Investing in Stocks For Dummies
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People make money from stock in different ways, using different strategies. Stock investing, stock trading, and stock speculating may sound similar, but they’re actually pretty different:
  • Stock investing: Investing looks primarily at fundamentals, which tend to be long-term drivers of stock prices. The long-term investor waits out the zigzags as long as the bullish outlook and the general uptrend are intact.

    The good part is that investing involves fewer transaction costs and usually lower taxes. The bad part is that sometimes the stock can correct (go down temporarily) or have periods of flat performance, which the long-term investor has to tolerate.

  • Stock trading: In trading, much more activity takes place during a range of a few days, weeks, or months. Traders may dump losers immediately and cash out winners to lock in some profit before the next dip in price.

    Trading can mean more costs due to frequent commissions and short-term taxable gains. For trading, the fundamentals are either not a factor or at best a secondary or minor factor because short-term movements in a stock price are more geared to momentum and sentiment.

  • Stock speculating: Speculating is a form of “financial gambling.” As a speculator, you’re not investing but making an educated guess about which way the stock price will go. Speculating is typically associated with a short-term time frame, but it can also be long-term.

It’s safe to say that much of trading is short-term speculating and that speculating is a much smaller dimension of investing.

The time factor

It used to be easy to delineate what was short term, intermediate term, and long term:
  • Short term was less than one year (some would say less than two years).

  • Intermediate term was usually one to three years or one to five years.

  • Long term was longer than five years.

Recently, however, investors have become very impatient. For some, short term is now measured in days, intermediate term in weeks, and long term in months. If an investment does well, they sell it immediately and move on to another (hopefully) profitable investment. If the investment is down, they sell it immediately to minimize losses and move on to (hopefully) greener pastures elsewhere.

There’s no such thing as a three-month investment when it comes to stocks. Stocks require time for the marketplace to discover them. Sometimes great stocks see their prices move very little because the market hasn’t noticed them yet. In trading, on the other hand, you jump in and out relatively quickly.

Typical trades occur over the span of a few days or a few weeks. Many experienced traders won’t tempt fate and stay in too long because a reversal of fortune can always occur, so they’re not shy about cashing out and taking a profit.

Usually the time factor for speculating is short term (less than a year), but it can be much longer. Speculating with options is short term by definition because options have a finite shelf life (even long-term options are typically two years or less). However, an investor who’s speculating using stocks can do so for a longer term because no finite time period is involved.

The psychology factor

In investing, you can be very analytical. You can look at a stock and its fundamentals and then at the prospects for the stock’s industry and the general economy, and you can make a good choice knowing that you’re not worried about the price going up or down a few percentage points in the next few days or weeks.

Trading involves looking at stocks that have the ability to move quickly, regardless of the direction; you look very little, if at all, at the company’s underlying fundamentals. Seasoned traders want to make money quickly and capitalize on crowd psychology and market movements.

Stock trading is short-term speculating because the trader is making an educated guess about something that’s not readily measured: figuring out which way the market will move.

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