This weekend, I thought I might address the concept of trading and take a look at how I think of it. As you read through this article, I suggest you consider how you think of yourself in terms of whether you might be an investor or a trader and whether or what difference it might make to your approach.
One of the hardest questions I've tried to answer recently is: "How do I define trading?" Dictionary definitions vary. The most common definition seems to be: "The business of buying and selling commodities; commerce." e.g., www.thefreedictionary.com/trade. We can see that definition incorporates no time parameters. On the other hand, www.investorwords.com/5030/trading.html adds a time parameter in defining trading as: "Buying and selling securities or commodities on a short-term basis, hoping to make quick profits."
I would tend to agree with the first definition and not necessarily incorporate the "on a short term basis, hoping to make quick profits" language. Setting aside the issue of what actually is a short term trade (is it 5 minutes, 5 days, 5 months?) how might the definition influence our thought and trading action? Of course a quick profit may be desirable to a trader, but not at the expense of cutting profits just to make it a short term trade. For example, what if a directional position is moving in a trend in the right direction? I certainly would not want to pull the plug and end a profitable trade as it is still going my way in exchange for a quick profit and a short term trade. Am I not still a trader even when I refuse to cut profits and stay in such a position?
In my own experience, trades can last from minutes to a year or more. As long as things are going my way and I have no emergency requiring me to close a trade to gain cash, I want to stay in as long as it keeps adding profit. As far as I am concerned, that is still trading.
A subscriber posed the question whether holding a long term stock position and selling covered calls is trading. My answer was yes. Even if the stock is held with a long term outlook, the regular periodic sale of calls constitutes trading in my book and, of course, if the calls are exercised the stock will be sold (assigned).
Why is a discussion about the definition of trading of any value? Many folks seem to think of trading as synonymous with daytrading and seem to have an aversion to trading as a result of that impression. In my own opinion, and I emphasize it is just my opinion, I consider anything short of pure buy and hold as trading. In other words if the trader/investor has any exit plan other than his own death he is trading because he has an established reason to get out of his position(s).
Most importantly, however, I believe the critical part of the definition of trading is that it is a business. I could not agree more with that part of the definition. It is a business, and in order to achieve success whether one styles oneself as a trader or as an investor, the person needs to treat it as a business. He needs to have an education, he needs to formulate a plan, he needs to understand the overall risks and the risks of a specific position, and he needs to have capital. Beyond that, from my perspective, he also should have an exit strategy in place before entering any position.
Maybe the distinction between investing and trading is one without a difference. Or maybe it should be. What do you think?
by Bill Kraft, Editor
Copyright 2010, Makin' Hay, Inc.
All Rights Reserved
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