The words investors and traders are commonly used in the world of stock market. Many people actually use them interchangeably as if they mean the same. Infact it is not true. Both words have different meaning. Even though investors and traders buy/sell stocks, they perform two very different tasks using very different strategies. Nonetheless, both of them are needed for the market to function smoothly.
So are you an investor or a trader ? Confused ? Let us find out the difference between an investor and a trader and then judge for yourself, which one you fit into.
Who Is an Investor?
An investor is someone who buys stocks of a company based on fundamental analysis. They hold the stock for long term with the belief that the company will have a strong growth in the future. They derive this based on two basic things.
Value: Investors consider whether a company’s shares represent a good value. This can be determined by looking at the price to earnings ratio and comparing it with similar companies. The lower the ratio, the better it is in terms of value. Also a good value can be measured by looking at PEG ratio (ie. P/E to growth ratio)
Success: Investors measure the company’s future success by looking at their financial strength and evaluating their future cash flows.
Both of these factors can be determined through the analysis of the company’s financial statements along with a look at industry trends that may define future growth prospects.
Who Are the Major Investors?
There are many different investors that are active in the marketplace. Vast majority of the money in the stock market belongs to investors. Major investors include:
Investment Banks: They assist companies in going public and raising money. This often involves holding at least a portion of their securities over the long term.
Mutual Funds: Many individuals keep their money in mutual funds, which make long-term investments in companies that meet their specific criteria. Mutual funds are required by law to act as investors, not traders.
Institutional Investors: These are large organizations or persons that hold large stakes in companies. Institutional investors often include company insiders, competitors, and special opportunity investors.
Retail Investors: They are individuals like you and me who invest in the stock market through a broker. At first, the influence of retail investors may seem small, but as time passes more people are taking control of their portfolios and, as a result, the influence of this group is increasing.
All of these parties are looking to hold their positions for the long term in an effort to stick with the company while they continue to be successful.
Who Is a Trader?
Trader is someone you buys stock of a company based on technical analysis. They hold the stock for short term to make quick profit. Traders derive this based on four basic things.
Price Patterns: Traders look at past price history in an attempt to predict future price movements.
Supply and Demand: Traders keep close watch on their trades intraday to see where money is moving and why.
Market Emotion: Traders play on the fears of investors where they will bet against the crowd after a large move takes place.
Client Services: Market makers are actually hired by their clients to provide liquidity through rapid trading.
Ultimately, it is traders that provide the liquidity for investors and always take the other end of their trades. Whether it is through market making or fading, traders are a necessary part of the marketplace.
Who Are the Major Traders?
When it comes to volume, traders beat investors by a long shot. There are many different types of traders that can trade as often as every few seconds. Among the most popular types of traders are:
Investment Banks: The shares that are not kept for long-term investment are sold. During the IPO process, investment banks are responsible for selling the company’s stock in the open market through trading.
Market Makers: These are groups responsible for providing liquidity in the marketplace. They make their profit through the bid-ask spread.
Arbitrage Funds: They are the groups that quickly move in on market inefficiencies. For example, shortly after a merger is announced, stocks always quickly move to the new buyout price. These trades are executed by arbitrage funds.
Proprietary Traders: Proprietary traders are hired by firms to make money through short-term trading. They use proprietary trading systems and other techniques in an attempt to make more money by compounding the short-term gains than can be made by long-term investing.
: Both traders and investors are necessary in order for a market to function properly. Without traders, investors would have no liquidity through which to buy and sell shares. Without investors, traders would have no basis from which to buy and sell. Combined, the two groups form the financial markets as we know them today.