I used to be a long-term investor. Today, I am a trader. I can testify that these activities have little in common. Certainly, we often use the same instruments—but that’s where the similarities end.
What are the Differences Between Stock Market Investing and Trading?
Holding Period, Financial Leverage, Catalysts
Investing in the stock market involves allocating savings with the aim of growing them over the long term, while accepting risk. The investment horizon is generally more than five years, and can extend to several decades. Only available cash is invested, meaning leverage is not used. This differs from real estate investing, which typically requires substantial leverage—often three to five times the available capital. Trading, on the other hand, commonly involves the use of leverage in several ways. The simplest is through a margin account. For example, with CHF 100,000 in a margin account, you can gain exposure to CHF 350,000 in assets—a leverage ratio of 3.5. Of course, this leverage comes at a cost. Another way to use leverage is by trading options.
A stock market investor will typically hold shares for one to two years at minimum, sometimes indefinitely. A trader, by contrast, will usually establish positions to hold them for a few days up to about three months—six months at most. What motivates the investor is a “thesis”—confidence in the company’s medium- to long-term outlook (for stocks, for example). The trader may have an opinion on the quality of a company’s project, but that’s not what drives a trade. The trader needs a clearly identifiable short-term catalyst—an internal or external event, fixed in time, likely to cause a sharp and rapid price move. Examples include clinical trial results for a biotech, the launch of a new generation of gaming consoles for a video game publisher, new regulations impacting a market, or a company’s earnings release.
“Direction” of Positions
Investing in the stock market means buying financial instruments with the goal of selling them later at a higher price. This is known as “long” management. There’s no betting on falling prices (“short” management), although sometimes investors may hedge against certain downside risks. While this alters the portfolio’s risk/return profile, it doesn’t change the objective.
In trading, it’s rare to only take long positions. Some traders are mostly long except in bear markets, while others specialize in special situations such as index inclusions/exclusions, lock-up expirations, IPOs, turnarounds, acquisitions, short squeezes, management changes, spin-offs, etc.—all potential catalysts. Some have made a specialty of these strategies, both long and short. Personally, I am neither net long nor net short—I am “neutral” most of the time. In other words, I have as many long positions as short ones. To be clear: my overall long exposure is, broadly speaking and with a few technical adjustments, roughly equal to my short exposure. The difference between the two is called net exposure, which I keep below 20% of my total assets. This may seem low, but in this strategy, 20% is a lot. This is referred to as having a bias—bullish or bearish.
Instruments Used
An investor typically uses stocks, ETFs, bonds, and funds (since ETFs and funds can provide access to almost any asset class—from commodities to tech stocks, miners, emerging market bonds, agricultural products, or currencies). But let's focus on stocks, bonds, and ETFs.
If an investor has a specific time horizon in mind (for example, retirement in 30 years), he will generally be heavily exposed to equities at the start. As the investment horizon shrinks to about 15 years, he will gradually reduce the equity allocation in favor of bonds, with the average bond maturity also decreasing over time, eventually holding only short-term bonds by the end.
A trader, meanwhile, typically works with stocks, options on stocks or ETFs, and sometimes CFDs and futures, especially if seeking exposure to non-domestic markets. This is a simplification, as many traders specialize outside equities, ETFs, or options—such as in commodities or currencies. I will focus on equity and index options and futures, as this is my area of activity, as it is for many hedge funds.
Personally, I run two main strategies: long/short and index arbitrage. In long/short management, I only use options on stocks or indices. In index arbitrage, as the name suggests, I only use index futures, and my time horizon is much shorter than for my long/short portfolio.
Diversification
An investor needs a minimum level of diversification: at least 15 to 20 different holdings in a portfolio, with the largest rarely accounting for more than 5% of the total. For larger portfolios, this could mean more than 50 holdings. I’ve even seen portfolios with more than 200 positions—frankly, that’s far too many for me; it’s impossible to track. Such a degree of diversification means you’ll likely just match the market’s performance, so why go to the trouble when a handful of ETFs will do? For individuals, 20 to 25 positions seems a reasonable maximum.
Trading is different. For me, having a long/short portfolio already achieves much of the necessary diversification, so I generally cap it at a maximum of six long and six short positions—twelve in total. Where things get more complex is in diversifying option expiry dates. I don’t want all my calls and puts expiring on the same day, as this would be too risky. So I stagger them across several expiries. Furthermore, for each position (long or short), I typically have two “legs”: a long leg expressing my conviction and a shorter-term short leg that helps offset the cost of the long leg if my timing is off. In total, across six long and six short ideas, I generally end up with 30 to 36 call or put positions spanning three to four months.
Portfolio Turnover
In investing, the focus is on fundamentals, not on market timing, which is a good thing. Therefore, portfolio turnover is low—maybe one new position and one exit per month, on average.
In trading, for my long/short portfolio, you can estimate as follows: six longs plus six shorts every three months = 50 to 100 positions per year—a significant difference. For arbitrage, it’s quite different: I am in position only about 20% of the time, because opportunities are rare and there is often not enough volatility to justify a trade. Moreover, the potential per trade is low. If the expected move happens, I exit quickly to lock in profits. As a result, I often finish the day with zero positions and 100% cash. So, the portfolio turns over a lot, within a restricted set of instruments and with short exposure periods.
Conclusion
To me, trading and investing are not mutually exclusive; they are complementary. The activity that occupies most of my time (trading) generates profits, which in turn feed into my long-term investment portfolio. This is possible because I have extensive experience, which allows me to choose the right approach for the situation.
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