With all the investing books and websites out there, it is incredibly easy to get confused with terminology. In this brief post, we want to make the distinction between a trader and an investor. Many people use the terms interchangeably, but the two are in fact very different. In short:
- Are generally short-term in nature
- Trade on technical analysis of a stock (how the stock price itself moves)
- Might move in and out of positions quickly
- See their investments as a piece of paper to be traded to someone else
- Might trade on perceived market currents for that day or week or month
- Generally buy stocks for a longer time period
- Use mostly fundamental analysis to value a company intrinsically
- May use technical analysis to consider when to time an investment
- See their investments as a piece of a physical company
- Trade generally with a perspective on the individual company’s prospects as the biggest factor
As you can see, traders are generally short-term focused, whereas investors are long-term focused. This affects the way they approach the markets, and thus the underlying incentives they have for buying or selling a stock. For example, a trader can be bullish (ie, optimistic) for the long run prospects of a company, but bearish (pessimistic) on the short run, and therefore sell a stock (or short it). An investor might be long-run bullish on the same company, and realize that it might drop in the meantime, but buys it anyway. Both can make money over the long run depending on the timing of their purchases and dispositions. But, for the average investor sitting on the side lines, it makes no sense—both parties have access to the same amount of public information, so why would they making the opposite trade?
The effect of this is both good and bad. Good, because it allows the public markets to function correctly; for every buyer, there must be a seller, and vice versa. Bad, because it creates a degree of inefficiency (in the sense that the company’s stock is not correctly priced), because buying or selling anything might cause other market participants to buy or sell and thus change the price. Over the course of the long run, different incentives for buying and selling create opportunities for both traders and investors to make money. Key takeaway: investors, in general, like short-term market inefficiency, because they believe over the long run, the market will more accurately assess the value of a company.