Difference between Trading, Investing and Gambling

It is important to know WHAT are you investing with and HOW are you putting

money into use. Some people use it to GAMBLE, some use their money to

INVEST, some use it to TRADE.

Difference between Gambling, Investing and Trading

Knowing the Differences

It is very important to know the differences between trading and investing. A

trading plan is very different from an investment plan. If you are putting your

money in the market, you must have a plan. An entry plan and an exit plan

with reasons.

Gambling

As you are starting out in the stock market, one of the most important

differences you must know is the difference between trading and investing. As

I started out in the market in 2007, i did not understand the difference

between trading and investing. I thought that by putting my money in the

market, I was 'investing' in the market. That is a very common misconception.

By not knowing what you are doing and throwing your money into the market

is not investing but it is GAMBLING.

Gambling is betting for return purely based on luck and no proven statistics or

analysis. I ever heard from newbies 'investing' in the market, but when I

started digging further for information like company business model, earnings

for company etc, these newbies couldn't answer any of my question.

Investing

Investing is a form of speculation that looks at the long-term outlook of a

certain stock. Typically, investing is being held for a long period of time from

half a year to years. Most of the time, investors are usually long in the market.

Being LONG or BULLISH in the market means that the investors will profit if

there is an increase in stock price.

There are typically 2 most common form of investing.

1. Investing for Price Gains

When you are investing in an asset i.e common stock, commodities, you want

an increase in price for the asset. The increase of price for the asset is called

Price Gain. For example, during the Financial Crisis in 2007/8, the common

stock of Bank of America, fell to a low of $2.53 and as of July 2015, the stock

is worth $16.70 per share. That would mean you have made an awesome

560% returns or a price gain of $14.17 per share of Bank of America share

that you purchased.

To simplify the concept of investing, here’s another example.

Imagine, Apple is releasing a brand new IPhone and you manage to able

obtain it ahead of everyone at $1000 per IPhone. When it’s being released,

the Telcos are selling at $1200 per IPhone. However, everyone is queuing for

the iPhone and the phones are sold out in the first day. As everyone is dying

for an IPhone (More demand than Supply), the prices of IPhone went higher

to $1500 per IPhone. As you have bought the IPhone at $1000, you would

have made $500 per iPhone that you purchased. Now replace the iPhone with

the stocks or other assets that you are going purchase. And you will want the

asset price to increase. And that’s price gain.

It is important to know what is the type of returns you are getting because it

will affect the taxes you pay. For example, in Singapore, price gains are not

being taxed. However, in the US, capital gains are being taxed. And any price

gains that you had made as a Singaporean from US stocks are not taxed as

well.

2. Investing for Dividend Yield

Dividends are what companies pay their shareholders for investing in their

company.

Here’s a simplified Profit and Loss Statement of a company.

+ Revenues

- Cost of Goods/Services

+ Gross Profit

- Expenses

+ Net Operating Profit before interest and tax

- Interest and Tax (Debt-holders get paid by interest)

+ Net Profit

- Dividends (Shareholders get paid on dividends)

+ Retained Earnings

As you can see, dividends are paid out last after tax. Dividends are typically

paid by per share basis. If a company is issuing $0.20 per share and you hold

1000 shares, you will get $200 for holding 1000 shares.

If you were to receive dividends as a Singaporean from a Singapore listed

stock, you will not taxed as Singapore practices a one-tier tax system.

However, if a Singaporean were to receive dividends from a US listed stock,

the dividends received are subjected to tax by the US government. Therefore,

it is important to find out from your broker about the tax regulations if you are

trading/investing in other countries.

When investing for dividends, we will be looking at the dividend yield. This

tells you how much dividends will you be receiving for the amount that you

invested in that stock. For example, if a $10 stock is paying a dividend of

$0.50, the dividend yield is 5%. Just simply take the dividend and divide by

the current stock price. Some stocks provide sufficient dividend yield to beat

inflation, which stands mostly at 2-3% per annum. It’s definitely much better

than placing your money in a fixed deposit account which pays you a much

lower returns.

To simplify the concept of dividend investing, imagine there is a money-

printing machine, that can last forever, that prints $1 a day, which means it

prints $365 a year. And this machine is selling for $1000. Would you buy it?

Definitely! You would have covered your cost within 3 years! However, what if

the machine is being sold at $1 million? Would you still buy it? I would reckon

not. This is the relative difference between whether it’s EXPENSIVE or it’s

CHEAP.

Now, replace the money-printing machine with the stocks you are buying. The

stocks that you are buying are essentially a money-printing machine that will

continue to print money as long as the business remains profitable.

The methods may differ when investing for dividend yield and price gains.

Trading

Trading is a totally different animal from investing. Trading is holding stock

positions on short term, ranging from a few seconds to a few months.

Regardless the stock goes up, goes down or even sideways, the traders can

still make money with the right strategy.

You might be wondering right now…. You can actually make money even

when the stock market goes down? The answer is definitely YES. This is a

vast difference between traders and investors. Traders are highly versatile

and are able to make money in the stock market whichever the market goes.

However, investors can only make money if the stock market goes up.

Short-Selling

Here’s a new term that I will be introducing. Short Selling is a process that

allows people to make money when the stock market goes down. So how

does short-selling works?

First let’s look at how a LONG position works. Being LONG or BULLISH in the

market means you will profit if there is an INCREASE in the stock or any

assets prices. In order words, you will have to BUY the asset at a LOW price

then SELL it HIGHER.

In summary, being LONG/BULLISH in the market, you have to BUY LOW first

then SELL HIGH later.

On the contrary, being SHORT or BEARISH in the market means you profit

with a DECREASE in stock or any asset prices. Being SHORT in the market,

you have to SELL HIGH first, then BUY LOW later. And the most obvious

question is… How can you sell something you that you did not buy in the first

place? The answer is that you BORROW the stock from someone who has

the stock. This is the mechanism how short selling works. The broker will

allow you to borrow stocks from others so that you can sell it first. When you

buy back low, you are buying back the stock so that you can return the stock

back to the lender.

There are a several different trading styles. Each type of trading styles will rely

on different types of information.

1. Scalping

a. Scalping is possibly the fastest trading style on can possibly

have. Scalpers get in and out quickly; can last from seconds to

minutes per trade.

2. Day-trading

a. Day-traders get in and out by the end of the trading session.

3. Swing Trading

a. Swing Traders enter and exit within a few weeks

4. Positional Trading

a. Positional Traders enter and exit within a few months.