Seven Key Differences Between Investors and Traders

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Are you a trader or an investor?

If you’re new to the stock market this question might seem trivial, but it’s important that you’re clear on the distinction. Many investors make mistakes by taking on the behavior of traders, and many traders often lose money when mistakenly acting like investors.

Investors enter positions for long-term gains, typically at least three years or more from the time of entering a position. Your 401k and IRA money are typically considered investments because you don’t need to access this money for multiple decades. Investors typically rely on fundamental information, such as how sound the underlying company they are investing in is, or if economic conditions favor their investment over the long-term.

If you come into a pile of money such as an inheritance or annual bonus, you may want to risk some of this money and actively trade it. Traders operate differently from long-term investors and more often rely on technical analysis such as reading charts and market sentiment. Traders care less about the fundamentals of what they are putting money in, so long as it makes them a profit in the short-term.

You can be both a trader and investor, but it’s important not to mix strategies. You should always segregate trading money away from your long-term portfolio positions. Maybe keep your long-term investments at one broker like Fidelity and your fun trading money at Robinhood.

Here are seven key differences between traders and investors, inspired by the excellent book Market Wizards by Jack D. Schwager, who interviewed the most successful traders in the world and identified the key commonalities amongst them.

1. Traders Will Trade Anything, Investors Focus on Quality

This is a key distinction between traders and investors. Traders are seeking gains based on volatility, or how the price of a security swings up or down. The underlying instrument could be a stock, bond or Magic the Gathering card.

A good trader can trade any market and won’t care much if the position they are holding is inherently worthless, so long as they can flip it for a quick buck. This is partly why penny stocks make such alluring targets for traders, as they have an established pattern of spiking on pumps, and then falling just as rapidly as they are dumped. Traders don’t care about how the underlying security they hold will fare in six months because their trades typically last just days, or in some cases, minutes.

Investors, on the other hand, generally eschew penny stocks and sh*t coins for investments they believe hold intrinsic value. This latter group tends to focus on earnings, macroeconomic conditions and supply/demand fundamentals to inform where to place their money. Sources like Morningstar, which rate funds and stocks, are much more important to investors than traders. Many investors worship tomes such as The Intelligent Investor and the concept of value investing, which preaches that long-term investors will be rewarded for paying less than the price of what an investment is worth.

Investors tend to fall in love with their stocks; traders just look for a quick buck.

This fundamental difference in mindset is a key differentiator for many issues to come.

2. Traders Master One Style, Investors Diversify

To be a successful trader, you need an edge.

An edge can be informational, technical or some other aspect that gives you an advantage over other market participants. Perhaps you work in biotechnology and have a deep understanding of what will make for the next great cancer drug. Or perhaps you’ve studied charts obsessively and can identify with 80% certainty where a stock will move when its 9 day exponential moving average moves above its 21 day exponential moving average.

Developing an edge is difficult and often narrowly focused. When a trader finds an edge, he or she will want to use it repeatedly, because these advantages will only last for so long. As the market evolves, edges that traders rely on dissipate and eventually vanish. It pays to specialize and make as many profits as possible with your unique edge, until that opportunity closes and you need to find a fresh one.

Finding an edge is hard work.

Investors don’t need an edge. Long-term investment success is mostly an established science of keeping your portfolio diversified in line with your risk tolerance, keeping transaction costs low, and in the case of value investors, seeking to invest when prices are low relative to historical averages and selling when they are high. Investors seeking a reasonable long-term return above inflation can rely on diversification of individual securities and asset classes, which one famous economist called the only free lunch.

3. Traders Are Obsessive About Trading, Investors Don’t Need to Be

A necessity of mastering a trading style and developing a true edge is focus. Traders need to spend a lot of time on their craft, typically studying charts and market dynamics for a long period of time before developing confidence in their strategies. Just because a trader has a period of success doesn’t mean their learning journey ends. Trading edges come and go, as the experience of master trend follower Richard Dennnis and the Turtle Traders shows. Traders who want to maintain an advantage in the market need to constantly be monitoring the market because the market is always changing.

Traders are obsessed with the markets, investors not so much.

Long-term investors need much less focus on the daily turnings of the market. Investors simply seeking reasonable returns beating inflation can turn to index funds and set a reasonable asset allocation, then simply check up on their quarterly brokerage statements. Some investors who play individual stocks need to take more caution in monitoring individual company news to ensure that their pick does not become the next Blockbuster Video, but overall long-term investing in stocks needs much less focus and energy than monitoring a day trading account.

