Investing gets a good press, trading less so. To talk of “investment” is to adopt, perhaps unconsciously, the sonorous tones of the traditional bank manager or family solicitor. But “trading” conjures up images of excitable young traders on dealing floors, waving their arms and destabilising whole economies in the process.
Trading seems uncomfortably close to “speculation”, an activity that has long been viewed with suspicion in polite society.
It is long overdue that the case for trading, as opposed to investment, was heard loud and clear. In that spirit, here we give ten reasons why trading beats investment:
- Trading is better suited to today’s turbulent markets than investment is. Traders embrace change and thrive on it, while many investors are scared of it. Investing is akin to rowing a small boat, which is fine on a quiet backwater but not such a good idea when navigating the great Pacific breakers. For that, you need the skill and grace of a surfer. Make no mistake, today’s markets are more likely to resemble financial versions of Venice City or Bondi than of Lake Windermere.
- Traders are less emotionally involved with the assets with which they deal than are investors. This is important, because it helps to iron out the “cognitive biases” that plague all those who are involved in the financial markets. These include risk aversion (an illogical preference for security over gain), the endowment affect (preferring what you already own to what you could own) and the sunk-costs syndrome, the belief that an investment “owes” you and that it will come right eventually.
- Traders, overall, run a lower risk than investors of a catastrophic loss. Because they are in and out of any number of positions, they are less likely to be exposed to one major wipe-out. This is simple probability theory, in that someone who visits the fairground once a year, pursuing other leisure activities the rest of the time, is less likely to be involved in an accident on the big wheel or dodgems than someone who goes every day. Not, of course, that this guarantees traders against loss.
- Traders, by definition, take short-term risks, but investors take considerable longer-term ones. Timing may be the essence of trading, but it is also for investment. Here is one example – an investor, buying the Nikkei 225 in December 1989, during the height of excitement about Japan’s miracle economy, would have bought in at a level of 38,916. The bubble burst, and nearly 30 years later, the level is 21,681. Even when the face value is higher, inflation eats into investment. Anyone buying the London market in the 1972 peak would have had to wait until 1986 to get their money back with inflation accounted for.
- Trading, being much nimbler than investment, is ideally suited to opportunistic position-taking. A whole school of “behavioural finance” has grown up to show how investors make foolish mistakes and smart operators can take advantage of them. The most obvious is the accumulation of over-priced securities during a bubble phase in markets. Investors, even assuming they wish to behave opportunistically, will find it more time-consuming and expensive than will traders.
- Trading is more intellectually satisfying than investment. This assertion will provoke a certain amount of harrumphing from investors, to whom the patient construction of a winning portfolio is the epitome of personal satisfaction. And, of course, it is a matter of temperament. But trading, with its cut and thrust, and its win-or-lose judgements, is, for those who are suited to it, simply the most compelling way in which to engage with financial markets.
- Trading is beneficial to the wider economy. This statement may grate on the ears of those who have been told that speculation is hugely destabilising and causes stock-price bubbles, currency crashes and similar unpleasant financial events. In fact, traders – or speculators, if you prefer – help to make the economy work more efficiently. They can help correct the mispricing of securities and, by standing on the “other side” of a deal, give effect to the nostrum that “two views make a market”. This is seen at its clearest in the trading of contracts for difference.
- Trading ties up less capital at any one time than does investment. This is by way of a truism, as money sunk into a long-term investment cannot be used again, other than through potentially-costly borrowing secured on that investment. Trading is considerably less capital intensive. But again, this is probably a matter of temperament. There are those who like to play the horses (not very capital-intensive) and those who prefer to put their money into a racehorse. Or, for those with serious funds, a racecourse.
- Trading and investment have more in common than many people think. This may seem to contradict the previous points, but that is not the case. We have touched on the exposure of investors to catastrophic loss, to buying in at the top of the market and to falling prey to cognitive biases. Investors are taking gambles, albeit differently configured gambles, just as traders are. The difference is that many investors seem unaware of this fact.
- To end by taking a slightly different perspective on the notion with which we began, that trading is a style of financial engagement well-suited to our turbulent times. Investment rests on a certain assumption of stability that can no longer, if it ever could, be taken for granted. In The Forsyte Saga, by John Galsworthy, written in the early part of the last century, the family patriarch Soames Forsyte advises one and all to “buy consols”, the then equivalent of today’s ten-year UK government bond, believing his advice to be valid pretty much forever. He was an investor, not a trader, and, just for interest, UK bonds entered a long decline that lasted until the 1980s.