Investing versus Trading Part I : The psychology behind trading

Making decisions on how to approach the markets can be done in multiple ways, such as fundamental analysis, or technical analysis. I wrote a dedicated article on these types of analysis here.

However, doing analysis is only the preparatory part of getting exposed to the markets. Actually, being in a position is a totally different beast, as this is where the mindset and psychology aspect of trading dominates over anything else. Curious? Lets dive straight into it!

For the purpose of this educational article, imagine the following scenario:

You have done analysis on an asset, and you have come to the conclusion that the price will rise in the near future. Your plan is to find the best opportunity, take on a position and get out after the price has risen in the next few months to your desired level. 

You are all set, the opportunity presents itself and then you decide to open up a position. Now all that is left to do is wait a few months and then simply sell your position for a nice profit. 

Sounds easy and relaxed! You set up a few alerts just in case something happens, and you decide to go on with your usual business.

Then, an hour later, your first alarm rings, and you decide to check up on the price. Price has gone the opposite way. You know that price fluctuates but it shouldn’t matter too much. You are in it for the long run, and leave it. 

A day later, another alert rings. This time, the price has traded in your direction. All is good and you can relax again. You set new alarms just in case. Once again, a few alerts go off, you keep checking prices and you find yourself glued to the charts for the next 2 weeks, until at some point your other obligations are starting to catch up with you and therefore, you decide to close out of the position for a loss.

Once you have caught up, you decide to check the price again after a few weeks have passed. You are astonished to see that the price is traded in the right direction and is now hitting your original target. 

The problem is, however, that you got fed up with being in a position, closed it for a loss and have now missed out on some nice profits. The consequences that come from here on out can vary wildly, and heavily depends on how you will react to this mental blow.

This is where your mindset can play nasty tricks on you. You were right on the idea, but you missed the move. How could this happen? The main reason is probably because you mixed up the concept of investing versus trading.

What is the difference then?

Investing and trading are two very different methods of attempting to profit from the financial markets. Both investors and traders seek profits by participating in it. One can do so through the act of opening and closing positions.

The goal of investing is to gradually build wealth over an extended period of time. These are typically positions that are held for a period of months, years and even decades. Naturally, the markets will fluctuate, but the investor does not care about those fluctuations and keeps the bigger trend in mind as they ride out the smaller increases and decreases in price.

Trading, while having the same goal, involves more frequent transactions. A trader rides the minor trends in both ways. If done well, the trader can make money by longing an asset, as well as shorting an asset.

It is all in the mindset:

The main reason why the trader in the above example failed to capture the move was because the approach was one of an investor, yet the execution proved to be that of a trader. As you may now understand, these have originated in two opposite mindsets. It is important not to confuse one with another.

When looking to take on a fresh position, simple analysis is not enough. Besides defining a point of entry and a target, one must never forget to include a point of invalidation and know fully when to get out when the trade does not play out. 

Finally, the mental approach must be determined. Will you ride out the fluctuations in between over a longer period of time, naturally going for larger targets and wider invalidation areas, or do you seek smaller profits within a shorter timeframe while trading the individual fluctuations in between a larger trend. Which one that will be, is up to you!

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The information provided above is not financial advice but for educational and entertainment purposes. Please do your own due diligence or consult a financial advisor before investing in any digital assets.

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