Click here for the Club Mailbag email address (investingclubmailbag@cnbc.com). Please direct your questions to Jim Cramer and his team of analysts. We cannot provide personal investment advice. We only consider more general questions about the investment process and stocks in your portfolio and related industries. This week’s question: What is the difference between “trading” and “investing”? thank you. — Robert M. Great question, and one that all members should consider as we head into the new year. Simply put, it’s the time axis. Trading usually involves a short period of time to buy and sell stocks for quick profits. Investing, in contrast, involves owning shares in a company for a longer period of time, typically quarters or years. But there are other, more subtle differences. Let’s start with the idea of investing. This is what we practice and advocate every day (it’s in the club’s name). The way you approach the stock market as an investor is the way you approach the stock market as a potential owner of a company. You want to earn and build a position in a company that will increase its revenue over time. This means targeting companies that you know will continue to hold, year after year, through various cycles and headwinds, and will continue to generate returns over the long term. Warren Buffett, perhaps the most successful investor of all time, once said: “Our most preferred holding period is forever.” Because of that philosophy, investors seek to establish and build positions over months or years, adjusting positions as needed to manage overall portfolio diversification. Weaknesses in the name allow investors to buy more shares at a better price. The idea is to use short-term volatility to your advantage to build positions. Short-term catalysts are great, but the main focus is long-term growth. Investing Long-term time horizons measured in quarters or years Catalysts are helpful, but the focus is on long-term revenue growth that drives stock prices higher Builds positions slowly over time Relies heavily on fundamental analysis to predict growth potential Volatility is an opportunity to build or reduce stake In contrast, traders rely on short-term catalysts to make quick buy and sell decisions. Often within minutes to hours for day traders and days to weeks for swing traders. The catalyst can be fundamental in nature (such as the results of a drug trial or a court ruling) or technical (such as a positive setting forming on a chart). Those who do technical trading may not even know what the company is doing, and they likely don’t care if the trade is based on a stock bouncing off a major support level. Traders want to identify short-term catalysts that can move material stocks in one direction and allow them to take quick profits. Therefore, traders are not interested in dollar-cost averaging on their positions. They usually aim to quickly take a full position with a single buy. Day traders looking to profit from recent headlines or play technical patterns close out all exposure at the end of the day, generating small daily profits that can accumulate over time. So while volatility may be an investor’s friend, it is not a trader’s friend. Investors may see a decline as an opportunity, but for traders, a move in the wrong direction means a failed trade and they need to cut their losses as soon as possible. For this reason, traders often use derivative securities such as options that allow them to take advantage of the underlying stock while limiting their losses, making them more sensitive to movements in the underlying stock. Trading Short time periods are typically measured in minutes, hours, days, or weeks. Catalysts are essential and provide the rationale for trading. Buy all shares at once, ahead of important events that move the stock. It relies heavily on technical analysis to make decisions. Volatility is usually a risk. Although our club focuses on investing, we understand that some members may wish to trade from time to time. If you do so, we recommend that you adhere to one of Jim Cramer’s golden rules: That is, never turn trading into an investment. This means that if the trade doesn’t go in your favor, you have to accept the loss and move on. Don’t try to lower the average by buying a depressed stock, telling yourself that the name was not good for trading, but will be a good investment. As Jim pointed out years ago in “Mad Money,” “When I’m investing, I buy down. If the reason I’m trading a stock doesn’t work out, I quickly cut my losses while trading.” Anyone who wants to try their hand at trading must do the same. (See here for a complete list of INJim Cramer’s Charitable Trust stocks.) As a subscriber to Jim Cramer’s CNBC Investing Club, you will receive trade alerts from Jim Cramer before he makes a trade. After Jim sends a trade alert, he waits 45 minutes before buying or selling stocks in his charitable trust’s portfolio. If Jim talks about a stock on CNBC TV, he will issue a trade alert and then wait 72 hours before executing the trade. The above investment club information is subject to our Terms of Use and Privacy Policy, along with our disclaimer. No fiduciary duties or obligations exist or arise from your receipt of information provided in connection with the Investment Club. No specific results or benefits are guaranteed.
