Friday, July 10, 2009

Traders and Investors

Just like to share my own definition of traders and investors that I thought about recently...

First let's start with Ben Graham's definition of investors and speculators.

Graham first stated that an investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return and operations not meeting these requirements are speculative.

So an investor focuses on analysis to look for capital safety and adequate return. This is usually interpreted as fundamental analysis of the company, its business model, its competitive advantage, margins, sales growth and of course, the financials: cash on hand, debt, bankruptcy risk, capex needs etc.

Anything less of such analysis means speculation. A speculator is simply one that doesn't do that kind of rigorous analysis.

Simple right?

For me I think it's about different focuses.

An investor focuses on value.
A trader focuses on price.

An investor is interested in the value of a stock (or any other thing he wants to buy), and he spends an awful lot of time and effort to figure out this value (or intrinsic value). This is analogous to Graham's analysis. Or more accurately rigorous fundamental analysis of business operations and financials. Price serves only to tell him how much he actually has to pay if he were to buy the stock. Needless to say, the lesser the better. Graham and most value investors advocate buying 30-40% (margin of safety) below the stock's intrinsic value.

To an investor, profit is made when the stock price subsequently rises to its value which usually take years.

A trader is interested in the price of a stock and he spends an awful lot of time and effort following how the price has moved. Actual value of a stock basically serves no purpose for the trader.

To a trader, profit is made when the stock rises above his buying price and he sells it to another person willing to buy at a higher price. Usually also known as the Greater Fool.

So, that's that! Just two different philosophies here to make money.

2 comments:

Daniel M. Ryan said...

Those two categories are different, but an experienced trader/investor tends to cobble together a bit of a hybrid. I don't believe that a trader can trade without reference to any fundamental information, even if it's only second-hand and of sound-bite quality. The anxiety over "what have I bought?" eventually get to him or her.

On the other hand, few investors are so stoical at to not care at all about further price declines. An investor can dabble with a few trading techniques simply to see if a better bargain on an already-chosen issue can be had.

I'm not suggesting blending the two approaches, as it leads to being neither fish nor fowl with a consequent degrading of performance. I just note that the two categories are ideal types.

8percentpa said...

Very well articulated. Thanks!

There are no true boundaries in the real world. Someone might be 70% investor 30% trader etc. I do agree with that.

There should be a sound investment philosophy to anchor oneself though.

Just my two cents...