In the world of investing, there is a key distinction between the strategies of trading and investing.
Trading usually refers to short term investing strategies whereby investors are trying to profit from short term mispricing’s of stocks. Investing, on the other hand, refers to more long term strategies where investors may invest for several years.
Trading has been popularised in recent decades due to the appeal of being able to make a sizeable return from the market across a short period of time. This phenomenon attracts individuals that are hoping to build wealth as quickly as possible.
Unfortunately, trading is a high risk investment strategy that most individuals are unable to utilise successfully. In fact, in the finance industry there is a saying that 90% of people lose 90% of their money within the first 90 days of trading.
With this in mind, the majority of investors would therefore be better off investing with a more long term strategy. Sadly, a lot of investors have suffered so badly from trading that they believe that it is impossible to make money from stocks – which is not true at all. It’s simply the case those individuals chose to utilize the wrong investment strategy.
There are a number of reasons why long term investment is more advisable than short term investing. The key reason is that investors are giving their investments more time to mature and are more likely to be successful as a result.
If you still feel that trading may be an option for you, then that’s okay. One word of warning though is that the majority of research findings show that long term investment strategies are more profitable, even if you are success with short term strategies. The main reason is that long term investments benefit from compounding, which has been shown to outweigh the cumulative short term gains over time.
Below are a number of investment strategies that investors can utilise.
Day trading is probably one of the most recognisable investment strategies. It has been widely promoted in the media over the past 20 years.
The concept of day trading is very simple, traders buy and sell stocks within 1 day. The timeframe that traders hold a stock for varies, it could be for 10 minutes, it could be for several hours.
The reason why day trading became so popularized is that traders reported large returns within a short period of time. For example, it was common to hear about an investor that made $4,000 in 10 minutes, which is more than a lot of people earn in a month.
The crucial factor that most media reports fail to disclose is the amount of money that the investor risked in order to get that return. Even if the $4,000 represented a 1% return, the investor would be risking $400,000 to make that return – which is more than most people’s life savings.
Day trading is the most risky investment strategy and it is unsuitable for the majority of investors.
The stock market is less efficient in the short term which means that it is less predictable. For that reason, it’s very difficult to make money from day trading as each bet is speculative.
Day traders use technical analysis to make trading decisions and are not so concerned about the underlying business. They are simply looking for statistically anomalies that present themselves in the short term.
Another trading strategy is called swing trading. It differs from day trading because traders are holding their positions over a longer period of time.
Swing traders typically hold stocks for between 2 months and 6 months.
It is still considered a high risk investment strategy but is safer than day trading as investors give more time for investments to mature.
Swing trading is often the investment strategy that most people think about when they think about stock market investment as it follows the notion of buying low and selling high.
Traders are anticipating that a stock will become more valuable in the short term due to speculation or new information that impacts upon the business positively in the short term.
For example, in the UK, a white paper was published recommending that the government should take action to increase the availability of housing in 2017, which increased the stock price of housebuilding companies in the UK.
Between 2016 and 2017, Taylor Wimpey stock increased from 130 GBX to around 200 GBX. This is a classic example of where a swing trader would buy low and sell high.
Swing traders do use technical analysis like day traders, but their trading decisions are much more informed by societal trends and information.
Value investing is arguably the most famous long term investing strategy as it is the strategy used by Warren Buffett.
This investment strategy is based solely on the underlying fundamentals of the business (i.e. financial health).
Those partake in value investing usually don’t care about the chart data of a stock, instead they are only concerned with the market capitalisation and the true value of the company.
Value investors are looking for companies that are undervalued by the market. They do this by looking for companies with unusually low P/E ratios or by looking for companies that have a market capitalisation that is below the net asset value of the firm.
Value investing is usually a long term investment strategy as it relies on the assumption that the market is more efficient in the long term. Without long term market efficiency, it would be impossible for value investors to profit as their investment may remain undervalued.
Value investing can be very complex as you have to make sure that companies are able to maintain (or grow) their value over time. A low P/E ratio, for instance, is a worrying sign that a company is in trouble, therefore it is unwise to simply buy a company based on a P/E ratio alone.
Value investors usually do a lot of research on a company before deciding that an investment is worthwhile.
People that undertake a growth investing strategy are looking to invest in companies that have the potential to blow up and become the next big thing.
The hope is that investor can identify companies that will help them to grow their capital as much as possible over the long term.
There aren’t specific criteria that a company must have to be identified as a growth stock, an investor must make that decision. A growth stock should have the potential to grow it’s earnings a lot in the long term.
Most of the time, growth stocks operate in new markets. For example, Tesla could be considered as a growth stock in the electric car industry, Amazon are considered a growth stock in e-commerce or companies operating in the emerging marijuana industry could be considered as growth stocks.
It may not always be the case but growth stocks often have very high P/E ratios, which is a sign that high levels of growth are expected in the future.
Growth investing can sometimes be high risk, especially if a company fails to meet future expectations. Having a margin of safety may not be possible with growth stocks as the market capitalisation is often a lot higher than the value of the underlying business.
For example, Amazon is valued by the market at $1.54 trillion but the net asset value of the underlying business is roughly $240 billion. You can see that Amazon stock is valued at a much higher price than the company is actually worth on paper.
Momentum investors attempt to identify trends and benefit from the continued growth of that trend. They assume that trends will go on infinitely, whereby winners will always win and losers will always lose.
In reality, this is not always the case as some stocks can be more volatile than others. More volatile stocks do not necessarily have an identifiable trend.
Momentum investors don’t necessarily care about the underlying performance of companies that they invest in, instead they are often using technical analysis to identify trends.
The appeal of momentum investing is that investors can benefit from ongoing upwards trends, avoiding stocks that perform negatively or have no trend at all.
In practice, momentum investing is a mixed bag and it may be difficult to deliver consistent results. This is usually the outcome of implementing strategies that solely rely upon technical analysis.
Investor that follow a strategy of dollar-cost averaging, simply invest regularly into the market.
This approach is advisable for most investors as it allows investors to buy at all prices, when the stock market is high and when it is low.
For that reason, the strategy is called dollar-cost averaging because it always an investors to spread the average price that they pay for investments.
For example, if an investor buys a stock at $10 at a high and $2 at a low, the average investment price would be $6 (assuming that the investor put 50% of their money in at $10 and 50% of their money in at $2).
Investing with a dollar-cost average approach allows investors to reduce their risk by exposing themselves to a variety of different prices.
When the stock market falls, the average allows them to get back into a strong position quickly, which is obviously useful if the stock market drops very sharply.
All of the investment strategies that we have discussed so far have been focused on capital gain, rather than on income.
Investing for capital gain is more suitable for younger investors as they have more time for their investments to mature, maximising their capital.
Older investors, particularly those that are set to retire, are usually more interested in boosting their income.
For those investors, buying stocks that have large dividends may be attractive. Some investors may chose to simply invest in bonds and accept a reduced return (1% to 4%), while others may prefer to take advantage of stocks with large dividends (5% to 10%).
The trick with income investing is to invest in stocks that are in good financial standing. It can sometimes be the case that companies offer a large dividend to investors to compensate for a falling stock price – which often can be interpreted as the company experiences financial weakness.
For income investors, the ideal situation is to invest in companies that are growing their dividend over time.
Coca-Cola is a famous example of a company that is trying to grow it’s dividend over time. In the last 5 years, Coca-Cola has grown it’s dividend by around 5.60% a year on average.
Coca-Cola would be the perfect example of what income investors are looking for, a company with a strong balance sheet and a growing dividend.