Posted on May 23, 2011

If the stock market is your chosen area of operation, then, in my mind, there is no question more important to answer than Are you a Trader or an Investor? So whats the difference

A trader looks for mismatch in the supply & demand for a commodity, focusses on filling the gap and thereby earns his returns. The operative term here is commodity. The trader doesnt care about what the underlying entity is – it can be gold, silver, real estate, cotton, sugar or equities. All a trader cares for is whether for that commodity there is a mismatch between quantity supplied and quantity demanded. A good trader will want to buy the commodity and hold it for as short a period as possible before unloading it. A good trader also knows that his return-on-capital-employed from any single transaction will never be large in percentage terms and hence he must undertake as many transactions as possible in as short a time period as possible to generate a cumulatively large return-on-capital-employed.

An investor is the exact opposite of a trader. An investor is like an individual looking to buy a home to live in. A potential homeowner is particular about the neighbourhood, the quality of construction, the cost of maintenance, the amenities in easy reach, etc. Typically he also doesnt plan to buy and sell the home in the short-term; ideally he wants to keep it as long as he can and perhaps pass it on to his children in legacy. Most of us buy homes to live in just once, twice or at most thrice in our lifetime. Now replace homeowner by investor and home-to-live-in by equities and you have the making of a successful investor. I had written earlier on my first principles of equity investment  and if you read the post with the analogy of a homebuyer at the back of your mind, you will see why selecting good equities to invest in is no different from selecting a home to live in.

Dont get me wrong. I dont mean to say that being a trader is superior (or inferior) to being an investor. Both these professions require a great amount of intelligence, discipline and spirit. However, these are different professions and require different mindsets and strategies. One must be clear what ones role is. A trader who acts like an investor is likely to lose his capital on one or two really risky transactions; an investor who acts like a trader is likely to incur transaction costs far in excess of the return he makes.