The Difference Between a Trader and an Investor
William is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
When I discuss the stock market with people who are “laymen”, I get different questions and comments such as “Do you buy low and sell high?” I also get questions such as “Isn’t the stock market a lot like gambling?” A number of people out there see stock market investing as something similar to going to the dog track or playing video poker. Well…if a person is a day trader, a person who buys and sells every day, then that is likely the case. The difference between a day trader and an investor is that the investor invests for the long-term based on solid fundamentals such as cash flow, revenue growth and low debt levels while the day trader wants to make a quick buck based on daily price movements on any stock.
The viewpoint of the day trader is in stark contrast to the long-term investor. A day trader might look at a company like Chipolte Mexican Grill (NYSE: CMG) and say “Man this company is going up today. I am going to buy it and at the end of the day I will sell at a profit.” An Investor would look at Chipolte Mexican Grill and say, “This company has a 34% growth rate in free cash flow and a 22% growth rate in revenue over the past 3 years and has yet to expand into foreign markets. It is too expensive now so I will wait for the company to become cheaper for a better buy.”
Similarly, a day trader may look at Microsoft (NASDAQ: MSFT) on any given day and say “This stock isn’t moving too much, I won’t buy it.” An Investor would see that Microsoft has $69 billion in cash and investments on its balance sheet and pays out only 21% of its free cash flow in dividends yielding around 2.8%. The long-term investor would buy it and collect the dividends while waiting for the stock price to go up.
As day traders move in and out of stocks every day they incur a commission not only on the buy order but on the sell order as well. A day trader’s gain would have to equal the total commission for the day. For example, if I bought 100 shares of company ABC at $20 per share and my commission was $10 at purchase and $10 when I sold, then I would have to have a $0.20 gain per share just to break even. I have seen many stocks move only that far in one day. If an investor executes a buy and hold strategy then he would have invested the $2,000 with the $10 commission. Years later if the investment is worth $6,000 and is sold with a $10 exit commission then the $4,000 capital gain would have far exceeded the $20 commission for the buy/sell transaction. Your net gain would be $3,980. Day trading is big business. Companies like Charles Schwab (NYSE: SCHW) had trading revenue of $927 million dollars in 2011.
The long-term investor utilizes a buy and hold strategy based on long-term fundamentals such as cash flow and low debt load and revenue growth. The long-term investor understands that there is a correlation between fundamentals and long term stock price return. The market on a short-term basis is guided by the fear and emotion of the daily headlines making it difficult to predict the direction of a particular stock price on any given day which means that a day trader could get burned.
stockdissector has positions in Microsoft mentioned above. The Motley Fool owns shares of Chipotle Mexican Grill and Microsoft. Motley Fool newsletter services recommend Charles Schwab, Chipotle Mexican Grill, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.