Trading vs investing
We tend to focus exclusively on investing in this column; after all it is titled Invest DIY. But this week I want to focus on trading as distinct from investing.
Typically, an investor is focusing on long-term capital gain, while a trader is looking for quicker profits or income. According to the Sars definition, if you sell within three years you are trading, and I subscribe to that definition.
The idea behind trading is that profits will be made quickly; those investors who are new to the stock market are often dismayed at how long it will take to create wealth via long-term investing. The reality is that wealth creation on the market is easy, but it will take decades.
Traders try to shorten these periods by using much shorter time frames and importantly using derivatives such as futures, contracts for difference and options t rading foreign exchange, stocks, commodities and indices.
The problem is that a new trader sits down in front of their computer with a newly opened trading account and some spare cash recently deposited, expecting to be rich in no time at all. The outcome is starkly different as the vast majority of new traders bust out, in many cases losing more than they started with. So, what goes wrong? Well, a few things, the most important simply being a lack of the skills required and a lack of risk management. When we start trading it is too easy to start with no knowledge or skills.
In fact, there is no sense that trading is a skill and that skill needs to be learnt. If we wanted to be an electrician, brain surgeon, accountant or any other expert we’d first spend years learning the skill before starting a job at the bottom of the ladder and working our way up to the top over the years.
Yet a newbie trader reads a book and maybe attends a course and thinks they are the real deal. But they are not; they are about to be parted from their money, and it’ll be painful.
So, we need to develop the skills to be a successful trader. The first port of call is to learn the basics. Understand the different products, what their benefits and risks are, why one should be traded over another. One also has to understand the trade trigger process, typically using technical analysis. This knowledge is not rocket science but the time does have to be spent learning the ropes.
Then comes the really hard part of trading, the psychology. Trading is mostly about our emotions and managing the fear and greed cycle of being a trader. This is the very hard part and one of the best books on this topic is Trading in the Zone by Mark Douglas.
The next lesson is about managing risk. A new trader often thinks that trading is about taking massive risks, but it is not. A large risk means one move against you and you’re wiped out. Keeping risk to a manageable level is one of the keys to survival.
The l ast piece of t he puzzle i s discipline. Trading is about having a strategy and sticking to it. On paper this sounds easy but there is a great deal of what I call noise trying to push you off your trade. This includes data f low, comments, opinions and the like.
So, if you want to be a trader start at the bottom and develop the skills before wildly jumping in, and expect this process of learning to take time, potentially years.