Many people use the words “trading” and “investing” interchangeably when, in reality, they are two very different activities. While traders and investors participate in the same marketplace, they perform two very different tasks using very different strategies. Both of these parties are necessary, however, for the market to function smoothly.
Stock traders: Individuals or entities engaging in the trading of equity securities, or the transfer of financial assets in any financial market, either for themselves, or on behalf of someone else. They operate in the capacity of agent, hedger, arbitrageur, speculator or investor.
Stock investors: Individuals or entities who use their own money to purchase equity securities, which offer potential profitable returns in the form of interest, income or appreciation in value (capital gains).
There is quite a variation of characteristics. To go into further detail on investors and traders:
Stock investors are the market participants whom the general public most often associates with the stock market. They rely primarily on fundamental analysis for their investment decisions and fully recognize stock shares as part ownership in the company. Many investors believe in the buy and hold strategy, which, as the name suggests, implies that investors will buy stock ownership in a corporation and hold onto those stocks for the very long term, generally measured in years.
These investors, who purchase shares of a company for the long term with the belief that the company has strong future prospects, typically concern themselves with two things:
- Value – Investors must consider whether a company’s shares represent a good value. For example, if two similar companies are trading at different earnings multiples, the lower one might be the better value because it suggests that the investor will need to pay less for $1 of earnings when investing in Company A, relative to what would be needed to gain exposure to $1 of earnings in Company B.
- Success – Investors must measure the company’s future success by looking at its financial strength and evaluating its future cash flows.
Both of these factors can be determined through the analysis of the company’s financial statements along with a look at industry trends. At a basic level, investors can measure the current value of a company relative to its future growth possibilities by looking at metrics such as the PEG ratio – that is, their price earnings (value) to growth (success) ratio.
Stock traders are market participants, either an individual or firm, who purchase shares in a company with a focus on the market itself rather than the company’s fundamentals. A stock trader usually tries to profit from short-term price volatility with trades lasting anywhere from several seconds to several weeks. The stock trader is usually a professional. Persons can call themselves full- or part-time stock traders/investors while maintaining other professions.
Markets involved in the trade of commodities are beneficial to a stock trader’s strategy. After all, very few people purchase wheat because of its fundamental quality – they do so to take advantage of small price movements that occur as a result of supply and demand. Stock traders typically concern themselves with:
- Price patterns – Stock traders will look at past price history in an attempt to predict future price movements. This is known as technical analysis.
- Supply and demand – Traders keep close watch on their trades intra-day to see where money is moving and why.
- Market emotion – Traders play on the fears of investors through techniques like fading, where they will bet against the crowd after a large move takes place.
- Trader support – Market makers (one of the largest types of traders) are actually hired to provide liquidity through rapid trading.
Ultimately, it is traders who provide the liquidity for investors and always take the other end of their trades. Whether it is through market making or fading, traders are a necessary part of the marketplace.
Clearly, both traders and investors are necessary in order for a market to function properly. Without traders, investors would have no liquidity through which to buy and sell shares. Without investors, traders would have no basis from which to buy and sell. Combined, the two groups form the financial markets as we know them today.