To Trade or Invest

The stodgy old world of stock market investing used to take place in the hallowed halls of dusty investment houses where buying stocks was viewed as a long term deal. You bought company stocks and held onto them for decades slowly earning dividends and appreciating value.

Then came the 1980s and the exploding stock market and the introduction of traders. With the introduction of personal computers in the 1990s, anyone could suddenly become a trader and the numbers of people directly investing in the stock market blossomed. Now, with cable TV replacing the quiet expertise of patrician stoke brokers like Louis Rukeyser with manic hedge fund traders like Jim Cramer you could be forgiven for thinking that long term investment went out the window and short term money making was in.

So what is the difference between 'investing" and "trading"?

Essentially, time is the difference. The terms investing and trading are used almost interchangeably these days although there are subtle differences. Investing is where the shareholder intends to hold a stock for a long period of time; trading is where the buyer intends to flip the stock after a very short period of time.

While the goal is the same – maximizing profits from a stock buy — trading has received a bad rap from the mainstream media and some view trading as a form of immoral addiction.

In reality, all stock investing is trading. Unless the investor is buying a stock in an Initial Public Offering, nothing of a stock purchase goes into the company, so it is hard to call that investing. Therefore, not to get all semantic here, but all stock purchases are trades -- only with a longer time horizon for selling

The investor, as oppose to the trader is not supposed to be swayed by the micro fluctuations of the market. Many investors claim that it is very easy to lose everything in mindless speculative trading. On the other hand, plenty of investors lost large sums of money in the stock market when it went south in the 2000 tech bust.

There is another distinction between trading and investing, although this has to do with the way in which invested capital is expected to produce a return. In trading, the appreciation of capital is the objective. You buy a stock at 10 dollars and sell at 15 and produce a capital gain. If dividends or interest are paid out then that's an added bonus but that is not the objective.

Investing, by its nature, looks at consistent income as a major component of the strategy. Dividends and bond interest payments are a significant part of the investment return. Capital appreciation only arrives at the end of the investment time frame when the investment is sold.

The distinction between investing and trading may become irrelevant as savvy investors realize that a mix of long and short term investment is key to maximizing profits. Investors may hold onto a stock for either five days or five years. The bottom line is what matters now. At both extremes there are those that claim their way is the best way. We have all heard the stories of day traders making four and five hundred dollars a day for a couple hours of work. We also hear of people who lose their initial two thousand dollar investment in less than a week. Like anything there is a skill involved and an expensive learning curve. On the other end of the scale we can look at a Warren Buffet and see that sober and long term strategies can turn into millions. Yet there are others that stick with their investment for the long haul, through thick and thin, and can slowly ride a deflating market down to the bottom.

Following one strategy over the other because of a philosophical belief, bereft of evidence, and believing that one strategy is superior to another is one way to lose money and miss profits.

One way to avoid this is to follow this philosophy. Only own a stock when it is rising and sell it if it is going down. In a volatile market, that would look like day trading but in a bull market you'll look like Warren Buffet. It is a simple concept. You have to factor in costs of trading and capital gains taxes, but you should be doing that anyway.

People will say that this philosophy creates volatile markets, pumps up stocks and unnaturally inflates the market. So? It is what is happening anyway so why not get in on the action and maximize your investments and profits. The new gurus of Wall Street are suggesting this philosophy with the daily updates and 'lightening rounds" so why not accept that investing has moved on from the starched collars and pin stripped suits of yesteryear into a brave new world of invest and trade.

Jay Northco

Jay Northco is the editor of a website dedicated to examining the skills of Wall Street Guru Jim Cramer while pitting Cramer's skills against a stock picking internet monkey named Leonard.