What are the differences between trading and investing?

Ä    Note: It is not necessary to read this section in order to use TradingSolutions. However, understanding the concepts used in the program can help you to get the most out of the intermediate and advanced features.

Investing traditionally refers to buying a stock or other financial instrument for a long period of time, typically over several years. Assessing good investment opportunities often makes use of fundamental information, such as earnings, but can also use technical analysis to detect long-term trends.

Trading typically refers to buying and selling stocks or other financial instruments for shorter periods of time, typicallly less than a few months. Assessing good trading opportunities typically makes use of trading systems or chart-based techniques to detect short-term patterns.

The main advantage of trading over investing is that it provides the ability to make money regardless of the overall direction of the market or the price of an individual stock.

Figure 1. Chart of Baxter Stock Prices during 1999. Notice that despite lots of movement between 57 and 77 over the course of the year, the stock price at the end of the year was very close to the price at the beginning of the year.

Traders try to buy the stock at each of the low points in the price and sell it at the high prices that follow it a few days or weeks later. This is also called a long trade. An additional tool that traders use is short trading. Short trades allow a trader to make money when a price is going down by borrowing shares of the stock from a broker at the high prices and replacing them a few days or weeks later with stock purchased at a lower price.

It is important to understand that it is not necessary to perform short trades in order to make a profit from trading, even in a down market. However, short trading will provide many more opportunities to produce profits.

Figure 2. Chart of percent gains for different approaches to trading Baxter in 1999. Buying the stock and holding it would have yielded a small loss. Buying the stock before each significant rise and selling it at the top would have yielded almost a 200% gain. Also shorting the stock before each significant drop would have yielded over a 600% gain.

Day trading is similar to this, except that time frames are even shorter. Day trading concentrates on the price movements within an individual day, with trades typically lasting less than an hour.

&  Continue to the next section, What is an Entry/Exit System?, or return to the Overview for this chapter.