Investing or Trading and Risk

Investing vs Trading

The main difference between investing and trading is time frame. The goal of investing is to buy an investment vehicle with the intention (and hope) of selling it at a higher price at a later date. The intention of trading is just the same, however the time frame is shorter.

What do you do when you buy an investment and it goes down in price? You either keep holding onto it, hoping it rises back to the price you paid for it, or you bite the bullet and sell the investment at a loss. You then channel the funds into another investment. While trading, the hold and hope method is counter-productive as precious capital is tied up when it could be used for better shot term opportunities.

Trading or Gambling?

Wikipedia.com defines gambling as:

' Wagering money or something of material value on an event with an uncertain outcome with the primary intent of winning additional money or material goods.'

This may not only refer to gambling. Replace the word gambling above with either stock market trading or property investment, and the definition would still fit.

I consider the stock market to be very similar to casinos, racetracks and property investment. At each of these venues are two main different types of players. The first is those who have no idea and take a punt, hoping for their stock to go up, the ball to land on red, their horse to come first, or the house they buy to increase in value. The other is those who know how the venue works, have studied the information available and make a trade, bet, or investment on the likely outcome.

As an example, take the casino game Black Jack. Most people play the Black Jack card game by just 'hitting' until the have 17 or higher, and not even looking at the dealer's cards. This is like buying a stock without knowing anything about it at all. At the other end of the spectrum are those who know how to play Black Jack, by comparing their cards with those of the casino dealer's. They then bet according to the odds of each likely outcome of the combination of cards on the table. This is similar to the stock trader that makes his buy / sell decisions based on the statistical odds of stock moving in the direction of his trade.

Stocks, Options, Futures and Commodities

The stock market is an extremely complex place to make a profit, but it is simple in comparison to the options, futures and commodities markets. I do not recommend trading in options, futures or commodities, until you have mastered the stock market. These markets offer very quick profits to the skilled or lucky, but you may get burnt quicker if you do not know what you are doing. As an analogy: pick up a sword for the first time two thousand years ago and enter the Coliseum and yell out “Gladiators are girls!” This is what it is like entering these markets with your money without knowing what you are doing. You may as well go to the casino and put it all on red.

I speak from experience when it comes to trading the options market. At first my beginners luck increased my capital by 250% in about six months. I took bigger and bigger risks until very quickly I lost 90% of my trading capital before I stopped. Luckily I did not get completely wiped out. At about the same time I decided to read William O’Neil’s How to Make Money in Stocks, and decided to stick with the stock market. Needless to say I have done a lot better on the markets since!

Risk

Risk is everywhere in our lives and if we were to be completely risk-averse then we would never get out of bed. There is much literature available on the subject of risk. A basic definition is:

‘Risk is the chance an investment’s actual return will be different than expected. This includes losing some or all of the original investment.’

Stock market trading is only risky to the uninformed and the uneducated, or to those who buy and hope. Risk can be managed by first properly researching and selecting the stocks likely to move the same way as predicted. Risk is further minimized by position sizing, setting and acting on stop losses and price targets.

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