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Investing and trading are two contrasting means of attempting to earn a profit through participation in various financial markets. Most people consider themselves to be investors, and they tend to have an aversion to the label “trader,” even though, in actuality, some of the self-identifying investors are, in fact, traders. These people don’t know that some of the biggest winners in financial markets consider themselves to be traders.
Generally speaking, investors seek more significant returns over more extended time frames through the buying and holding of assets. They put capital into their select markets under the assumption that the value of their investments will increase over an extended period. As the value of the assets they invest in increases, so does the value of their investment.
The difference between investors and traders
Due to their long-term mentality, investors typically don’t have a plan for when their investments decrease in value. They hold onto their investment in the hopes that, over time, its value will eventually reverse itself and continue on its upward trajectory. That is because investors anticipate bear markets with trepidation and do not plan how to respond when they are losing. When prices crash, investors tend to continue to hold onto their positions.
By contrast, traders take advantage of both rising and falling markets to enter and exit positions over shorter time frames, taking smaller profits more frequently. As such, they have a somewhat negative reputation amongst innovators and investors. It’s not uncommon for traders to be referred to as “greedy” or as “innovation killers.” However, the truth is that traders are some of the bravest and most disciplined stakeholders in financial markets.
A trader has a defined course of action or strategy to put capital into a market with one goal: making a profit. Traders don’t concern themselves with the assets that they trade. All they care about is analyzing trends for an opportunity, such that they end up with more money than they started with. In a perfect world, traders would like to go short as often as they go long, enabling them to profit in both up and down markets. However, similarly to investors, most traders have a preference not to go short, as they struggle with the concept of making money while there are declines in financial markets.
Fundamental analysis and technical analysis
There are two basic premises of trading: fundamental analysis and technical analysis. Fundamental analysis studies externalities that may affect the supply and demand of a particular market, such as government policies, domestic and foreign political or economic events and much more. For fundamental analysts, they believe that it is possible to foretell changes in market conditions before they are reflected in market prices by scrutinizing these external factors.
On the other hand, technical analysis is based on the belief that market prices reflect known factors affecting supply and demand for any particular market at any given point in time. It is a broad area that uses price and price-related data to determine when to buy and sell. Technical analysis attempts to bridge the problems that fundamental analysis has about the specifics of timing and risk. Technical analysts believe that careful analysis of price action is sufficient to capitalize on trends. A technical analyst can analyze the charts for any given market and trade them successfully without understanding them.
There are two types of technical analysts in financial markets. One type “divines” the market direction through their ability to read charts and use indicators. The other type of technical analyst neither predicts nor forecasts the direction of markets. They are known as trend followers.
Instead of predicting a market’s direction, trend followers react to the market’s movements whenever they occur. They respond to what has happened rather than anticipating what will happen and attempting to outthink the market. Trend followers keep their strategies based on statistically validated trading rules, allowing them to focus on the market without letting their emotions interfere.
We have established the difference between being an investor and a trader. We have gone a step further to define the two primary theories behind trading: fundamental and technical analysis. There is one more distinction for traders: traders can be discretionary or mechanical.
Discretionary vs. mechanical traders
Discretionary traders make their buy and sell decisions based on the sum of their market knowledge, their view of the current market conditions or any number of other factors. In other words, they use their discretion to make their trading decisions, and as a result, their choices may be subject to behavioral biases.
By contrast, mechanical traders practice a much more disciplined investment process. They never use their discretion when making trading decisions. Their decisions are based on an objective and automated set of rules derived from their market philosophy. Mechanical trading systems simplify life by eliminating emotions from trading decisions, forcing traders to stick to rules.
Recent years have seen political and economic changes of enormous proportion. At the same time, technology has made immense advances that have caused significant changes in the trading and investing industry. It’s become all-important for individuals interested in entering financial markets to discern what strategies work best for them and exercise those strategies with discipline.