The difference between trading and investing

Both have their place in optimising portfolio outcomes.
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Warren Buffet once famously observed: “You need to know very well when to move away, or give up the loss, and not allow the anxiety to trick you into trying again.”

Buffet also quipped that the ideal period to hold a stock is forever – provided that stock belongs to a quality company.

Online trading has enjoyed an unprecedented boom over the last two years as millions of people worldwide, unnerved by the impact of Covid on their lives and incomes, searched for additional sources of income. Not all of these newcomers to online trading take the time to understand companies or markets, says Shaun Murison, senior market analyst at IG Markets South Africa. And that can cost them dearly in the long run.

“There is a difference between trading and investing, and it has to do with length of time in the market. Many people do not distinguish between the two,” says Murison.

“I think Buffet’s advice about selecting good quality companies and staying with them for the long haul is sound advice – that’s what investing is all about. But there are times when short-term exposure to the market is warranted, for example if you are long the market and are nervous about a possible short-term correction.”

Hedging has long been a part of prudent portfolio management, rather like car insurance against the possibility of an accident.

“For example, if you are long AngloGold Ashanti and expect a drop in the gold price, but do not want to incur the costs of selling your equities and then trying to guess the right time to re-enter the market, you can short AngloGold using derivatives like futures or CFDs [contracts for difference].”

CFDs are a type of derivative that gives you exposure to the price movements in an underlying security. For example, if you bought AngloGold on IG Markets, your trading account will reflect the underlying price movements in the actual stock, without owning the stock itself. You are also able to leverage your trading position, meaning you can magnify the underlying price movement up to five times the spot market price.

Any type of leverage carries elevated risk. Profits and losses are amplified, and inexperienced traders often commit too much capital to a single trade, and don’t really have a trading plan. They fail to exit a trade when it goes against them and can quickly blow their accounts. More experienced traders have a plan, stick to it, and exit a trade quickly when it goes bad, says Murison.

Shorting stocks with CFDs is a relatively inexpensive way of hedging a long position. The question then becomes whether to hedge your equity position fully or partially. Some investors are prepared to hedge just a portion of the equity position and take the risk on the remaining 50%.

Murison says hedging an equity portfolio comprising dozens of individual stocks is best achieved by identifying and shorting an index that best approximates the portfolio.

CFDs are geared for short-term trading

CFDs are geared towards short-term trading and holding them for more than a few months can be costly as there is a finance charge of roughly 6% a year.

“Most of our clients are speculators, so they are on the hunt for short-term profit opportunities,” says Murison. “Many of them have equity portfolios which they hold for the long term, but they allocate a portion of their portfolios for short-term trading.”

Another reason to look at CFDs is to profit from short-term opportunities that may not exist in the SA equities space, such as an expected bounce in the Nasdaq index, or the S&P 500.

Murison says the most popular trading instruments among SA-focused clients are the JSE Top 40 index as well as the more liquid stocks within the index, gold and gold shares, which are notoriously volatile – something traders look for.

“Traders will have their favourites, and bear in mind that you can go long or short with CFDs, so you can potentially profit no matter which way the market is moving.”

For those trading the international markets, indices such as the Nasdaq and S&P 500 are among the most popular, as well as large-cap equities like Tesla, Amazon, Apple and Netflix.

Though CFD holders do not receive dividends, if a trader is long an equity CFD they will receive a cash adjustment equal to the dividend amount. Conversely, a trader short a CFD will pay an amount equal to the dividend. CFDs replicate the underlying cash adjustments, but do not confer shareholder rights such as voting at annual general meetings.

“Long-term investing is a more passive approach, where the investor generally anticipates holding the security for several years. However, short-term trading definitely has a place in any prudent portfolio, both as a hedging tool and as a way to capitalise on expected short-term movements in the market,” says Murison.

Demo account

Murison advises those interested getting started in online trading to open a demo account, and to study up on the educational material on the IG Markets website and experiment with various trading styles and strategies.

When you’re ready to go, you can fund your account and start live trading. IG Markets offers a vast library of training tools on its website, with webinars every week from seasoned analysts from around the globe providing market insights and tips.

About IG Markets South Africa:  IG Markets South Africa was established in 2010 and is regulated by the Financial Sector Conduct Authority (in South Africa) as an over-the-counter derivative provider and an authorised financial services provider (FSP No 41393). It has an office in Sandton to service its thousands of South African clients. Its board and senior management in South Africa consist of largely South Africans making it a truly South African operation. As one of the biggest employers in the online broking category, it is proud to be playing a leading role in the growing financial services industry in South Africa

Note that CFD losses can exceed your deposits.

IG Markets is part of the LSE-listed IG Group, which has a market cap of £3.4 billion (R71.4 billion). It has more than 330 000 active clients worldwide.

Brought to you by IG Markets South Africa.

Moneyweb does not endorse any product or service being advertised in sponsored articles on our platform.

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