The Pro's and Con's for each.
Most newbies enter the financial markets for the lure of easy money. A raging bull market sucks everybody in, and provides the adrenaline rush for excessive risk-taking.
It works for a while, sometimes a long while, but ends badly for most people. A bull market makes everyone overestimate their ability to make money in markets.
Truth be told, making money trading or investing is simple but it’s not easy. It’s simple because the techniques and strategies are easiest to learn and implement. It’s not easy because our default psychological makeup is stacked against us.
This is the reason that too many people make a lot of money trading or investing, but only a few are able to keep it. Therefore it’s essential to know what to expect out of markets and always plan accordingly.
The first thing is to decide between trading and investing.
Trading or Investing
Most people by default enter as traders. They flip a few counters, make some money and become addicted to it until they see a bear market. A bear market turns them into compulsive investors because their loss aversion stops them from accepting the loss, which is the most basic premise of trading.
They sit through long declines because they would exit only when they are even, no matter if it’s a lifetime.
The idea is not to become an investor by compulsion but by choice. When you become an investor by choice, you are in absolute control of your fate.
To avoid being caught off guard, here are a few things you must consider to choose between trading and investing.
Trading requires you to be a good at several things like technical analysis, timing, market reading, position sizing and risk management. Though most of these aspects can be mastered with practice, it’s a long grind for all the traders.
An investor needs to understand different business models, competitive edges and financial statements. Most importantly an investor must know what to get into and what to avoid during various market cycles. There are many basic rules that an investor must know of before committing meaningful capital to investing.
The time devotion
Both trading and investing require varying time commitments.
As a trader, you have to be very proactive in researching your trading ideas and managing your positions. If you are trading on leverage, you will have to be even more alert to manage your risk well. Furthermore, day trading or futures trading is like a full-time occupation and costs money if treated like a hobby.
As an investor, you can spend less time on your portfolio and still be fine as investments take time to play out. You can form a thesis, get on the stocks and wait for the market to do its thing. You don’t have to be on the screen to monitor your investments, nor do you have to research ideas every day. You can go about your routine life and still be a good investor.
The physiological makeup
Trading is by nature a high-risk activity. It challenges the mental set up much more than investing does. If you are too scared or enthusiastic about losing or making money, you will have a rough ride in trading. The right trading mindset comes with practice and practice costs money and time.
So, if you are beginning to trade, give it enough time, keep learning and keep your bets small to limit the capital burn. Staying in the game long enough gives you a competitive edge. Trading is quite volatile and requires a calm head to deal with the fluctuations.
Excessive greed and fear can play spoilsport in investing as well. You must have the stomach to deal with occasional heavy losses and have the patience to let your winners run.
Investing either makes you rich slowly or kills your capital slowly depending on how smartly you handle your investments. Being stupidly complacent with bad investments can blind you to new opportunities. Therefore it’s important to keep an open mind while investing.
Trading focuses largely on capturing short-term moves and compounding smaller profits. If done well, trading can deliver huge returns and if done poorly, trading can wash out your capital in minutes.
Investing is mainly about accumulating steady returns for long periods to build wealth. The focus is to get to a few winners that can continue to deliver and add to your returns year after year.
Diversification or concentration
Trading is very concentrated because you would want to achieve the maximum portfolio impact of the short moves in your favour. Concentration makes it possible. For example, a 10% move on 10% of your capital adds only 1% to your returns, while the same move on 50% of your capital will add 5% to your portfolio returns. Concentration is a good thing if you are able to manage risks well.
Investing is relatively more diversified as you are betting on the long-term without too much safeguarding. You would want to play multiple themes knowing well that a lot could go wrong in the long run and only a few of your bets will be responsible for the majority of your returns.
Trading can be riskier than investing and requires a hands-on approach to be successful. Trading without a plan and discipline is akin to gambling, which gets you addicted and leaves you broke.
On the other hand, investing is more like watching the grass grow - boring but rewarding in the long term.
Which is the best?
There is no one answer to the question as it depends a lot on the factors we discussed above. Both these activities don’t have to be mutually exclusive either. You can put a large part of your capital in decent investments and trade with a small part for the short term. Once you get accustomed to the nuances of trading you can allocate more capital in trading to enhance the overall return on your portfolio.
Personally my approach is somewhere in the middle, trading the weekly charts with the combination of fundamentals - See our Youtube channel here to help you decide....