Investing and trading are two different things
Investing means taking a stake in something that creates value and then waiting. Trading means trying to make money from price movements. One runs on the side, the other is a profession.
Learning objective: After this lesson you can tell investing and trading apart clearly and judge which suits you.
An investor buys stakes in companies that make money and leaves them alone. Her gain comes from those companies earning profits over the years. It takes her a few hours a year.
What a Trader Does
A trader buys and sells to profit from price changes. He only gains if he's right more often than the rest of the market. That's a full time job, and on the other side sit professionals with better data and faster computers.
The Problem With Mixing
Both are allowed. What goes wrong is mixing them. Svenja buys an ETF for twenty years, then checks the app every day and sells out of fear at the first 15 percent drop. She bought like an investor and sold like a trader. That's one of the most common and most expensive mistakes of all.
The Question of Time
So the honest question is: how much time do you have? If you can spare ten minutes a month on the side, you're an investor. Anyone who tells themselves otherwise usually ends up paying for it.
The return comes from different sources. The investor earns a risk premium for putting up with swings and the risk of loss. All long term investors can benefit from it at the same time, because the companies behind it really create value. When companies make profits, the cake gets bigger for everyone.
Trading as a Zero-Sum Game
Short term trading, by contrast, is a zero sum game before costs. What one wins, another loses. After the spread, fees and taxes, everyone together even loses. Someone can still win, but only a minority, and their gains come from the losses of the majority.
The Claimed Edge
Anyone trading short term is claiming to have something others don't: better information, better models or faster execution. Before every trade, ask yourself what exactly your edge is. If you can't name it, you probably don't have one. Then the best you can expect is the market return minus your trading costs, and you get that more cheaply with an ETF.
| Investing | Trading | |
|---|---|---|
| Source of return | risk premium and value creation | being more right than the other side |
| Zero-sum or not | everyone can win | negative after costs |
| Time required | a few hours a year | full-time |
| The other side | doesn't matter | usually institutions and algorithms |
| Costs | low, because you trade rarely | high, because you trade often |
| Edge required | patience | a nameable information advantage |
Summary
- With investing, all long term investors can win at the same time.
- After costs, trading is a game where everyone together loses.
- If you can't name your edge, you don't have one.
Did you get it?
Where does a long term investor's return come from?
From the risk premium and from companies really creating value. All long term investors can win at the same time.
Why do traders lose money together after costs?
Because every gain is matched by a loss, and on top of that spread, fees and taxes go out.
What question should you ask yourself before every trade?
What exactly your edge over the other side is.
What others often ask about this
Can you make a living from trading?
Do the maths: if you need €30,000 a year to live on and earn a very good 20 percent every year, you need €150,000 in capital. Most private investors who trade actively earn nothing at all after costs.
What percentage of traders lose money?
Depending on the study and market, the large majority. For CFDs, providers themselves state loss rates mostly above 70 percent. More in the reality checks.
Check your understanding
Your task
You trade 30 times a month, and each trade costs you $4 in fees and spread. Work out the yearly costs and set them against an account of $10,000. Use the breakeven calculator to see how far a price has to move for a trade to cover its costs, and write down what edge you would have that justifies it.
Sources and further reading
- Barber and Odean (2000) show in the Journal of Finance, using data from over 66,000 households, that the most actively trading retail investors underperform the market average significantly. View source ↗
Related
- What an ETF isStage 1
- Who really moves the marketsStage 1
- Gold and precious metalsStage 1
- Matching questions for this stageQuestions