There are two main ways of profiting from the financial markets. The first is to buy and hold assets with the aim of achieving a reasonable and sustainable return. The second, higher risk approach, is to trade in and out of assets for a quick profit.
Someone pursuing the former strategy could most accurately be described as an ‘investor’ while a devotee of the latter is essentially a ‘trader’.
For most of us, being a genuine long-term investor will be the more appropriate route to go down. But understanding the distinctions between these two approaches is important. If you are someone with long-term investment goals behaving like a short-term trader of the markets, then you may need to take a step back and reassess your tactics.
WHICH ARE YOU?
Which camp do you fall into? Do you want the long-term returns offered by dividends or coupon payments from government and corporate bonds? Or are you instead focused on securing capital gains from share price appreciation over a short space of time? An investor will arguably take a long-term view.
With a stock market investment, for example, this might mean buying a company because it operates in a market with high barriers to entry or has strong brands, pricing power, proven management or an established market position. The investor will also be looking for value – using key metrics to decide whether a share is cheap, expensive or fairly valued.
Or will you instead seek to capitalise on short-term volatility, chasing share price momentum, looking at the key announcements and news flow likely to move the price, with valuation much further down the list of priorities, reacting quickly to the latest market developments to avoid being caught on the wrong side of a trade. The table below sets out in broad terms some of the key differences between traders and investors.
|Trader||Short-term||Equities, commodities, forex||Exchange-traded products (ETPs), CFDs, spread bets, warrants, turbos, futures and options||Online|
|Investor||Long-term||Equities, bonds||Funds, ETPs, shares||Online/telephone|
Not everyone will automatically fit into either of these two categories. You might have funds accumulating slowly in an individual savings account (ISA) while at the same time playing the markets more actively through spread-bets or contracts for difference (CFDs).
ASSETS, INSTRUMENTS AND PLATFORMS
The broad category into which you fall determines not only your approach but also the underlying assets you are likely to take an interest in as well as the tools, broker and platforms through which you gain exposure to them.
Investors and traders alike will be active participants in the equity markets but, while a long-term investor will concentrate on stocks offering generous dividends and stable, sustainable growth; traders are looking for something which can generate a substantial capital gain in the near-term.
An investor might therefore consider buying a utility company for its dividend income, while a trader is far more likely to seek exposure to a small cap resources company, capable of more than doubling or, equally, seeing its value crash, on the strength of a single set of drilling results.
The commodities and foreign exchange markets are ideally suited to traders due to the level of volatility and, in the latter’s case, liquidity and transparency. Here it is all about news flow, market sentiment and psychology as well as a clear understanding of the macro-economic backdrop.
The way investors and traders access these markets will also differ considerably. An investor may use funds, exchange-traded funds (ETFs) or may buy and share stocks directly – enjoying the rights of ownership associated with an individual stock. They may also avail themselves of the two simple and accessible tax breaks offered by the government: ISAs and Self Invested Personal Pensions (SIPPs).
A trader is very unlikely to make use of a fund, may rarely trade through an ISA or SIPP and will often utilise leveraged instruments and particularly spread bets and CFDs to boost their returns. Because spread bets are ‘bets’, any return derived from them is received free of capital gains tax and both instruments are exempt from stamp duty.