The financial industry is one of the largest in the world. It is the backbone of most economies and if it fails, chances are that other industries will fall as well. This is because, the finance industry provides other industries with capital to grow business. They provide the capital knowing very well that the companies they provide could fail. They are the risk takers.
Every day, investors from around the world take time to think about how to maximize their returns. There are two broad ways they approach this. First, there is the Warren Buffet model. This involves buying stocks – or any other financial asset – and holding them for years. For stocks, they benefit from the stock price appreciation and the dividends. On the other hand, there are traders who buy stocks and other financial assets and sell them within a short period. A good example of a trader who follows this model is James Simons who runs Renaissance Technologies.
The benefits and disadvantages of each of these methods have been written and talked about. In this article, I will look at the benefits why I consider trading better than investing.
First, no one can predict accurately the future tastes of people. For example, a decade ago, media companies were the best bets for long-term investors looking to capitalize on an expanding economy. Companies were forecasted to increase their ad spending to reach this target. At the same time, young companies like Google, Twitter, and Facebook were starting new models of marketing. Today, most media companies have been forced to shut down as online advertising gains momentum.
The same example can be told of other industries like beverage. For decades, Coca-Cola was the leading beverage company but as people’s tastes changed, more people moved to healthier categories. Another example is in the transport industry. A decade ago, companies like Avis were growing. They didn’t foresee a future where people would hail cars using mobile apps. Today, the car rental and taxi business is facing a crisis as Uber and Lyft becomes more pronounced.
Second, we all make mistakes. When they realize their mistakes, traders have the flexibility to exit their trades. Often, this is usually a bit difficult for long-term investors. For them, they make investment decisions based after months of fundamental research to find whether a company is over or undervalued. When the investment thesis fails, they usually have a difficulty in exiting. A good example for this is Bill Ackman, a prominent hedge fund manager who bought a stake in a company called Valeant Pharmaceuticals at $150 a share. A few months later, the company’s stock rose to above $250, before falling to $10. He exited the stake at $11, losing $4.4 billion.
Third, traders have the flexibility of being either long or short a financial asset. Short sellers benefit when the stock is going down by borrowing and selling the stocks. In the above example, short sellers benefited when the stock of Valeant Pharmaceuticals fell from $250 to $11. This is very difficult to achieve for investors, who bet on the growth of companies they invest in.
The benefit of trading is the flexibility that it gives to traders, who can potentially benefit from the upward and downward movements of financial assets. Even when the assets are moving upwards, there are usually short-term swings that benefit traders. Consider the 2008/9 financial crisis. While large investors like lost big, traders like James Simmons had their best years.