Why Become a Trader?
Initially would be traders spend some time investigate whether trading is right for them. There is the prospect of gains, but there are uncertainties too. Many people are realising that being an employee is no longer a secure and lucrative way to spend their lives.
This article compares trading to other financial opportunities, such as starting a business, or being an investor (see our article comparing investment and trading to understand the differences between investment and trading). I’ll discuss whether trading is right for your personality in an upcoming article.
Being a business owner
A business is based around selling either goods or services at a profit. This means that you must have customers. Acquiring and keeping customers is the essence of business. In addition, you will need to provide what you are selling to your customers. This may mean that you need to take on employees, buy or rent an office, shop or factory and purchase supplies or stock.
Businesses are heavily regulated by the government. Typically, you will do a lot of unpaid work for the government, such as preparing tax returns, managing payroll taxes and doing statutory returns.
In terms of your own time, businesses can be full on. You will need to provide a service. Customers will not hesitate to contact you after hours. Many small business owners work very long hours. It can be difficult to take a break, even for a short time. It is possible, but difficult to run a part time business. Most customers will expect to be able to contact you during business hours.
There is some risk in our litigious society. Someone may slip and fall and sue for millions. An employee may claim victimisation. These are all business risks. You will need sufficient capital to start your business and survive on until you make money. This amount may be substantial.
Trading offers a far more flexible way to make money. There is no stock, you don’t need employees and can work from home and work part time.
Commonly cited statistics show that a high percentage of businesses fail in the early years. This may be due to insufficient sales, inadequate capital or a number of other reasons. Having said that, small business is one of the ways that people can earn substantial wealth, so there are rewards also. Most traders are also unsuccessful, but this is mainly due to lack of trading experience, and similarly, there is the opportunity of reward. On balance, the risks are similar, but trading offers more independence and uses less capital.
Being an investor
An investor typically buys and holds either financial assets, or real estate. The distinction between a trader and an investor is primarily one of time. A trader holds assets for much shorter periods and actively buys and sells based on market fluctuations.
Investors avoid much of the work associated with moving in and out of investments and also avoid the time commitment and costs associated with trading. Investing is generally less time intensive than trading. If you go on holidays, you will still need to monitor your investments, while a trader can close out positions.
Over the long term, they may benefit from large scale movements (provided that they can ride out huge market fluctuations). An investor is generally fully exposed, unlike a trader who can quickly cut losses, or lock in profits. The investor will also not be able to benefit as easily from short term upward movements, while the trader can typically identify and exploit these. Also traders generally use leverage, so can realise a higher return on investment. Generally investors make much less than successful traders, and also assume more market risk (which is a function of time in trending markets).
Again, investment is generally more capital intensive than trading. A number of government studies have focussed on day traders and commodity speculators, and a large percentage of participants lose everything they trade with. Generally investors who have properly diversified their risk will not suffer this fate. Having said that, there are many long term investors who have lost substantial amounts of their investments.
Conclusion
Being a trader is not for everyone. An upcoming article will focus on the mental characteristics of successful traders. Both owning a business and investment also offer opportunities, particularly if you have already accumulated substantial capital. The risks and time commitment of running a business should not be underestimated. In all cases, some risks can be mitigated by doing your homework. Trading is a learned skill and a mental attitude and offers prospects for substantial gain with minimal capital.
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