predetermined price level. If you are going to make trades, you must always have capital available to make the trades!
Do you really have time be an active trader?
If you are an active trader, you need to be available when the markets are open. Also, be prepared to spend 15-40 hours a week doing research on your trades. In comparison, your typical long-term investor rarely spends more than 3 hours a week doing research.
Traders often employ technical analysis tools, such as moving averages and stochastic oscillators, to find high-probability trading setups. While this reduces research time in the long run, there is definitely a learning curve while you are getting started.
If you are just making a short-term hedging bet against the market, your research time is somewhat reduced and you can often place a Limit Order before or after market hours. I always used Limit Orders when I bought or sold positions, especially with trades, because it allowed me to target a certain price I wanted and if it couldn’t execute, the trade wouldn’t go through. You never want to be held hostage by the market.
While trading and investing are two totally different methods of making money, they can sometimes be used together with great success. The key takeaway to remember is to never turn a trade into an investment because it almost always results in failure.