As I mentioned in my blog, Stockopedia (part 2), all the information you will need to analyse a company’s performance is delivered to your screen for you to peruse over your pan au chocolat and coffee every morning. The vast amount of information provided might look a little daunting at first but essentially it is divided into 2 categories; Fundamental analysis and Technical analysis. Fundamental analysis concerns itself with the facts and figures of the company such as profit, debt levels, cash in the bank etc and is primarily used by investors. Technical analysis concerns itself with market sentiment, global economic events, volume of shares bought/sold, momentum swings etc and is primarily used by traders. In this blog, Trading vs Investing, I explore the difference between the two types of stock market activity and the information they use. Let’s look at trading first.
Trading vs Investing
Stock Market Trading: What is it?
Stock market trading is the process of making profit on the back of swings in the price of commodities ( stocks, bonds, currency, precious metals, cocoa beans etc). It focus’s primarily on the economic principle of supply and demand. If there is more supply than demand the price goes down and if there’s more demand than supply the prices go up. No different to house prices. There are two types of trading – Day trading and Swing trading.
Day trading
A day trader is a person that starts the trading day with no shares in their portfolio but cash in their account. They spend the entire day looking at trends in prices of commodities and they attempt to make profit by GUESSING which way the price is going to go. The time period for the trade can be minutes to hours but the key factor is that they have no shares in their portfolio at the end of their trading day. If you are a day trader you are in and out of trades all day and by 4.30 (whichever way your day has gone), you only have cash in your account and you are ready to do it all again tomorrow.
Swing trading
Swing traders do exactly the same thing but they hold shares for a longer period of time (days/weeks/months). They wait for the anticipated swing ( either up or down ) and place their trade accordingly.
The interesting thing to note about a Trader (day or swing) is that when they are trading shares they have no interest in the company itself. They are not interested in the quality of the product, profits, margins, customer engagement, size. Nothing. All they do is analyse price trends using (amongst other things) a system called Japanese candlesticks. Introduced in Japan in the early 1700’s, they were designed to predict the future price of rice based on supply and demand and more importantly human emotion.
A trader can be an individual, an organisation or a computer system and all they are doing all day is trying to outdo each other. Trillions and trillions of trades are made daily exchanging huge sums of money which is why the share price chart for the last month for Rolls Royce looks like this.
The share price has gone 6.14% up, just not in a straight line. Every time the line goes up there are more buyers and every time the line goes down there are more sellers. The company itself is just getting on with business and has no control over the battle between buyers and sellers. Nothing much more going on here.
So, what is a candlestick?
A candlestick is a graphic image of what’s happening to the price of something for a given time period. Let’s assume these candlesticks on the right refer to Rolls Royce shares. In any 1 hour period you could get a green or a red candlestick. ( Green is on the left for the colourblind). In the green example the share price started at the open level. Buyers pushed the price up to the high position, sellers pushed the price all the way down to the low position and buyers pushed the price back up to the close position. It is green because the price ended higher. The opposite is happening for the red candlestick.
Nothing too scary about that. On its own a candlestick doesn’t tell you much but when you start to group them together, a trader can identify which way the share price is moving. Here is the 5 day candlestick pattern for Rolls Royce and yes you guessed it, It’s from stockopedia.
All these candlesticks have fancy names such as Doji, inverted hammer, morning star etc and there are 42 recognised patterns that traders look out for and they too have fancy names such as bullish harami and bearish engulfing. The trader sits down at 7AM to analyse the RNS for the day, he assesses all the global economic news and acts upon certain emerging patterns. If you place 1Million on a trade and the share price goes up 10 pence you make £100K. It’s not hard to understand why people are lured into the world of trading.
Trading vs Investing
Stock market investing – What is it?
