| Trading
versus
Investing
The
concept of investing is as old as business commerce itself.
In the purest form of investment, an investor supplies the
capital (money) needed by a business concern, and in return,
the business concern grants the investor an ownership stake
in the business, or “shares.” Under such an arrangement, both
parties are hoping that the business will grow in value. Hence,
the investor’s stake grows in value as well.
One form of business investment
occurs when a corporation offers a portion of its stock to
the public (“IPO,” Initial Public Offering). Such offerings
can raise millions – or even billions of dollars of capital
for the company. In return, the investors who have purchased
the stock each own a piece of the company’s equity.
"The activity of 'trading'
is considered politically incorrect by certain
portions the mainstream media. Some anti-trading
advocates go so far as to imply gambling addiction
and other questionable morality associated to
'trading.'"
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Stock trading differs from investing when
you consider that trading relies more on the fluctuations
of the stock value itself. Investing, on the other hand, relies
more on the growth of the company who has issued the stock
which, in theory, will raise the value of its shares over
time.
For instance, let’s say that Joe Investor
purchases 1,000 shares of a company’s Initial Public Offering
for $10 per share. Joe is thinking that this is an excellent
investment since the company is expected to grow by a factor
of 20 during the several years. If this pans out, his initial
$10,000 investment might be worth at least $200,000.
Now let’s say that the word gets out about
this company, its future is looking quite promising, and suddenly
everyone wants “in.” Because of the high demand for the stock,
its price is driven up to $20 per share, then to $30, then
$40, etc. Other investors notice the new “hot” stock issue,
and in a mad buying frenzy its price is driven up to $100
within a matter of days.
What just happened? The company hasn’t changed,
it hasn’t made one penny, and it hasn’t had a chance to grow.
Yet, Joe’s initial $10,000 investment is now worth $100,000!
If Joe wanted to, he could sell his shares immediately for
a 10-to-1 gain rather than wait for several years to realize
his goal of a 20-to-1 gain.
Probably, Joe will sell. In this case, he
has made a trade---trading the stock for cash. His
profit, while large, did not result from the underlying company’s
success, but rather his profit is the result of investor speculation.
Additionally, those who bought Joe’s shares could turn around
and sell them to someone else, again, as another trade.
This is the fundamental difference between investing and trading.
Nonetheless, the terms investing and trading
have come to mean the length of time that one intends
to hold on to stock. Today, the terms investing and trading
are used almost interchangeably---with the distinction of
time. One is “investing” if the shareholder intends to hold
for a long period of time; one is “trading” if the stock is
held for a very short period of time.
This distinction is important to understand
more from a philosophical point of view than a technical one.
For whatever reason, the activity of “trading” is considered
politically incorrect by certain portions the mainstream media.
Some anti-trading advocates go so far as to imply gambling
addiction and other questionable morality associated to “trading.”
Yet, in today’s market, every stock purchase
is, in fact, a trade. Unless one is participating in an Initial
Public Offering, not one penny of a stock purchase goes into
the company, so one isn’t really investing at all. They are
all trades, albeit some of them with longer time horizons
than others.
In spite of its apparent social taboo, trading
differs from “investing” only in technique. Both the trader
and investor share the same goal---to profit on a rising stock.
While convincing arguments can be constructed for both
techniques, the point is that “moral” implications about trading
should not be a factor and need not be part of the debate,
at least not without indicating that "investing"
has the same implications but with the intended time horizon
as the only technical difference.
Long-term investors are quick to point out
that some people have lost fortunes in day-trading and other
forms of stock market “gambling,” hence its ill repute. On
the other hand, the “investor” is certainly not immune to
losing vast sums of money, which by now might be painfully
obvious to thousands of speculators who held on to sinking
technology issues throughout the year 2000.
“Investors are the real gamblers,” said the
legendary 19th Century trader Jesse Livermore. “They make
a bet and stick with it, and if it doesn’t go their way they
lose everything.”
In truth, successful trading demands a skill,
as with any other profession, as special skill that requires
precision and concentration, else misfortune. In the hands
of a skilled surgeon, a heart transplant goes smoothly. Such
surgery, attempted with no education, would be certain death.
Stock trading is no exception.
GarsWorld is all about trading, although the
technical distinction between trading versus investing is
really about time. Considering such a distinction,
I must emphasize the following approach to my strategy.
I have no fixed rule about time. I may hold
a stock for five minutes or five months, all that matters
is that I maximize profit and minimize losses.
It surprises me that the concept of ignoring
the time factor is somewhat “new” to many who participate
in the stock market. Most investors and the day-traders alike
have a very specific idea about time. The investor is often
in for the long haul, through thick and thin, come hell or
high water, while the day-trader specializes in split-second
shaving of fractions from 5-minute trades. I find it interesting
that neither of these approaches consider maximizing profit.
Instead, they emphasize time as the senior importance
to their strategies.
Consider the following strategy as an alternative:
Owning a stock as long as it is rising and not own it otherwise.
In volatile markets, this will look like day-trading. In steadier
bull markets it will look like investing.
The guiding principle should be maximizing
one's profit!
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