In present day’s context, the processes of wealth accumulation and wealth creation centre primarily around two fundamental concepts – Investing and Trading. For an individual to create and accumulate wealth effectively and efficiently, it is of vital importance that the individual understands and grasps these two concepts very well. In this case, the first question that the individual may possibly ask would be as follows:
What is investing and trading respectively?
In essence, investing refers to the act of purchasing a stock or other financial instrument and holding them for a long period of time before disposing them off for a profit. It primarily concerns the identification and assessment of attractive investment opportunities and allocating financial resources into these opportunities with an expectation of favourable future returns over a certain period of time. To identify and assess investment opportunities, investors typically adopt fundamental analysis to carry out their assessment (Equities context). By definition, fundamental analysis involves analyzing a particular business/company’s financial statements and health, its management and competitive advantages.
An investor will pay special attention with regard to the sustainability of the company’s revenue (sales) generators as well as the economic moats (if any) that the company current enjoys before determining whether to invest or not. At the same time, some investors may also utilise fundamental valuation methods to evaluate the intrinsic or fair value of the business/company or asset class. Here, investors look at some valuation indicators and will tend to invest into businesses/companies or asset classes which are undervalued and may have upside potential in the near future. Some of these valuation indicators include Price/Earnings ratio, Price/Book ratio, Price/Sales ratio etc. Hence, an investor often makes use of fundamental information, such as earnings to evaluate investment opportunities, but can also use technical analysis to detect long-term trends. All in all, an investor buys a company with the intent of holding on to the stock for a long time. The investor should have done a thorough analysis of the company, believes it has long-term growth potential and understands what the company does and its position in its industry.
[Free Ebook] How should you invest your first $20,000?
We asked 14 Singapore finance bloggers to share what they would do if they could go back in time and invest their first $20,000. They can no longer rewind time, but you can learn from their experience and hopefully start with a better footing.
On the other hand, trading represents a different genre. Trading refers to the act of purchasing and selling of stocks or other financial instruments for a short period of time. In this context, the time horizon can range from less than a day to at most a few months. Trading primarily involves the identification and assessment of attractive short term trading opportunities and allocating financial resources into these opportunities with an expectation of favourable future returns over a relatively short period of time. To identify and assess trading opportunities, traders typically adopt technical analysis to carry out their assessment. By definition, technical analysis is a security analysis discipline used to determine the direction of asset prices through the delicate study of past market data. In other words, technical analysis deals primarily with price and volume. In the assessment of good trading opportunities, most traders usually utilise trading systems or chart-based technical techniques to detect short-term entry and exit positions.
A trader is only interested in profiting from intraday or short term price movements, executing buy or sell trade decision whenever he/she senses a price movement for some reason (through technical analysis, market/sector news, and so forth) and that the trader feels he/she could reasonably benefit from such movements within a short period of time. An important point that I wish to highlight is that trading provides a trader the ability to make money regardless of the overall direction of the market or the price of an asset class. In other words, a trader could reasonably be able to profit from the market by ‘Longing’ (Buy low first, sell high later) or ‘Shorting’ (Sell high first, buy low back later) the particular asset class (Stocks, Forex, Futures etc) if the trader’s assessment and judgement of the market is spot on. Another point to note is that a trader typically possesses a trading plan which contains a specific set of criteria which will trigger an entry or exit position. This is often associated with price action (Specific movement of asset class). Here, the trader is less concern with the fundamentals of the stock or asset class.
As mentioned earlier on, these fundamentals include earnings, revenue, profit margin etc. The trader will be more concern with the technical aspects of the stock or asset class. In other words, he or she is likely to pay more or special attention to the price movements of the stock or asset class, identifying potential technical chart patterns and utilising technical indicators to determine the direction of a particular trade. Some of the more common indicators that traders will utilise include Moving Averages, MACDs, and RSI etc. All in all, a trader places a stronger emphasis on precision entry and exit, taking advantage of technical analysis to determine the timing of their entries and exits into the market.
At the end of the day, the differences between investing and trading remain distinctively relevant. It is highly debateable though at times on the roles and characteristics display by investors and traders respectively. Whether you consider yourself an investor or a trader in your quest to achieve investment excellence and financial independence, it is of vital importance that you exercise discipline and establish a proper investment or trading plan for the execution of all decisions. Learn to execute good entries and exits. Engage in prudent and proper money management. For traders, this mainly centres on the usage of effective stop loss orders to curb and limit potential losses. Investor or trader – which is better? Make sure that before you decide to err on either of the two sides; give some due consideration with regard to your risk appetite, asset class preferences, liquidity needs and lifestyle.
PS: This post is contributed by Sam Goh. He is a dynamic youth who has build up his credentials as the Wisdom Capital Founder, Money Sensible Youth Ambassador, Associate Financial Planner, and committee member of FISCA. He runs a two-day Technical Analysis course.