Thursday, May 3, 2012

The different mindsets of traders and investors

The terms ‘trader’ and ‘investor’ are often used interchangeably because both participate in stock market transactions. In commodity markets, you will hardly ever hear the term ‘investor’. Why so? Because the mindsets of traders and investors are quite different.

A trader has a ‘short-term’ mentality. Time span for a typical trade can be a few minutes, or hours or at most a few days. An investor has a ‘long-term’ mentality. Time span for an investment can stretch from a few months to a few years.

Traders don’t worry whether the price of a stock (or commodity) is going up or down. If a profitable trade is possible – whether on the long side (up) or short side (down) – the trader will jump in. Investors usually enter long-only positions. They buy at a lower price, and expect to sell at a higher price.

A trader is quick and nimble. If a trade is turning into a loss, such losses are booked quickly by using a strict stop-loss mechanism. If a trade is in profit, the profit is also booked quickly. The process is repeated several times during a day or a week, depending on the traders time frame. An investor is more deliberate and slower in decision taking. Once a stock is bought, it is held for a long time to achieve the profit target. Short-term losses (or profits) are ignored.

Traders thrive when a stock (or commodity) has liquidity (i.e. large volumes) and shows volatility (i.e. big swings in price between the high and low points for the day or week). Liquidity allows trading in large quantities easily. Volatility allows huge profits within a short span of time. Investors prefer steady compounders that rise in price more gradually instead of swinging wildly, and provide returns through dividends and rights/bonus issues.

For traders, price action is the sole criterion. The best way to determine likely price movements in the short-term is to use technical analysis tools - like PSAR, CSI, pivot points. Investors are more concerned about the quality of the company they are planning to invest in. They go through a process called fundamental analysis to assess a company’s near and long-term growth, profit and cash generation capabilities; its management’s competence and integrity; and the valuation of its stock.

Now you know why there are no investors in the commodities market – because there can’t be much fundamental analysis for iron ore or turmeric or guar gum.

What successful traders and investors have in common is a plan and a system that has been developed over time and which has worked for a trader’s or investor’s individual style; and the discipline to stick with a good working system. Most losses are incurred by not having a plan, or deviating from a working system.

The better traders and investors use each others best practices: traders pick and choose the better companies to trade in; investors use some of the technical tools to better time their entry and exit.

Related Posts

Do you like short-term Trading or long-term Investing?
Why stock market, forex and commodity traders use a Pivot Point calculator


Nasir said...

Hi Subhankar, many accomplished traders look at fundamentals and many respected fundamentalists look at technicals.

I think the key difference is that fundamentals tell you WHAT to buy/sell and technicals tell you WHEN it is likely to be a good time to buy/sell. In a way, both are inseperable - none can work in isolation.

Subhankar said...

Thanks for your comments, Nasir.

It is unfortunate that too many investors deride technicals and most traders believe that all the fundamentals are 'in the price'.