The Basic Differences in the Psychology of Traders and Investors

Today, most of the trading has moved online. Technology has moved to the point where individuals can trade at home on their personal computers or phones. Trading involves stocks and other types of investments. Yet, trading has been seen as a different financial practice from investing.

A trader and an investor are two different types of creatures indeed. Traders are more visible in the popular media. They are also quite famous for making large profits from stock trading. But you probably don’t know that the cases you hear about are exceptions.

Most people would be better off staying away from trading. Apart from the sound technical skills needed, there is also the danger of online stock trading scams. Stock trading has become available to the masses. Thus scammers now have a large pool of misinformed individuals to fool.

Keep reading to find out more details about the differences between trading and investing.

The Terms

Investing is the act of spending money with the expectation that, in the future, that money will generate more money. Trading is the buying and selling of those aforementioned investments. There is no clear technical difference between trading and investing are. The terms are rather used to define an individual’s different approaches to generating returns.

An investor puts money into an asset and expects that money to grow over a certain period. On the other hand, a trader does large volume transactions and has a very short-term perspective. An investor relies on an organic appreciation of the asset value, while a trader relies on the market’s volatility.

The Difference in Timing Between Traders and Investors

Investment is a long-term strategy. When you decide to invest in a company’s stock, you are speculating that the company will grow over a long period. That could happen if the company starts growing the number of assets it has, or it could grow by increasing its profits.

In practice, an investor will hold on to the stock for anywhere between 5 and 30 years. On a day-to-day basis, the stock prices fluctuate. Some investors even try to take advantage of those dips by investing more when the prices have fallen. However, the focus is always on the long-term movement of the stocks.

Trading is complete short-termism, where traders buy and sell investments quickly to take advantage of every little price swing. Day traders buy and sell stocks on the same trading day, whereas swing trading expands the same process from a few weeks to a couple of years. Some trades even happen in a matter of seconds. For this reason, traders perform at a far higher volume than investors.

The Difference in Analysis Between Traders and Investors

A stock’s price and its intrinsic value are different. The price of a stock is derived from the number of buyers and sellers transacting with that stock at any given time. Apart from this, there is the concept of the intrinsic value of a stock. The intrinsic value is considered to be the true value of a stock.

It is expected that the stock’s price movement should track closely with the intrinsic value of the stock over time. However, this isn’t always the case. Like buying or selling frenzy, human irrationality causes the stock price to deviate from its intrinsic value.

Passive investors completely ignore the stock price. They invest and remain invested in deriving profits from the rise in intrinsic value over time. Active investors buy stocks when the price is lower than their intrinsic value to make profits from two avenues – the increase in intrinsic value and the return of the stock price to its intrinsic level. There is a minor difference between these two approaches, but they depend entirely on intrinsic value.

Traders completely ignore the intrinsic value. They only monitor and analyze the rise and fall of the stock prices. Many traders don’t even know a company’s activities since they are only interested in the swings. Hence, traders only study the technical fundamentals of a stock.

They study historical trends to see if they can spot patterns that they can take advantage of. Some traders also take fundamental analysis into account, but that also benefits from the price swings.

The Risk of Short-Term Trading

Trading is a high-risk activity. Professional traders put a lot of equity behind individual trades. The practice of leveraged trading by borrowing money is also common. It exposes them very heavily to short-term fluctuations in the market. Apart from being high-stakes, trading is also a very high-pressure act.

Individual trades only generate returns to the degree of a fraction percentage point. Thus, traders need to keep rolling their money to generate substantial returns. They frequently change positions in the market.

That is where most amateur traders lose out. You have to work in a small window of time. The information you have is not complete, but because you are low on time, you have to make informed gambles. You compete with professional traders who can control the market with large amounts of money. They also have research teams and in-house algorithms. These factors end up making trades go in favor of institutional investors.

While you can still make money from trading, it is very similar to gambling or playing a hand of poker. Like professional gamblers, if you do get very good at it, you can make a living of it. As was mentioned before, these are the exceptions. The average person will not stand to gain a lot out of trading and are better off investing.

These are basic differences in the approaches to trading and investing. Which kind of financial practitioner do you think you are?

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