Monday, May 12, 2014

What is the Difference between Investing and Trading?

Over the past several years, I have engaged in multiple conversations (and debates) about the definition and role of investors and traders.  I have encountered several strong opinions on the topic and in this post I will seek to concisely describe the difference between investing and trading.

In The Intelligent Investor by Benjamin Graham (Warren Buffet's professor), Mr. Graham clearly expresses the difference between investing and speculation. "An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative."

These words, from perhaps the most qualified individual to define investment, seem to indicate that anything that does not promise safety of initial investment and satisfactory return is speculation.  There are very few true investments in that I cannot think of a single instrument that promises both safety and return, not even government bonds.  Essentially, if you are in the arena of actively managing your portfolio, you are speculating.

Graham understands this and adds that "outright speculation is neither illegal, immoral, nor (for most people) fattening to the pocketbook".  In other words, if you are a speculator, there is no need to experience illicit feelings, but understand that most people fail in this endeavor.

Trading is a form of speculation.  Trading is the willingness to trade a market on either side without ideological attachment.  In other words, if you are willing to buy, sell, and short a market, you are a trader.  Traders dispassionately examine risk and seek to earn a profit regardless of market conditions.

The Fine Line
According to Benjamin Graham, the "father of value investing", the vast majority of market participants are speculators.  Trading is simply speculation with a willingness to buy or sell either side of the market.  In light of these definitions, much of the dialog and debate between "investors" and "traders" as to the best and most profitable course of action is irrelevant.  Perhaps we should focus on common ground rather than trying to stir up conflict in nuanced definitions.  We are pretty much all speculators in some form or fashion - let's help either other speculate better.

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