The Difference Between Trading and Investing

What is the difference between trading and investing? Is one better than the other, and does it make sense to discourage short term trading?

Over the weekend i was browsing through twitter  and someone had posted a warren buffets quote   trades actively in the market an investor   “is like calling someone who repeatedly engages  in one-night stands a romantic.” and this got me   after all the people involved are just  trying (with varying degrees of success)  

If you reach for the dictionary, you’ll see   the hope of making a profit or a return”.   that is exactly what a trader does – and outside  of the stock market – it is what most retailers   that no one is encouraging walmart to hold on   so, what is the difference between trading and   investing? is one better than

The other, and does  it make sense to discourage short term trading?  well, the online consensus appears to be that  investors are people who build diversified   portfolios of assets and stay in them through  the ups and downs of the market seeking a larger   do this through buying and holding. traders,   on the other hand,

Take advantage of both rising  and falling markets entering and exiting positions   quick returns based on short-term market moves.  these are clearly quite different approaches,  but why is it argued that one approach is better   than the other? the buffett quote even implies  that there is possibly something less wholesome  

About short term profits. most governments seem to  agree with that point of view and discourage short   term trading, by setting a higher tax rate on  short term capital gains versus long term gains.  one of the first arguments i found comparing the  two approaches put forth that investors do more   analysis than traders do. long term

Investors  generally build dcf models and attempt to   calculate the intrinsic value of a company. they  assess the competitive advantage of the business   traders pay no attention to any of this stuff   this argument unfortunately shows a complete  misunderstanding of what traders actually do.   fundamental value of a

Company, it is worth   noting that there is limited evidence that that  such calculations have any real predictive power.   but this is not the only style of research that  can be done) most successful traders spend all   just a different style of analysis. and this is   because most trading strategies aim to profit from 

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Pricing anomalies that can be found in markets,   so, some examples of the strategies that   traders might specialize in are things like merger  arbitrage, where one company has agreed to buy   another, and the trader has expertise in assessing  the probability that the deal will close.   often, these traders have a background

In m&a  or in securities law, they’ll know a lot about   the industries that they cover and they’ll have a  good understanding of things like antitrust law.   convertible bond arbitrage is another trading  strategy, where the trader identifies mispricing   bond and the fair value of such an option.   statistical

Arbitrage is a strategy that takes  advantage of price distortions caused by large   buy and sell orders being executed in the market  – it is one of the core strategies at renaissance   capital – one of the most successful funds in  history. distressed debt investing is a strategy   that tries to profit from market imbalances

Caused  by certain investors being prohibited from holding   driven, involves trading the securities of   companies undergoing corporate events like m&a  spin offs restructurings and bankruptcies where   specialist traders understand how these events  can make price changes more predictable than   under normal

Circumstances. i have spent most of  my career building quantitative models that make   short term predictions of price changes in various  futures contracts. without belaboring the point,   rely on just instincts and chart patterns.   so next up, is there a social good associated  with buy and hold investments when contrasted

With   short term trading? i don’t believe there is. most  short-term trading strategies make markets more   efficient, ensuring that all investors get a fair  price when they buy and sell financial securities.   for example, if companies are issuing convertible  bonds too cheap, traders will step in and compete  

To buy that bond pushing the price closer to fair  value. if a big investor is selling their coca   cola shares, there is a chance that a statistical  arbitrage trader is buying these shares   and hedging the trade with a short position in  pepsi. this means that the big investor is more   likely to get a good price on their

Sale. short  term traders make market prices more efficient on   a good way of thinking about how markets work is   that if a commodity is in short supply, traders’  step in, hoping to profit by buying the scarce   good. these purchases will push up the price,  thereby reducing consumption of that commodity   so that

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The available supply might last a bit  longer. producers see these higher prices and   the good. equally, in other situations where   the price is higher than the speculators think  is reasonable, they sell. this reduces prices,   traders through their actions ensure  provide the required quantity and quality of  goods at the

Right time, minimizing waste.   now, traders are not always  right in their predictions,   and when they are wrong, they can contribute to  price bubbles, panics, or even crashes. but the   are there any other advantages associated with   trading rather than long term investing? well,  an investor might want some exposure

In their   strategy, simply because most of the returns   dependent on the overall market direction,   while the returns of a given trading strategy  should relate more to the quality of analysis,   another argument i often hear is that traders  are just gamblers. does this argument have   any validity? well, it is

True that there are  short-term traders who are just seeking the thrill   of a gamble, in fact when most sporting events  were cancelled last year due to the pandemic,   cryptocurrencies – possibly to alleviate   between trading and gambling though – is   that the risk in gambling is specifically created  by a casino

For entertainment purposes while the   risk of trading is a risk that is inherent in all  economic activity. i do agree that a gambler is   probably more likely to be attracted to active  trading than long term buy and hold investing.  up long-term investing in favor of trading?   in trading that long term investors avoid.  

First up is transaction costs. when you are buying  and selling a lot, what can initially look like   a lot of retail traders tell me that they pay no   broker. there is however a fee, that doesn’t   show up on your brokerage statement, the “spread”  which is the difference between the price you pay   to buy a stock and

The amount you’d receive if you  sold it. this can be thought of as being like the   house take in a casino. the spread can be as low  as 0.02% in the most liquid stocks and as high as   8% in microcap stocks. let’s say you are an active  trader who turns over their portfolio once a day   in the most liquid stocks. in a year

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You would  have lost 10% or more to transaction costs.   that drag on your returns is as much as a buy  and hold investor might expect to make in a year.   the worse your broker is, the more of a drag you  will have on your returns, if you are trading   this reason, most professional traders aim   to trade as little as

They can get away with.  they realize that they are swimming upstream.  long-term investor is that you get significantly   investors taxed at the lower long term capital   they sell their stocks. many wealthy investors   never sell their stocks, they just borrow against  their investment portfolio for living expenses.  

Don’t push their taxable income into a higher tax   bracket either. i suspect that the main reason  buffett never sells stocks relates more to tax   efficiency than anything else. there is no reason  to believe that because he felt that a stock was   he is simply managing his money in the most tax   efficient manner –

Which is what the government  must want you to do, as they set the tax rules.  now, the final disadvantage of being a trader is  that it usually consumes pretty much all of your   activity, and most people who do it are a bit   they find it both interesting and challenging.   long term investors on the other hand can work 

A full-time job and spend a few hours a year   enough capital to not need a steady paycheck,   at a computer researching trading strategies.  so back to the warren buffett quote. can you call  a trader an investor? in my opinion yes, they   are managing their money to grow their wealth. i  would add that not only is a trader an

Investor,   but warren buffett is himself a trader, often  trading derivatives, getting involved in merger   the economist henry crosby emery describes   intelligence against the rough powers of chance.   active person is involved in, whether they   want to be or not. victor niederhoffer in a wall  street journal

Article titled “the speculator as   hero” argued that speculators who apply their  intelligence to predict tomorrow’s prices today   are an indispensable component of all societies.  by buying low and selling high, they bring about   for those of you interested in learning more about   check out my video on the top ten books for  

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The Difference Between Trading and Investing By Patrick BoyleliveBroadcastDetails{isLiveNowfalsestartTimestamp2021-09-09T150010+0000endTimestamp2021-09-09T151421+0000}

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