The Difference Between Investing/Trading and Fundamental/Technical Analysis
January 7, 2016 15:36
I often get asked by potential students to explain the difference between investing/trading, and fundamental analysis/technical analysis. The second question is usually why I personally lean towards trading over investing, and technical analysis over fundamental analysis. With that said I wanted to first share with you an article written by Jean Folger that addresses the basic differences between investing and trading. Following the article I'll add my personal take on why we teach swing trading over longer term investing and why we focus on technical analysis over fundamental analysis. Enjoy!
What is the difference between investing and trading?
By: Jean Folger
"Investing and trading are two very different methods of attempting to profit in the financial markets. The goal of investing is to gradually build wealth over an extended period of time through the buying and holding of a portfolio of stocks, baskets of stocks, mutual funds, bonds and other investment instruments. Investors often enhance their profits through compounding, or reinvesting any profits and dividends into additional shares of stock. Investments are often held for a period of years, or even decades, taking advantage of perks like interest, dividends and stock splits along the way. While markets inevitably fluctuate, investors will "ride out" the downtrends with the expectation that prices will rebound and any losses will eventually be recovered. Investors are typically more concerned with market fundamentals, such as price/earnings ratios and management forecasts.
Trading, on the other hand, involves the more frequent buying and selling of stock, commodities, currency pairs or other instruments, with the goal of generating returns that outperform buy-and-hold investing. While investors may be content with a 10 to 15% annual return, traders might seek a 10% return each month. Trading profits are generated through buying at a lower price and selling at a higher price within a relatively short period of time. The reverse is also true: trading profits are made by selling at a higher price and buying to cover at a lower price (known as "selling short") to profit in falling markets. Where buy-and-hold investors wait out less profitable positions, traders must make profits (or take losses) within a specified period of time, and often use a protective stop loss order to automatically close out losing positions at a predetermined price level. Traders often employ technical analysis tools, such as moving averages and stochastic oscillators, to find high-probability trading setups.
A trader's "style" refers to the timeframe or holding period in which stocks, commodities or other trading instruments are bought and sold. Traders generally fall into one of four categories:
Position Trader – positions are held from months to years
Swing Trader – positions are held from days to weeks
Day Trader – positions are held throughout the day only with no overnight positions
Scalp Trader – positions are held for seconds to minutes with no overnight positions
Traders often choose their trading style based on factors including: account size, amount of time that can be dedicated to trading, level of trading experience, personality and risk tolerance. Both investors and traders seek profits through market participation. In general, investors seek larger returns over an extended period through buying and holding. Traders, by contrast, take advantage of both rising and falling markets to enter and exit positions over a shorter timeframe, taking smaller, more frequent profits."
Why We Teach Trading Over Investing and Why We Focus on TA over FA
The truth is when I first got started in the stock market, I was an "Investor." I watched Jim Cramer every day, read the "Intelligent Investor" by Benjamin Graham, and looked for high quality companies with great fundamentals. I paid zero attention to technical analysis because everything I was reading told me it was completely flawed and could produce no consistent long term results. It wasn't until I ended up losing patience with investing and basically lost all of my money on pump and dump emails that I actually sought out to master TA. I learned some very interesting things along the way that have inspired the way I teach.
1st) Newer traders will fail at day trading 9/10 times.
I began as a day trader. It, to this day, still haunts me how terrible I was at it. Yet, looking back, my strategies were solid. However due to the speed of the process and the potential for quick profit or quick losses, my mind was not seasoned enough to deal with the overwhelming emotions involved. It is because of this that I recommend any new trader start first with swing trading, then move into day trading if they desire. Swing trading is slower paced, can still produce great profits, and teaches principles that can one day transition you into day trading.
2nd) 90% of traders fail because they have no clear strategy
There's a common stat I'm sure you've heard over a dozen times claiming roughly 90% of traders fail. In reality, that stat refers to day traders. For swing traders, it's more around 80%. Still far too high for any reasonable person to ever want to get involved. But here's the secret...the reason that number is so high is because 80% of swing traders and 90% of day traders are in it to get rich quick, and have zero interest in putting in the time to actually learn how to trade. By coming into trading with a level head and commitment to actually learning technical analysis before ever actually putting a single dollar at risk, your chances of success are greatly increased! The difference between students who go through our course and elite videos multiple times, ask questions, and paper trade for at-least a month and those who rush right into actual trading without any idea what they are doing is significant. The first group generally makes money once they move into trading with real capital, the latter group nearly every time ends up blowing their entire account.
3rd) Fundamental analysis/investing causes more emotion
Contrary to what most big time investors will tell you, in my experience relying heavily on fundamental based investing (or even trading) actually causes one to be more emotional than simply relying on pure technical analysis. Here's why...When someone who truly understand TA and has a clear trading plan enters a trade, they are entering merely because a certain criteria was met. They understand the risk involved, have a stop loss in place, and are prepared for whatever happens. They are, in a sense, robotic. They have zero attachment to the actual company or it's balance sheet. The chart is telling them the story of what it is worth through supply and demand. End of story. When someone relying on pure fundamental analysis enters a trade, or investment, they have a connection to the actual company they are investing in. They see value, inspect the balance sheet like an accountant, and truly believe in the company. Supply and demand is nothing to them because the company itself is solid and set up for future growth. So when their investment doesn't pay off and the stock price falls, they are left confused and wondering how it could happen to such a great company. Generally, they look for excuses to explain the bad week or bad month, and end up holding their position for far too long thinking it will rebound because it's "such a great company." See the difference and how emotion plays a major role? The reason this often get's twisted is because people look at those 80-90% of traders who really have no understanding of TA and use them as the example of how technical analysis fails and causes emotion, when really they should study those who have truly sought out to learn and educate themselves.
4th) A good trader or investor should be well versed in both TA and FA
The truth is there's value in both fundamental analysis and technical analysis, whether you are an investor or trader. Any good TA trader will have at-least a basic understanding of fundamentals to prevent them from buying shares in companies based out of mini vans (I'm talking to you sub penny stocks!) and any good FA investor will have at-least a basic understanding of TA to help them enter their longer term investments at the best price possible and to understand that supply and demand is a major player in the movement of the stocks price.
The main reasons I teach swing trading over investing is because it caters more towards those with the lack of necessary capital to ever see any significant long term profit in investing, it allows people to take more control over their money and to be more involved which ultimately leads to increased commitment, and it takes advantage of multiple entry and exit opportunities over the same period an investor would buy/hold and produce less profit. The main reason I focus on technical analysis over fundamental analysis is because TA removes emotion from the equation and allows a trader to be robotic in their decision making, TA places much more emphasis on the actions of other traders and investors and shows an historical picture of how they react, allowing one to predict future price movements, and TA essentially paints a picture of the true worth of a particular stock without having to delve into the actual company and becoming overly attached. So, if you're looking to control more of your portfolio and trade stocks on your own, then technical analysis based swing trading is the best place to start in our opinion!