The debate between investing and trading has been ongoing for years among market participants. Those who favor investing believe it is impossible to beat the market by frequent trading and attribute any success to luck rather than skill. On the other hand, traders believe that holding positions for extended periods exposes them to too much market risk. Both approaches have their strengths and weaknesses, and it's essential to understand the trade-offs involved.
Is Overnight Risk Worth It?
Investors and traders both aim to make money, but investors are willing to be exposed to overnight market risk, while traders are typically not. A simulation of the long-term performance of the S&P 500 ETF (SPY) can shed light on this question. The study showed that almost all SPY returns come from overnight movements, and a strategy of buying at the open and selling at the close would have resulted in no gains since 1993.
Now, let's take a look at some of the important factors that influence the odds of success for risking capital in the markets.
𝐑𝐢𝐬𝐤 𝐑𝐞𝐰𝐚𝐫𝐝 𝐑𝐚𝐭𝐢𝐨
Investors can potentially achieve a high risk-reward ratio by holding positions for an extended period and allowing profits to run while limiting losses. Traders, on the other hand, must have a high accuracy rate and take quick profits to compensate for their lower risk-reward ratio per trade. They need more winning trades than losing ones to overcome transaction costs and make a profit.
𝐓𝐫𝐚𝐧𝐬𝐚𝐜𝐭𝐢𝐨𝐧 𝐂𝐨𝐬𝐭𝐬
Investors typically have low portfolio turnover, which results in low transaction costs over the year. On the other hand, traders make many trades and incur high transaction costs, which eat into their profits. They need a significant edge to overcome these costs and make a profit.
𝐁𝐥𝐚𝐜𝐤 𝐒𝐰𝐚𝐧 𝐑𝐢𝐬𝐤
Investors are continuously exposed to the market due to their long-term holdings and are more vulnerable to black swan events that can result in sudden and significant losses. Traders are less likely to suffer negative surprises as they have limited exposure or no positions. However, investors can mitigate black swan risk through proper diversification and risk management strategies.
Conclusion
In conclusion, both investing and trading have their advantages and disadvantages, and the best approach depends on the individual's risk tolerance and investment goals. Instead of taking a hard stance, it's essential to understand the trade-offs and choose the approach that suits you best.
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