To trade or to invest

Different factors affect stock prices in the short run and the long run. In the short run, recent and imminent developments as well as investor psychology matter most. In the long run, however, the fundamental viability of a business matters more as the intrinsic value of a business is realized in the market sooner or later. In the words of Benjamin Graham, known as the father of value investing: “In the short run, the market is a voting machine but in the long run it is a weighing machine.”

Graham and his disciples, the most famous of whom is Warren Buffett, choose to focus on the long term by finding stocks that are underpriced relative to their intrinsic value. For Buffett and many others, this has worked very well. Of course, many have also done well by focusing on shorter term price movements in the markets. While this is frowned upon by some value investors and not always feasible for casual investors, people who are serious about their involvement in the markets have all the options at their finger tips. They only need to think clearly about their time horizons.

Define your horizons

Where does a trade end and an investment begin? Is there a clear line that can be drawn between the two? Day trading (intra-day) and swing trading (typically lasting less than a week), as the names imply, are clearly trading activities. On the other end of the spectrum, buying stocks to hold onto for years or decades obviously falls in the investing category.

Or perhaps that is an arbitrary distinction to make. Stocks are always bought with the anticipation that their price will rise (and sold short with the anticipation that they will perform poorly). Long-term investing can be seen as trading with a very long time horizon where the trend being capitalized on is the tendency of stocks to go up over the long run.

The important thing is to know which timeframe you are working with and behave accordingly. Don’t make the mistake of entering a trade that you expect to be out of in a couple of weeks, then reclassify it as an investment when the trade goes against you and agonize over it for the next few years as you wait for it to break even. Conversely, it would be a mistake to make an investment based on fundamentals and take a small profit after a couple of months because your nerves can’t handle the fluctuations.