Investor or Trader...Which Are You?

03/27/2015 6:00 am EST

Focus: STRATEGIES

Frank Kollar, of Fibtimer.com, weighs the key differences between being an investor versus being a trader, and more specifically, the crucial differences between each type of trading. Frank also highlights the trend trading style he prefers and why.

Most market participants consider themselves to be investors. But if you look at a list of the really big winners on Wall Street, you will see that most of those who make big profits, list themselves as traders.

By big profits we mean doing better than the S&P 500 Index or Nasdaq 100 Index by a substantial margin over any three-year period.

Investors

Investors put their money into stocks, real estate, etc., under the assumption that over time, the underlying investment will increase in value and the investment will be profitable.

Typically, investors do not have a plan for what to do if the investment decreases in value. They hold onto the investment in hopes it will bounce back and again become a winner.

Investors anticipate declining markets with fear and anxiety, but unfortunately, they usually do not plan ahead of time how they will respond to them. When faced with a declining (bear) market, they hold their positions and continue to lose.

We all know investors. In many cases it was us before we realized how dangerous buy and hold investing could be to our savings.

Investors often have some knowledge of trading. But that knowledge is tainted by how it is all too often described in the financial press. Trading is risky, dangerous, foolish, bad, involves a great deal of work, etc. On the other hand, investing is good, reliable, and safe.

"Investors anticipate declining markets with fear and anxiety, but unfortunately, they usually do not plan ahead of time how they will respond to them."

Investors had a taste of what buy and hold can do to their capital in the 2000-2002 bear market. They lost again in the 2008-2009 bear market.

Traders

On the other hand, traders take a proactive approach to their investing. Traders have a defined plan and invest with one goal, to put their capital into the markets and profit.

They trade with a plan that tells them what to do in any situation. When to enter and when to exit. They never allow large losses.

Being a trader does not mean you must move in and out of the markets frequently. This is a common misconception. A trader simply is one who has a plan for entering and exiting. They know what to do if their trade goes against them and they know what to do when their trade is profitable.

Some traders go short (take bearish positions) as well as long (bullish) positions. Some are unable to go short or they find short positions to be uncomfortable. Probably the majority of traders do not ever take short positions.

But traders do have a plan. This is where they differ from investors.

Every Trader Needs a Trend

If you think about it, you will quickly realize every trader needs a trend to be successful.

No matter what trading method is used, whether it is pattern trading, swing trading, long-term buy and hold investing, fundamental analysis, technical analysis, buying or selling on news events, IPOs, splits, you name it. If the stock or mutual fund does not trend in the required direction after the trade is made, you cannot be profitable.

This also applies to all asset classes. Stocks, bonds, currencies, commodities. You must have a trend to profit.

NEXT PAGE: The Trading Approach Seldom Discussed

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Putting Trader and Trend Together

There are two major camps when it comes to deciding what method to use to plan a trade. There are those who follow a fundamental analysis approach and those who follow a technical analysis approach.

Traders use both methods to forecast future market direction. If combined with an exit strategy, either can be successful, but debate has raged for 30 years over which is the most successful strategy, as well as whether either method truly outperforms the markets over time.

Some very astute market players have said that both fundamental and technical analysis approaches, though they can be profitable, usually are "no more profitable than an index fund."

There is a scary thought. All that work when an index fund could do as well?

"Price is always right. If prices are moving up, the markets are advancing. Down and the markets are declining."

But there is another approach that is almost never discussed. Many hugely successful traders use it, though the financial press seldom mentions it. In fact, many who use it are very quiet about their successes. They do not try to publicly prove themselves right, they just trade and make money.

This approach is the use of price to determine trends. Price does not forecast and it does not predict. Price is always right. If prices are moving up, the markets are advancing. Down and the markets are declining.

Using price to determine trend does not allow trend traders to enter at the exact bottom or to exit at the exact top. In fact, trend traders do not try to forecast the market, but instead let the market tell them when to trade and in what direction.

Trend traders wait patiently for prices to tell them a trend has begun. Then they jump on board. If the trend fails, they exit quickly to control losses. Price tells them when to enter and when to exit. If the trend continues, trend traders have no predetermined profit goal. They stay with the trend until it reverses.

Cutting losses quickly and staying with a trend until it ends is how trend traders realize huge profits in the financial markets. The financial markets are trending about 80% of the time. That means trend traders are profitable 80% of the time. During the other 20% trend traders keep losses very small so that they are ready when the next trend starts.

This does not mean 80% of their trades are winners…just that they are in the plus column for that 80%. If you have three losing trades of 2% and one winning trade of 18% in a year, you finish with a 12% gain, even though most trades were losers. This fits the old saying, "cut your losses short and let your winners run."

Conclusion

Remember that price is determined by millions of investors and traders.

By using price, trend traders take advantage of the combined wisdom of millions of investors and traders to trade a successful and profitable market timing strategy.

Yes, it takes patience to be a successful trend trader. Yes, it takes discipline to follow the strategy and make the trades, which many times go against the prevailing wisdom. This is true of all winning market strategies.

But trend traders who use price to determine trends have been quietly beating the markets for many years. They will quietly continue to do so for many more.  

By Frank Kollar, Editor, Fibtimer.com

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