Investing, on the other hand, is the process of seeing companies as businesses, understanding what the businesses do and building an ownership through the purchase of shares. Investors benefit from all the profits and cash returns the company delivers through allocation of dividends ( a cash bonus to the shareholder for holding shares in the company). A bit like the game monopoly where you buy houses and then sell the houses for hotels, investors build wealth over the long term by buying more and more shares in companies that grow and grow. Here is the growth of Amazon over the last 20 years
If you invested £10K in Amazon in 2000 at $3.18 dollars a share you would have made over 27% a year each year by doing absolutely nothing. Warren Buffet calls this the snowball effect. The earlier you start the bigger the snowball grows. You have invested in the future growth potential of the company. There are two types of investors. Active investors and passive investors
Active investing
Active investing involves spending lots of time researching, analysing and restructuring portfolios to meet certain targets. Active investors can be individual people like you and me or they can be large corporate fund managers running billion dollar portfolios for pension funds etc. They have teams of analysts and researchers pouring over endless amounts of company specific data and economic outlook forecasts to determine which way the portfolio should go to achieve the projected targets.
Active investors are constantly tinkering with portfolio sizes, industry spreads, risk management equations and analysing economic outlook forecasts etc to get the best possible results. The problem with active investing is best summed up with this phrase;
Money is like soap – The more you touch it the less you have.
An average actively invested fund managed by a fund manager should return between 8 and 10% per annum so if you didn’t fancy doing you own stock picking, buying funds and letting them do all the work is not a bad way to invest your money.
Passive Investing
Passive investing involves buying shares and holding those shares for a long time. It is a buy and forget type of operation. Each year you collect the dividend and either buy more shares thereby increasing the dividend next year or use the dividend as additional income. The passive investor only sells when the fundamentals of the company change or they find a better opportunity elsewhere.
If you invested £10K in Amazon in 2000 at $3.18 dollars a share you would have made over 27% a year each year by doing absolutely nothing. Warren Buffet calls this the snowball effect. The earlier you start the bigger the snowball grows. You have invested in the future growth potential of the company. There are two types of investors. Active investors and passive investors
You do upfront research using a platform such as Stockopedia ( here’s my discount code https://stk.pe/md15) which provides all the necessary financial figures and you can read annual reports ( scanning for phrases like ‘We are well placed for the future’ or ‘the future looks bright’ etc in the chairman’s statement) and you can dedicate as much or as little time as you want. As with anything in life you reap what you sow so the more you research you do the more chance you have of finding those golden nuggets. The passive investor only sells when the fundamentals of the company change or they find a better opportunity elsewhere.
You can invest passively either on your own or you can setup an investment club ( bit like a book club evening ) and make it fun. Make it a treasure hunt. What better way to spend a cold and wet December Tuesday evening drinking wine and nibbling cheese looking for a gem of a company that you can invest in to make some money.
It’s all very well trying to unravel Heathcliff’s love for Cathy but what a great way spend an evening asking questions such as;
- What’s Aviva’s dividend this year?
- Is hydrogen going to be the next big clean energy sector and what companies are in the market already?
- If Putin’s banks are frozen out of international markets what banks will benefit from the reduction in competition?
Or is that just me, lol?
Trading vs Investing: What you need to know – Conclusion
Trading is the process of jumping in and out of a series of time periods buying and selling shares based on supply and demand indicators using the candlestick method to determine which way a share price is going to go. Everyone is trying to out do the other and this is performed on a very large scale worldwide daily.
Investing is the process of building wealth through either actively changing portfolios on a regular basis or by passively buying shares and holding them for a long time and adding more shares along the way; a buy and forget and let it build style.
The problem with the Stock Market is that it has a perception of just being about trading. Pin stripe suits with red braces people shouting buy/sell, buy/sell all day long using convoluted and complicated jargon which I hope by know you know that’s not the case at all. There are a whole bunch of different methods to stock market investing that you can fit into your lifestyle.
For me it’s a passive investing approach ( where I can allocate my time to travel, enjoyment and investing research) wherever I am in the world. I don’t have the time to be a trader or an active investor. Those methods are full time jobs otherwise they just don’t work.
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