Trading vs Investing[/caption]
Before you step into the complex world of stockmarkets and it all starts to make sense to you, you should understand the basic difference between trading and investing. New stock market participants often get confused between trading and investing, end up mixing both and ultimately losing money.
Let's understand the basic difference between trading and investing
What is Investing?
Investing is buying and holding stocks for a longer duration with an objective to create wealth, let's say 3-5 yearsWhat is Trading?
Buying and selling stocks in the short term to make some immediate profits. Trading can be buying a stock or options for few seconds to few hours. Investing and trading both pursue the goal of seeking profit in the stock markets. In general, investors seek better returns by buying and holding stocks for the long-term. Traders, by contrast, take advantage of both rising and falling markets to enter and exit positions over a short timeframe, taking smaller but more frequent profits. The real secret, of all world-class performers in history, is 'Focus on the One' whether it is Arjun in the Mahabharat for Archery or Sachin Tendulkar in cricket. If Sachin tried to play all the sports, he probably wouldn’t have been a 'Master Blaster Batsman'. For that matter, Best Practices in manufacturing highlighted in ‘6 Sigma’ or the ‘Kaizen’ clearly spells out that, the human mind is capable of doing only ONE process very efficiently when done repeatedly. Whether it is manufacturing or human skills, cricket or archery, in order to be best in the class – 'Focus on the One' Just like Archery or Cricket, Trading or Investing, both require different sets of skills, mental attitude, and divergent rules. In order to be world-class, one can therefore either be a Top-class Trader or a Legendary Investor, but never both, not possible, never in the history it has happened. The rules of the game whether Trading or Investing are to such an extent diametrically opposite, that the human brain will never be able to do both effectively. When there is confusion, mind freezes, and decision making gets paralyzed, and that’s the reason why countless people on the street can’t pull the trigger when most needed and therefore are mediocre or just average. They are neither traders nor investors but a hybrid class. That being the case, now the next question, what are the diametrically opposite rules of the game which leads to such freeze of mind while decision making, eventually leading people to mix both, thereby kicking them out of business quickly or in other words, the manufacturing stops.Let's look into 5 differences between trading and investing
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Trading vs Investing[/caption]
1) Stop-loss OR Hold on:
In Trading 90% of the battle is controlling the losses no matter what strategy is adopted. Thus in a long position, even in good quality stock, if prices fall by some percentage points, the trader needs to exit taking a small loss, because his risk management may not permit further losses in the portfolio. However, in investing it is the stark opposite. For an investor, if the price of a good quality stock goes down it is a great buying opportunity, he can buy a larger quantity of shares at the same constant capital thus giving an attractive return on investment. Mixing the two converts an original trader into an investor by holding on to the shares without having understood the real worth of shares, which is probably not understood might even lead him to hold on to a JUNK Stock, thereby causing him to quit the business or the manufacturing stops.
2) Long term OR Short term time horizon:
In investing the investor puts his money for the long term in good quality stocks having robust business models. Temporarily the business may or may not perform but in the long term it does due to its robustness of the model, eg ITC a really good consumer-centric robust business model, had its own ups and downs, but the stock still has delivered 23% CAGR (compounded annual growth rate) in last one decade and 20% CAGR in two decades. Thus when 'Focus on the One' is lost and he becomes a trader by trying to play short term ups and downs, he misses the best of both. It’s like changing a sensible and faithful wife when at times she nags. If she is good she remains good, but sometimes she may be off the mood but that’s ok, that does not mean her goodness has evaporated. Similarly, a good stock for the long term must remain in the portfolio, of course, subject to its inherent business strength, but there is no reason why it needs to be churned just for short term moves. Therefore mixing the two get’s best of none and therefore a mediocre performance.
3) Generating cash flow OR Investing cash flow:
In trading, the trader’s endeavour is to generate positive cash flow through trading, it’s just like any other business. However, the motto of the investor is to invest his surplus cash, generated from where ever in the stocks for the long term. He is in no hurry to withdraw. This very divergent need, make the rules of the game different for investors and traders. Thus, the mixing of the two, makes the cash flow move in and out of markets quite frequently in the least efficient manner, thereby generating mediocre returns.
4) Analysing price OR Analysing value:
In trading, the single most input for generating profits is Price. Keeping an eye or following the prices will generate profits for a trader, but for investors, it’s the eye on the value that will generate returns for him. An investor compares the value with the price so as to buy shares available at prices below the fair value, having enough margin of safety. Thus the decision-making inputs are different in both cases and therefore any confusion on the battlefield of the stock market leads to erroneous, input-output results. It’s like Arjun shooting the arrow at the bird’s eye, his focus was clear, the eye, while for others it was the bird, others did not succeed, but Arjun did, why? because he understood 'Focus on the One'
5) The Market is Right OR Market is Wrong, the basic premise to start:
The underlying premise for the investor to start is that the market is wrong in the short term and in the long term it will show its’ true worth. However, the trader starts with the contrasting assumption that, the market is right in the short term, and therefore in order to make money just follow it. This intensely conflicting assumption is the biggest hurdle for the brain to function flawlessly. If the process or destination whether a person is a Trader or an Investor is clear at the very beginning, the brain can work flawlessly and take quick decisions based on whether the rules of Investor or the Trader are to be applied. Once the brain is trained to do the same process repeatedly, again and again, it achieves mastery over it, and rises above everyone and makes one as a Top-class Trader or a Successful Investor. The ability to 'Focus on the One' is the key to achieving Mastery.
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