What is the Stock Market? Should I Trade Stocks or Invest?

What is the Stock Market?

What exactly is the stock market? Sometimes it may feel as though the world of investing, trading and finance is completely foreign but hopefully I can clear things up for you.

To start from the very basics, the stock market is a place where people can buy and sell very small percentages of companies. By small, I mean very, very small. As in ~0.00000001%, but this is dependent on how big the company is. This is mainly because companies are worth millions or billions of dollars and if the average person wants to be a part of it, they need to break that down into very tiny fractions. These small percentages that you can buy or sell are called shares. Shares are just the units of ownership issued by a company.

The reason why companies allow you to buy these small percentages is to raise funds. The idea is that you get a small bit of ownership in the company, and they get money to help them fund projects or grow and progress. The reason why people like you and me decide to buy these shares is to potentially make more money. Let me give you an example.

Let’s say that company X has shares that are worth $10 each, and I decided that I want to buy 100 shares. So in total I purchased $1000 worth of company X. As time goes on, company X expands and makes progress and the company increases in value. So now each share is worth $13. If I now decide to sell my shares, my $1000 turned into $1300 and I made $300 profit. This is the main idea of buying and selling stocks. Now let’s take a look at different ways that people buy and sell these shares.

Trading vs Investing

Typically when it comes to buying and selling shares, there are two main schools of thought. There is trading, which is generally buying and selling shares for short term returns, and there is investing, which is more focussed on long term returns.

Back to the example of company X, if I were to invest, I would hold my shares for months or even years. I would be focused on the performance of the company, their revenue, leadership, and future plans. This is called fundamental analysis. If I were trading company X, I would hold my shares for weeks down to minutes. I would be focused on patterns and trends in the price of my shares. This is called technical analysis.

Both trading and investing can use a combination of fundamental and technical analysis but in general trading is more technically focussed and investing is more fundamentally focussed. Now let’s take a little bit of a deeper look into both of these concepts.

If I were investing, I would do research into companies I believe will grow over time. This generally takes less effort than trading, but it comes at the cost of lower returns and introduces speculation. If I am investing, I am relying on the information I can find about the company, and trusting it will continue to have growth in the future. But how am I supposed to know that the CEO is making good decisions or that there aren’t any internal issues with the company? That’s why there is speculation.

Trading generally takes more effort because it involves understanding patterns in price movements and what variables need to be considered, but it removes speculation and relies on numbers and probabilities of specific movements occurring. If you have a degree in finance or business, you might be thinking “HA! Probabilities in the stock market? That’s not how it works!” But let me break this into simple terms for you. So when these probabilities of outcomes can be predicted (using a lot of data), then trading can be very profitable. Trading offers much higher returns than investing due to the idea of compound growth.

Compound Growth

Compound growth is the idea that the initial amount of money I am trading or investing with is compounded, or combined with the profit or loss attained which then affects the future profit or loss of trades or investments.

Using the same example as before, the $1000 that I put into company X turned into $1300 so I made $300 profit or 30%. I am now working with $1300. So instead of 30% profit being $300, 30% of $1300 is $390.

Here is another example. If I start with $1000 and make 1% gain, each day for a year, I end up with over $37000. If I do the same, but only compound the 1% gain each week, I end up with under $2000. So the more times my initial capital is compounded, the higher my returns. This is why trading offers higher returns than investing.

Which do I choose? Trading or Investing?

Trading is more attractive than investing for a lot of people. Each trade made is another compound, whereas with investing, compounding happens less frequently. So then why aren’t more people trading? This comes down to lack of time, lack of information, and risk.

Most people work jobs and don’t want to spend their free time learning strategies and patterns.

Those who do want to spend the time, have no idea where to start. Online there are a lot of gurus with content and too many online courses. In reality there isn’t one best strategy or pattern, and all of the info people try to sell you, you can easily find yourself. Trading is not as complex and difficult as most people are trying to make you believe.

As for risk, everything in life is a risk, all you have to do is plan for that risk and suddenly it’s no longer risky. Driving cars is extremely dangerous, but put on a seatbelt and install airbags and suddenly it’s not so dangerous. Think of this as a form of risk management.

So back to the question. Investing or trading? This is dependent on your own personal goals and situation, but if you’re looking at it rationally, if you want to minimize speculation and maximize returns, then trading is the obvious choice. Conversely, if you don’t have a lot of time you are willing spend on how you manage your money, and are happy with long-term slow and consistent returns, then investing is probably for you.