Have you ever wondered what is the difference between trading and investing?
Both terms might sound as synonyms and to average Joe they are, however if you are going to be part of this game you should make the difference. Both traders and investors are involved in the financial market. They buy and sell financial assents in order to profit from the margin that arises from the time of buy or selling the instrument, until the time same is sold (shorted) or bought (longed). The main difference is that traders would try to do that a lot more frequently than an investor.
Trader may open and close 10 positions today or during the entire week while an investor would carry his trade for longer periods of time such as months or years.
An investor is someone who for example would buy a house, believe that the housing market will rise in the future. Investor purchases a home for $100k. A few years later same house is valued at $200k due to various reasons (neighborhood is growing, new factory or tech company has opened doors nearby, there are good private schools and hospitals that are being constructed etc…) At this point the margin is 100K (200k-100k=100k). This margin of 100k could be the profit of the investor if he decides to sell.
The amount of 100 thousand dollars is his floating profit. Floating because he didn’t realize the sell. If he would sell the house and the profit of 100k goes into his bank account, then the profit would be realized, not floating.
This is how trading works. You want to buy at cheaper price an asset (currency pair in forex, stocks or any other financial asset) that you expect to appreciate in value. The house in the example above is the asset.
Now let’s see the other situation. Investor buys a house, however the housing market in this particular area drops (there is a new airport close by that makes too much noise, schools are closed, there was a water pollution from a factory – any reasons could be a factor). Two years later, the investor’s house is valued at $50k. That’s 50% drop. At this point the investor has a floating loss of 50,000 dollars. If he sells the house to get back at least some of his investment (50% in this case) he will realize the loss.
The investor could decide to hold. He can either lose more, if the real estate prices drop further, or if he believes the drop is temporal, and the future of this neighborhood is bright, he can hold in hopes that prices will go back up. And maybe at some point he will be able to sell the house in profit.
This decision is extremely important. I want you to remember this example as I will refer to it later on the next subject that I will cover. When everything is going as planned, there isn’t much room for errors. When things go south though, holding a losing position MUST be a decision that follows and is according to your trading plan 100%. But more on that later on as I said.
This is how it works when we are buying in the market. Selling is the same but vice versa. For the sake of the example imagine that you already have a house. Nice beach house. One day you see in the local newspaper that a construction magnate has purchased a huge lot next to your house and is planning to build a chemical factory there.
Naturally that will drive people away from this place as who wants to smell chemicals while laying on the beach and there is always the possibility that there could be spills into the water. You do the math in your head, the second you have read the news and make the conclusion that the real estate prices will drop. The great vacation town will be ruined. You call your broker and put the house on the market immediately while the prices are still high. You manage to sell the house after a few months at the price of $250k. Time passes by, the factory is ready, production starts and problems start growing as mushrooms. People start selling their homes and prices drop quickly. The owner of your old house is trying to get rid of it but the price is now $100,000. If he sells he would realize a loss of $150,000.
How much money you made, selling your house? It really depends on how deep the market will go.
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Have a wonderful weekend!
Yours,
Vladimir
