Are You a Trader or an Investor? Or Both? – Liz Baker

Liz Baker
Open Your Own K Account Liz Baker

What’s the Difference?

I consider myself both a trader and an investor. Most traders are also investors, but not all investors are traders.

  • An investor puts money in the market for the long-term, and other than adding or rebalancing, may not buy or sell anything for decades
  • A trader takes advantage of short-term moves in the market to make quick money

There are different markets to trade and invest, but my trading is in the stock market.

Day-traders are in and out the same day. Swing-traders prefer to take advantage of larger and longer stock moves and hold a position for several days or weeks.

Most importantly, all traders have pre-defined sell-points. As the stock rises in price, at what point should you sell it and take your profits?

Sell too early, and you miss out on a move that may continue upward. You “leave money on the table”.

Wait too long, and your stock suddenly switches direction, goes down, and wipes out all your profit.

This decision is dictated by the trader’s individual strategy. It is part art and part math. (Lots of math…)

Sometimes your recently purchased stock doesn’t go up at all, but simply reverses direction. When do you sell it? This is called your stop.

All trading platforms allow you to place your stop ahead of time. So, when you have step away from your keyboard to grab coffee and the market (or simply just your stock) takes a turn for the worst, you are out before you lose too much.

Other traders prefer to simply keep the stop in their head and act quickly when required.

Where do you place this stop? Stock is very volatile during the day; it might temporarily bounce down only to immediately switch directions, and head forward with conviction. You need to give it some room, but not too much or you lose more money.

Again, part art and math.

As an investor, I don’t place stops

I used to, and this is what happened: the market would experience a “correction” or dip of around 10–20%, enough to trigger my stop. I’d sell.

Then the market would bounce back. Sometimes within a few weeks, sometimes within a few days!

But now I had to rebuy my investment at a higher price. I was selling low and buying high!

Do this a few times and you screw up your portfolio.

Sure, you miss the “big one”. That big bear market that happens only once a decade or so.

But corrections happen all the time, on average at least once a year.

I even ran the numbers, based on the historical returns of the market. The results? There was no advantage to “active management”, even with a plan following strict trader-like rules.

Even in the worst market conditions, over decades, “buy, hold, and rebalance” had returns as good or better than an active management strategy.

And it’s a lot easier to implement. Simply leave it alone, until it’s time to rebalance.

Being both a trader and an investor feels like I have two personalities. Personalities that have completely different approaches to their assigned task.

Like everyone out there — trader’s and non-traders alike — I would like to retire someday. Therefore, I must maintain an investment portfolio.

Some traders trade part or all their retirement savings. If you’re successful and consistent. But otherwise, it’s not recommended.

Every trader has a story about when they “blew it” and had to start over. This is part of the trader learning experience. Never risk more than you’re willing to lose; respect your stops.

You should maintain separate accounts for investing and trading.

Traders also experience a great deal of FOMO: Fear of Missing Out. Again, and again we’ll see a stock that just took off before we had the opportunity to buy. This is a daily occurrence.

In fact, you may end the trading day having bought nothing at all while the market rallied up 200 or more points!

On those days it’s nice to remember that your long-term investments made money while you were ignoring them.

As I mentioned above, there’s math involved.

As a trader, when you purchase a stock, sometimes it will go up and you make money, and sometimes it hits your stop and you lose money.

Your percentage of winning trades is your “winrate”.

The most successful traders that you read about — those making a gazillion dollars — their average winrate is around fifty percent.

Yes, approximately half their trades make money, and half lose money.

How are they making a gazillion dollars? Simply win more on your winners than you lose on your losers.

Your stop is your “risk”. Let’s say you set your stop $0.50 below the price you purchased your stock. When will you sell this stock? If you have a winrate of 50% and you sell it at $0.50 above the price you paid, you are simply breaking even.

Better to sell it at 2X your risk or 3X or even 5X. Sell it at $1.00, $1.50, or $2.50 above your purchase price.

If you made $1.50 on this winning trade but lost $0.50 on your next trade, you net $1.00.

Repeat this again and again.

Disclaimer: this isn’t a real strategy, but simply an example.

A trader will have an individual strategy which dictates how much risk they take initially — where they place their stop — and where they sell to make a profit based on their winrate. It’s different for every trader.

Investors don’t quantify risk. Instead, we qualify it.

The future performance of the market is unknown; we base our strategy on either past historical data or a model of future performance (eg, Monte Carlo simulations).

All of us have a certain risk tolerance and time horizon for our investment goal. Goals in the near-term, eg, a down payment on a home, should be invested conservatively in cash equivalents or treasuries.

Goals decades away should be invested more aggressively, such as the stock market.

Some of us are afraid of the stock market. Can you achieve your investment goals without it, or do you need to put a portion in the stock market to get the growth you need?

The answer will be different for everyone.

If we are looking at any numbers, it may be performance or risk metrics of a fund we are considering investing in.

For example, the Sharpe score of a fund provides the rate of return (minus the risk-free rate) per unit of risk. It’s a valuable tool for comparing one fund to another.

That aggressive-growth fund you are eyeing may have a high rate of return, but I bet the risk is much higher as well.

By comparing the Sharpe score to say, that of an S&P500 index fund, you can determine if the extra risk is worth it.

Recall the $1.00 earned above from two trades? This could be $100, $1000 or even $10,000.

The trader needs to make trades regularly to make money. The smaller the net gain, the more trades need to be made to achieve your trading income goal.

Mark Douglas in his book “Trading in the Zone” (2000) has an excellent analogy. Traders are not gamblers, instead, we’re the casino.

Every day in a casino, many many gamblers are placing “trades”. But as you are aware, the House always has the edge, even if it’s a small edge. Yes, the gamblers sometimes win, but the casino wins more often or wins a larger pot per “trade”. After hundreds and thousands of these transactions, the casino is very very rich.

Traders also must deal with a certain degree of complexity. Every good trader has a strategy. What type of stock (or another financial thing) will be tracked, what will trigger a buy decision, and what will trigger a sale, either to the upside or downside?

Research must be conducted. Some traders are technical and look for patterns in the price. Other traders review fundamentals and research the company behind the stock.

An investor with a lengthy time horizon could put 100% of their invested savings in an S&P500 index fund and be done.

You could add a bond fund, perhaps a small-cap growth fund, and/or an international fund if you like.

One to five funds is all you need as an investor. Simple.

You don’t want to overcomplicate things. You don’t want to constantly switch from strategy to strategy. That simply results in selling low from a strategy that is struggling, to buying high into a strategy that is winning now.

It’s ok to re-evaluate and switch strategies but keep change to a minimum. Less is more. K.I.S.S etc.

Are you a trader, an investor, or both? Sometimes playing two disparate roles can be a challenge, but hopefully, you can make money at both.

Good luck!

For additional reading:

This information has been provided for educational purposes only and should not be considered financial advice. Any opinions expressed are my own and may not be appropriate in all cases. All efforts have been made to provide accurate information; however, mistakes happen, and laws change; information may not be accurate at the time you read this. Links are included for reference but should not be considered an implied endorsement of these organizations or their products. Please seek out a licensed professional for current advice specific to your situation.

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