Ask Colin

Where is the divide between trading and investing?

Again it will make it easier for readers of my answer on my website or in my newsletter if I quote your extended question:

I am essentially an investor looking for trends, rather than a trader in the true sense of the word. I like the idea of staying with a trend to benefit from both capital growth and dividends. However, I wish to supplement my approach by doing some short term trading. My dilemma is in distinguishing the divide between investing and trading. I believe investing requires a fundamental evaluation of a company, an assessment of the chart to determine the trend/support/resistance, patience in allowing the trend to work over a longer period of time and a stop loss that is a bit more liberal. The essential feature of short term trading appears to be that you believe a sharp move in the price is imminent or is already happening. It has nothing to do with fundamentals, but requires good chart analysis and tight stop losses must be adhered to. I also believe investing is best carried out using weekly charts, while trading is best with daily charts. An investor would probably sit through a consolidation whereas a trader wouldn't because of potential opportunities elsewhere. Is that the way you see it?

In my book, which I am progressively publishing on my subscription website, I address the issue of the distinction between trading and investing. These are much-abused words, with no clear distinction between them.

The essence of trading is capital gain. You buy something and hope to sell it later at a higher price. Dividends, interest or any other income stream is not the primary consideration. In many trading instruments, there is no associated income stream.

The essence of investing is total return - capital gain plus an income stream. In some investments the income stream predominates and there is no capital gain possibility or it is very secondary. However, with investments in shares, the capital gain component is historically two thirds of the return and dividends only one third. This means that capital gain is the more important consideration. Therein lies the problem. Capital gain is obtained by buying and selling - trading that is - not by just holding for a pre-defined period like a term deposit.

The most useful distinction is that trading seems to be short-term and focussed primarily on capital gain, while investing is long term and focussed on total return. They are therefore two ends of a continuum. In the middle the distinction is blurred.

I am interested in your statement that you want to supplement your approach by short-term trading. In particular, what is your motive. If it is to increase the return, that is a dubious objective. The big money is made on the big moves. The short-term trader has the huge handicaps of transaction costs and slippage to overcome. If it is to create excitement in your life, it could be an expensive pastime. You would be better off at the casino with a small part of your funds than to imperil your financial health trying to find excitement in the stock market.

On the difference between swing trading and trend trading, the best description of them and discussion of the issues is in Dr Alexander Elder's book Come into my Trading Room. Every would-be trader should read this book before they start. For those that have started already it is never too late to read it.