I have been trading for more than 10 years and investing for more than 20 years now. I keep getting asked which is more profitable. - trading or investing? Being a technical analysis trader and investor, I truly think this question is not right. More appropriate way to ask is how can I be an effective trader and investor at the same time. In this article, let's learn what is trading, investing and how they can act as two vehicles that could help you achieve your short term and long term goals.
There are different kinds of investing and trading strategies like equities (stocks and options), forex, futures etc. For brevity, we will discuss trading and investing from equities (stocks and options) perspective.
Investing
You can own a piece of an organization like Apple, Microsoft by buying shares of the assets ( organizations). Investing is the process of buying and holding the shares of the assets concerned over a long period of time ( more than a year) based on the fundamental analysis. Equities always have been increasing over a period of time and is considered less risky. Typically, investments in a particular asset are held for more than a year and are taxed as long term. Investment is a buy and hold strategy that can create wealth over a period of time. Investors typically invest in an asset in three different ways
One time Investment :
Here, investors invest a chunk of money for one time in an asset and let it grow over a period of time.
Buying on dips:
Here, the investor is actively looking for more opportunities to invest in an asset and allocates more capital as the price of the asset falls in a typical trading cycle. Usually, this happens more often in the beginning of the investment cycle where the investor seizes the opportunity to buy the asset at a a better price points than he had originally purchased. I like to buy on dips as it averages down the buying price of my asset that enables me to have greater profits.
Dollar cost averaging
Here the investor is passive and eliminates risk by buying small chunks of an asset periodically ( weekly, monthly, quarterly, yearly) instead of investing the desired capital all at once. This is very popular strategy used in retirement accounts such as 401k where a portion of the salary is invested in the assets selected by the employee on the pay day. This strategy is so effective to generate wealth over a long period of time. Why? As already mentioned, price of the equities always rise over a period of time. However, in a given year, as per statistics, equities rise 53.3% of the time and drop 46.7% of the time in a year. A typically equity chart over a period of 10 years looks like a sine wave rising and falling. When the investor allocates same amount of capital periodically, more amount of equity is bought during the down days and less amount of equity is bought on the up days. In a nutshell, over a period of time, he would be able to own more equity than he had invested the capital one time.
I love this strategy and use it for my personal investment accounts in addition to my retirement accounts using apps like Stash which enables me to buy fraction of the shares for fixed capital allocated every week.
Trading
Trading is the process of buying and selling an asset over a short period of time with the intention of making profit in the transaction. So, how can a trader make profit in the short time frame? As we had already mentioned, price of the equities move up 53.3% and down 46.7% in a year and the trader capitalizes on the movements of the price over a short period using technical analysis tools. A trader typically determines 3 prices for every trade he enters - entry price, targeted exit price ( price at which he exits the trade) and stop loss ( price at which he exits the trade with a loss). A trader might buy and sell the shares of an equity multiple times in a year. This is in contrast to buy and hold strategy of investing and is taxed short term for the trade transactions. Traders typically have a profit mindset and are looking for ways to generate consistent income out of the trades. In fact, there are so many traders who make a living out of the consistent profits generated over a period of time. There are typically two types of trading strategies based on the time period.
Day Trading
Day traders typically enter and exit out of the trade the same day. There are so so many varied strategies in day trading such as first hour trading, intra day trading and last hour trading.
First hour trading
For a day trader, volatility is their friend. In the first hour of the trading, volatility is high and these traders capitalize on it and complete their trades in the first hour to meet their daily goals. These traders are early risers and follow the markets to be ready for their trades in the first hour.
Intra day trading
These day traders typically trade the whole day. Equities tend to move in the same direction they had moved in the first hour. However, they may drop and rise every hour. These traders capitalize on the movements of the equities using technical analysis tools like VWAP.
Last hour trading
These day traders typically trade in the last hour. Equities tend to move in the same direction they had moved in the first hour and may either form a higher high or lower low for the day in the last hour unless the markets ( SPY, QQQ) have adversely changed directions
Swing Trading
Swing traders trade typically for more than a day and focusses on profiting off changing trends in price action over relatively short timeframes.They use technical analysis and market news to determine the entry and exit points for their trades. They do not care much about the time frame but more about the price reaching their destined targets and about adjusting their stop losses as the trade progresses These traders typically use price action and volume as primary indicators and may use other leading ( fibonacci) and lagging indicators ( Moving averages, MACD etc) for their trade execution.
Trading vs Investing
Trading is like a job where you get paid with profits only when you place trades. A trader needs to spend considerable time technically analyzing the trades for profitable trades. Investing is totally passive and your money is working for you once you have your investing strategy set up for the asset.
Traders need to learn how to analyze the trades using technical analysis and can be a steep curve based on their background. Investing also requires knowledge about the fundamentals of the asset and the trends in the industry.
Trading is risky as it might result in losses if either set ups are not analyzed correctly or if the markets adversely change directions based on news. Though investment is typically buy and hold strategy and may be less risky than trading, one can incur heavy losses if proper fundamental research of the assets is not done.
How to trade and invest together
How can one use trading and investing effectively to build wealth? There is a saying in the financial world - more money makes more money . So, How can we invest more than our current savings rate? one way is to create an additional stream of income through trading.This stream of income generated can offset some of your expenses and thus increase your savings.
Investing regularly builds wealth over a period of time and trading helps reduce the time taken to build wealth by generating income that can be additionally invested.
How do I achieve this personally? I personally have a long term account where I do dollar cost averaging of the assets I want to invest in. I also have a short term trading account where I primarily trade for short term gains and profits. I personally have set goals of achieving certain income in my short term account that is automatically transferred to my long term account. In a nutshell, I use my short term account for income generation using trading strategies as mentioned above and invest in my long term account to generate wealth.
FYI, If you like this post, you would also like 4 stages of technical trader. if you are interested in learning more about technical analysis, check out our beginner page
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