What is the difference between active trading and investing, and which approach should I use?
It has been said it’s like the difference between the actions of one individual versus the actions of a group as a whole. Each strategy has certain advantages. Investors stand to make a lot of returns over a significant period of time, as long as the stock goes in the intended direction.
For more volatile stocks, those that are not necessarily expected to continue to rise or fall in a certain direction, short-term trading, sometimes known as scalping depending on the relative timeframe, exemplify the active investing style that can make the most of the fluctuations of the market.
So what does active trading mean?
Active traders, or “day traders” make money in every type of market cycle – bull or bear.
An active trader buys and sells stocks with the intention of making money in the short term. Active traders typically don’t hold individual stocks for many months or years, and generally do not focus on long-term economic trends.
They also need to actively manage risk.
Active traders need the flexibility to take either side of a trade if something changes in the market.
Timeframe analysis is a critical factor for active trading, something we discuss later in this report, but in general, active trading is always based in high probability setups, and usually within a trading day.
The sole purpose of active traders is to attempt to profit from the daily price fluctuation of a particular stock. They rely on technical analysis rather than fundamental analysis for predicting these price fluctuations, making multiple trades, scaling in and out of positions throughout the trading day.
OK – but is active trading for me?
Active traders sometimes border on the fanatical. They read everything on investing, study stocks, and subscribe to magazines, associations, or newsletters such as New York Times newspaper. Their motivation can be to flip stocks and make money fast, or it can be the satisfaction of finding a treasure missed by Wall Street pundits. Whether driven by wealth or ego, this type of investor turns to invest into their hobby and even passion.
Active traders have the potential to make (or lose) money quickly but must devote much more time to trading than most long-term investors do.
Active traders prefer stocks that are rising and promise to be a forerunner for future outperformance. They have one focus, accelerating earnings, such as from a company that has tapped into a new product or innovation that promises to hit the market hard. There are many approaches to picking stocks, based on a number of factors including stock price behavior, markets, and earnings growth.
What makes active trading most appealing to some is that active trading is not limited to professional day traders. Active trading can be used by any individual who seeks to build a plan for taking control of their assets.
But does investing become more appealing for high net worth investors, who have opportunities that small investors do not?
This type of trader is often interested in investing their money, but they do not want to spend their weekends studying financial statements, markets, and even weather reports, often happy to put their money in the hands of a financial manager and walk away.
The investor creates a plan, researches stocks, invests, and then patiently waits for a return in the future, but also has a lack of flexibility, and is at the mercy of the system, having money tied up over long periods of time.
An investor takes a look at the company’s value, assets, debt, and financial health. They consider market and competition when estimating the company’s opportunity for success. They are not aggressive or looking for a quick gain.
As long as their losses are not at the high-risk level, they leave their portfolio alone. They follow the 10% rule when estimating acceptable loss. Once a stock falls 10% below what they paid, it is time to sell to the bargain hunters.
Investing can deliver a decent return in the long run with a minimum of involvement. It is of most critical to an investor to choose stocks that have good potential to increase steadily in value over the term of the investment (which is extremely difficult), and selecting a diversified portfolio, to offset the unforeseen fate of one particular company or market sector.
If executed correctly, the main advantage of investing is that it can bring in a lot of profit.
Taking the auto industry as an example – when the auto industry was greatly suffering, investors may buy a significant amount of shares of a car company that they think will rebound, and wait years for the industry to improve, and the company stock to increase.
Although investors regard short-term fluctuations in stock prices as minor compared to long-term growth, they still can’t just pick a portfolio and forget about it.
Investors may not even monitor stock for fear that checking in regularly could reveal enticing short-term values that might cause the investor to abandon their strategy and settle for short-term gains rather than the expected, more favorable long term. However, investors should re-evaluate the performance of their stocks periodically and respond to long-term market changes.
Thinking like a professional.
Few things are certain in the trading world, but thinking like a professional trader helps the odds weigh in your favor.
Whether you choose to actively trade in smaller timeframes during the day or build positions over time and invest, the key to success in any style is to think like a professional.
For instance, professional traders do not follow the irrational nature of the herd.
Professionals tend to be cautious when others become too greedy. On the other hand, professionals tend to be aggressive when others become anxious and overly fearful.
Above all else, professional traders always place the greatest emphasis on risk management. Seeing both the potential gains while being aware and ready for potential losses, are keys to being a professional trader, regardless of the timeframe.