The number one reason I believe that people lose a substantial amount of money in the markets is because they think they are investing when in reality they are just trading. To a person unfamiliar with the financial markets, these two terms might sound more or less the same. However, for those who are more experienced can easily tell the difference between the two, yet constantly forget the true meaning when opportunity comes knocking on their door.
Whether it be trading or investing, in the end we all strive for the same thing, and that is to make money. But how you go about to make that money is what distinguishes the two terms. A trader is a person who buys a security, and in turn hopes to sell it for a profit. An investor is person who buys a company, and in turn looks for it to grow in value before its stock. Remember, a stock is an ownership in the company, and if you are owning a stock you are owning a piece of that company. Just as if you were starting your own sole proprietorship and look for the company to grow, the investor also looks for the company in which he has bought the stock for to grow. The difficulty that most new comers(and sometimes even experienced individuals) face is that they think they are investing, when they may secretly be trading without even realizing it.
If you are at a bar, and over hear a couple of people discussing the next big company, you might get tempted to go home and buy their stock. You realize, this stock has so much potential, the company is going to be earning a lot of money in the future etc., that you decide to go ahead and place an order for that stock with your broker. Your hopes are set high, and in the next few days the stock is up 5-6%. You feel like you are on top of the world, and then the market starts correcting. You wonder what is going on? Why is the stock dropping, there were no negative press releases or any breaking news or anything. The stock just recently posted good earnings so what is going on? Before you know it you are down 10% and you give into the market and sell the stock for a loss. Then you try to pick out another big company that you think will just fly through the roof, and the cycle repeats and you end up selling the stock for a loss. That is the perfect example, of a trader in denial. With just doing the absolute basic research on the company, you decided to “invest” in a stock which you were deep down inside just planning to trade. If you realized that you were a trader, you would’ve took your 5-6% profit and exited at the right time.
A true investor would’ve taken a much different approach to this. He would’ve done much research into the underlying company and found the true value of that company and compared it to many things including the stock price of that company. He would also seek out the growth potential in that company before buying a share. Then the investor would look for the COMPANY to grow, while giving him good earnings each year per capital invested, and expanding its assets. Only then, after the company has grown, the true appreciation in the stock price will come which is when the investor will look to sell his ownership before a reversal in the business cycle.
To a trader, the stock is a piece of paper that they believe they can sell for more than what they bought it at to another party. They try to predict the extreme short term movements in the price of these pieces of paper through various techniques and such, and look to unload their paper as soon as possible for a profit. Now understand, I’m not saying there is anything wrong with being a trader. But there is just a set mentality required to be a trader that most people don’t understand, and jump into the markets as if they jumped into a cage to tame lions with no training. Some people are meant to trade and are very good at it, but for most of us who don’t have their emotions in check would probably get brutally destroyed.
To an investor, the stock is an ownership, just as it would be in a sole proprietorship. The price of a stock is the function of an underlying company, and in the long run as the company grows, so will the price of that stock. An investor will actively look for stocks that are undervalue compared to the value of its underlying company, and look to buy ownership into these companies so they can grow and bring the value of the stock to where it belongs, and that is when the investor will look to sell.Just think of it this way, if you started a sole proprietorship today, and three days later the market value of your business fell by 10%….would you still sell it?