Difference between trading and investing? It’s more than time horizon
Here’s our Club Mailbag email address—sendingclubmailbag@cnbc.com—to send your questions directly to Jim Cramer and his team of analysts. We cannot offer personal investment advice. We will only address more general questions about the investment process or stocks in the portfolio or related sectors. This week’s question: What is the difference between “trading” and “investing”? Thank you. — Robert M A great question and definitely one that all members should consider as we head into the new year. The short answer is time horizon. Trading usually involves a short window to buy and sell a stock in order to achieve a quick return. Investing, by contrast, is about owning shares of a company over a longer period of time, usually quarterly or years. But there are other, more subtle differences. Let’s start with the investing mindset that we do and advocate every day (it’s in the Club’s name, too). The way you approach the stock market as an investor is the approach of a potential business owner. You are considering taking and building a position at a company that will increase your earnings over time. This means targeting companies that you can see hold up through different cycles and headwinds each year, knowing that they will continue to generate returns over time. As Warren Buffett, arguably the most successful investor of all time, once said: “Our favorite holding period is forever.” Because of this philosophy, investors attempt to build and build positions over months and years and adjust as needed to manage diversification within the overall portfolio. Any weakness in the name allows the investor to buy more shares at a better price. The idea here is to use short-term bouts of volatility to your advantage to build the position. Near-term catalysts are great, but the real focus is on long-term growth. Investing Longer time horizons measured in quarters and years Catalysts are useful, but the focus is on long-term earnings growth that will drive the stock price higher Builds positions slowly over time Relies heavily on fundamental analysis to help predict growth potential Volatility is an opportunity to build or reduce stocks In contrast, traders rely on short-term catalysts to make quick trading decisions, typically within minutes to hours for a day trader or days to weeks for a swing trader. This catalyst can be fundamental in nature (such as drug trial results or a court decision) or technical (such as the formation of a positive pattern on a chart). Someone trading on technicals may not even know what the company does and probably won’t care if the trade is based on a stock bouncing off a significant support level. A trader wants to identify a short-term catalyst that can direct material stock movement in one direction and make it possible to make quick profits. Therefore, investors are not interested in dollar-cost averaging on a position; They generally aim to quickly gain a full position with a single purchase. A day trader looking to profit from a current headline or play a technical pattern will cover all risk at the end of the day, creating small daily returns that can accumulate over time. Therefore, while volatility may be an investor’s friend, it is also not an investor’s friend. While investors may view the decline as an opportunity, for a trader, a move in the wrong direction means a failed trade and losses need to be cut as soon as possible. For this reason, traders often use derivative securities such as options, which can limit losses while benefiting from the underlying stock, thus making them much more sensitive to movements in the underlying stock. Trading Shorter time periods are usually measured in minutes, hours, days or weeks. Catalysts are a necessity and provide the justification for the trade. Buy the entire stock at once to get ahead of the major event that will move the stock. It relies heavily on technical analysis to guide decisions. Volatility is often a risk. While our focus as a club is on investing, we are also aware that some members may wish to trade occasionally. If you do, we recommend sticking to one of Jim Cramer’s basic rules: never turn a trade into an investment; This means that if the trade does not work out in your favor, you must take the loss and move on. Don’t try to beat the average by buying the stock when it’s falling, convincing yourself it will be a good investment even if its name isn’t good for a trade. As Jim pointed out years ago in “Mad Money,” “When I’m trading, I buy down. If the reason I’m trading the stock isn’t working, I just cut my losses when I’m trading.” Anyone who wants to try their luck in trading should do the same. (See here for a complete list of INJim Cramer’s Charitable Trust stocks.) When you subscribe to the CNBC Investment Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trading alert before buying or selling a stock in his charitable foundation’s portfolio. If Jim talked about a stock on CNBC TV, he waits 72 hours after issuing the trading alert before executing the trade. THE ABOVE INVESTMENT CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY, TOGETHER WITH THE DISCLAIMERS. NO CIVIL OBLIGATIONS OR DUTIES EXIST OR SHALL BE RESULTING FROM YOUR RECEIVING ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTMENT CLUB. NO SPECIFIC RESULT OR PROFIT CAN BE GUARANTEED.
