Difference between trading and investing? It’s more than time horizon
Here’s our Club Mailbag email investingclubmailbag@cnbc.com — so you send your questions directly to Jim Cramer and his team of analysts. We can’t offer personal investing advice. We will only consider more general questions about the investment process or stocks in the portfolio or related industries. This week’s question: What is the difference between “trading” and “investing”? Thank you. — Robert M Great question, and certainly one for all members to consider as we look to the new year. The short answer is time horizon. Trading typically involves a brief window to buy and sell a stock to generate a quick return. Investing, by contrast, is about owning shares of a company over a more extended period, typically quarters or years. But there are other, more subtle differences. Let’s start with the investing mindset, which is what we do and advocate every day (it’s right there in the Club’s name). As an investor, your approach to the stock market is that of a potential owner of businesses. You’re looking to take and build a position in a company that will grow earnings over time. That means targeting companies you can see holding year in and year out through different cycles and headwinds, knowing that over time they will continue to generate returns. As Warren Buffett, arguably the most successful investor of all time, once said: “Our favorite holding period is forever.” Because of that philosophy, investors seek to establish and build positions over months and years, and to trim as needed to manage diversification within the overall portfolio. Any weakness in the name allows an investor to buy more shares at a better price. The idea is to use short-term bouts of volatility to your advantage to build the position. Near-term catalysts are excellent, but the primary focus is long-term growth. Investing Longer time horizons, measured in quarters and years Catalysts are helpful, but the focus is on long-term earnings growth, which will drive the stock price higher Build positions slowly over time Heavily relies on fundamental analysis to help forecast growth potential Volatility is an opportunity to build or trim stake By contrast, traders rely on near-term catalysts to make quick buy-and-sell decisions, often within minutes to hours for a day trader or days to weeks for a swing trader. That catalyst may be fundamental in nature (such as drug trial results or a court ruling) or technical (such as a positive setup forming on the chart). One who trades on technicals may not even know what the company does, and they likely won’t care if the trade is based on a stock bouncing off a key support level. A trader wants to identify a near-term catalyst that could drive a material stock move in one direction and enable quick profit-taking. For that reason, traders aren’t concerned with dollar-cost averaging into a position; they typically aim to get a full position quickly, often in a single buy. A day trader seeking to profit from a recent headline or to play a technical pattern will close all exposure at the end of the day, generating small daily returns that can accumulate over time. Volatility is therefore not a friend to the trader, as it may be to the investor. Whereas investors may view a decline as an opportunity, for a trader, a move in the wrong direction amounts to a blown trade, and losses must be cut as soon as possible. For this reason, traders often use derivative securities, such as options, which can limit losses while leveraging the underlying stock, thereby making them far more sensitive to moves in the underlying stock. Trading Shorter time spans are usually measured in minutes, hours, days, or weeks. Catalysts are a must and provide the rationale for trades. Buy the full stake all at once to get ahead of the key event that will move the stock. Relies heavily on technical analysis to drive decisions. Volatility is typically a risk. While our focus at the Club is on investing, we understand that some members may wish to trade occasionally. If you do, we recommend adhering to one of Jim Cramer’s cardinal rules: never turn a trade into an investment, which means that if the trade doesn’t work out in your favor, you have to take the loss and move on. Do not try to average down by buying the stock as it falls, convincing yourself that while the name wasn’t good for a trade, it will make a good investment. As Jim once pointed out years ago on “Mad Money,””I buy down when I am investing. I cut my losses immediately when I am trading if the reason I am trading the stock doesn’t pan out.” Anyone who wants to try their hand at trading must do the same. (See here for a full list of the stocks INJim Cramer’s Charitable Trust.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.
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