4. Traders Let Their Winners Run, Investors Take Profits and Rebalance

“You never go broke taking a profit.”

This cliche resonates with long-term investors but often steers traders wrong.

Investors seek to compound reasonable gains over time. If one stock or fund in their portfolio skyrockets while others decline, it makes sense as a long-term investor to lock in those profits and redirect them to the underperforming parts of the portfolio. This is because a long-term investor has conviction in every part of their portfolio (they only invest in quality assets) and also because the return profile of asset classes tend to be cyclical. If you’re invested in the long-term, you want to make long-term cycles work on your behalf.

Traders should have a different mindset. When a trade is going in your favor, you should ride that trade for as long as the trend confirms your position. Many novice traders focus on metrics such as “win rate,” which is how often they have a winning trade vs. a losing trade. This metric ignores the size of wins compared to losses however. Many successful traders, including some of history’s best traders as profiled by The Market Wizards book, placed a much a greater emphasis on the size of winning trades compared to overall win rate. In fact, successful traders often will double down and increase their positions in winning trades, even as an investor will be focused on selling that same move for profits.

The trader mindset.

Successful traders understand that even just a few very successful trades will make their account profitable, even if the majority of their trades are break even or for small losses. That’s why it’s so important for traders to maximize their best moves and not sell too soon.

5. Traders Immediately Exit Losing Positions, Investors Average Down

The flip side of the previous rule is the difference in how traders and investors view paper losses. Traders who focus on a time horizon of anything shorter than weeks will immediately cut their losses on a position moving against their thesis. Traders are focused on short-term wins and keeping their overall account balance healthy. A move to the downside threatens their overall account equity, and there is no sense in taking a risk with their overall account on any one individual trade.

Traders have little patience for a losing position.

Investors, because they enter positions with more conviction, are not immediately put off by temporary swings in price. In fact, investors will take a downwards swing in the price to “average down” and improve the cost basis of their position. If your time frame for an investment is three years or more, then losing 5% in a week is not that big of a deal. As long as your investment thesis for that position remains intact, then short-term swings in price should be opportunities to add to your position.

6. Traders Exploit New Information, Investors Assume It’s Priced In

A big point of contention among The Market Wizards interviewed by Schwager was the “Efficient Market Hypothesis,” (EMH) or the idea that markets mostly behave rationally and that all information related to a market or security is collectively priced in by the collective participants. Most of the Market Wizards disagreed strongly with EMH, and many had credited their fortunes with this disagreement.

Traders typically are involved in the markets because they believe they can capitalize on the dynamics of greed and fear and that drive market behavior. One only needs to look at financial stocks in 2007 or the outlook for energy stocks at the beginning of this year to see their point that the market’s participants are sometimes imperfect at accounting for all possible outcomes for a market.

A trader reacting to the Efficient Market Hypothesis.

Investors tend not to try to outwit the market and instead rely more on sound principles such as asset allocation, dollar-cost averaging and rebalancing to achieve reasonable returns over the long-term. It’s true many investors tend to take contrarian positions that play out over the long-term, but typically these ideas are developed over a longer-term horizon and don’t rely on short-term imbalances that traders thrive on.

7. Traders Monitor the News, Investors (Mostly) Ignore It

“Buy the rumor, sell the news.”

Here we have another classic investment cliche that differentiates traders from long-term investors.

Traders often rely on news related to a stock or market and take positions based on how credible that news feels to them. Some times a news item can drive a stock up on the initial market reaction, only for the stock to crater once the full implications of the story are digested by market participants. This type of news-driven volatility is a godsend for traders, who often go long or short on the same stock within the same day, but is merely an annoyance for long-term investors.

More likely to interest a trader than a long-term investor.

Investors may factor in surprising news into their thesis for whether or not to hold on to their position, but a single large company will generate many such positive and negative news items in a year, especially considering there are four earnings reports per year. If an investor senses that the news flow is turning decidedly negative against a stock or investment they hold, this might prompt them to exit their position. It’s rarely a good idea, however, for a long-term investor to sell out of a position based on a single bad headline.

There you have some of the key differences between traders and investors. Great traders tend to be active, while great long-term investors are mostly passive. Interestingly, the same information will be reacted to very differently by an investor or a trader in the same position. While you can be both a trader and an investor, it’s best not to mix styles because the goals for traders and investors are different.


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