The ChoosaBroker Trading Academy

3.2. Investors

Many people use the words “trader” and “investor” interchangeably when, in reality, they refer to two distinct sets of market participants. While both traders and investors operate within the same domain, they essentially carry out two very disparate tasks using very different strategies. Through this lesson, we will look at:

Definition of an Investor

An investor is any person or entity who commits capital to an investable asset in anticipation that they will generate a return from it. The assets an investor may purchase include stocks, bonds, commodities, mutual funds, foreign currencies and real estate.

Typically, investors differ from traders and speculators in terms of their investment time horizon and their day-to-day involvement in the markets. Investors generally take a longer-term view of their positions, while traders seek to make quick profits by taking advantage of short-term volatility in asset prices.

Becoming a successful investor demands that a person or an entity have the capability to consistently pick assets that either generate income, or appreciate in value, or both. To do so, most investors will employ some form of market analysis and choose an investment that best fits his or her risk-reward profile. Investors with low risk tolerance will target conservative gains, and will primarily focus on debt securities. Other investors, who are willing to take additional risk with a view to amassing bigger profits, may opt to invest in stocks, currencies and commodities.

There are two types of investors:

Retail Investor

A retail investor is an individual investor who buys and sells financial assets for his or her own personal account rather than for an organisation. In comparison to institutional investors, retail participants execute smaller trades, and also operate less frequently. However, the widening reach of online trading platforms and better access to financial information have resulted in a substantial jump in the number of retail investors over the past couple of decades.

Retail investing commonly occurs through three routes:

Individual investors,

  • who perform their own analysis and shortlist the assets to be purchased.

Managed accounts,

  • where investment managers make the buy and sell decisions on behalf of the individual investor. The manager has to investment in accordance with a set of pre-determined rules, and is paid to administer the individual investor’s funds.

Investment clubs,

  • whereby groups of individual investors pool their funds together and periodically meet to make buy and sell decisions as a group through a voting mechanism. Investment clubs are an ideal vehicle for retail investors to learn about financial markets, while interacting and working with people who share similar interests. In the United States, the upper limit for an investment club’s value is $25 million. There is no lower limit.

Institutional Investor

An institutional investor is an entity or an organisation which pools money to invest in a variety of financial assets like stocks, bonds, commodities, currencies and real estate. Institutional investors generally invest money raised from other people or entities.

Institutional investors have the resources to conduct extensive research on diverse assets, and due to their sophistication and specialized knowledge, they tend to have an edge over individual investors. Since they buy and sell large blocks of any asset, institutional investors are usually the biggest short-term determinants of demand-supply dynamics in any market. Also, because they are considered to be the “smart money,” their market activity often generates substantial interest among retail investors.

Institutional investors can be broadly classified in to six groups:

  • Pension Funds – Pension funds are the largest institutional investors in most developed countries. These are corporate investment pools that provide for employee retirement benefits. Both the employees and the employer contribute towards the fund.
  • Insurance Companies – Since insurance companies are contractually obliged to pay out future liabilities, they generally invest the premiums collected conservatively so that they have a ready reserve of liquid assets to settle those claims.
  • Commercial Banks – Commercial banks trade and invest both their own money and those of their customers through proprietary desks, whose sole objective is to make profits for the banks. They are active participants in the debt, equity and Forex markets.
  • Mutual Funds – A mutual fund is a managed fund that collects money from both retail and institutional investors to buy and sell securities. From the point of view of individual investors, mutual funds are beneficial because they offer professional money management, higher level of diversification and economies of scale.
  • Hedge Funds – These are investment funds that pools capital from high net worth individuals and institutional investors to invest in a wide range of assets. In comparison to mutual funds, hedge funds are more aggressive in nature, and their use of leverage is also not limited by regulators.
  • Endowment Funds – An endowment fund is an investment fund, typically set-up by non-profit organisations like universities, churches and hospitals, which make consistent withdrawals from the invested capital either for specific needs or to further the operating process.

Essential Qualities of a Good Investor

Successful investors come in many different shapes and sizes. Some are value seekers, like Warren Buffett and John Templeton, while some others are activist operators like Carl Icahn and Bill Ackman. Yet all of the world’s top investors share at least five common traits. Let us closely examine each one of them, by cultivating which, even an average, retail investor can aspire to earn superlative returns.

Failing to Plan is Planning to Fail

An intelligent investor will always first define his or her goals. Once the objectives are set, the next important step is to draw up a plan to realize those goals. Good investors are prepared for the uncertainties that financial markets repeatedly throw up, and construct their plans keeping in mind this unpredictable nature of markets.

When You Know Better, You Do Better

Some of the foremost investors are information junkies. They don’t just read financial reports and press releases, but keep abreast of the latest news from across the political, social and economic spectrum. Warren Buffet summed it up succinctly when he said, “The rich invest in time; the poor invest in money.”

Listen to the World But Do What is Right

Every successful investor has over a period of time developed a well defined investment strategy that works and they steadfastly stick to it regardless of what the majority opinion in the market is. The world of money knows no democracy. Crowds may tend to get whipped in to hysteria, but astute investors will always base their market decisions on the analysis of cold hard facts.

Keep Calm and Stay Focussed

If you track five different successful investors, you may see five different opinions, five different investment choices, and five different styles of investing. But one quality will invariably be common to each one of them – the patience and conviction to let their strategies unfold. It is probably the finest quality to have. It is what sets apart the smart from the mediocre investor.

Know Thyself

Investing entails risk but not knowing what you are doing entails greater risk. A vital difference between a successful investor and an average investor is that the former will always have an exit strategy in place. Conviction is important but must be balanced with generous doses of humility. Otherwise, you are more than likely to be undone by your mistakes.

Investor Protection

Investor protection is a broad economic term to denote the institutional safeguards that have been put in place to protect the rights and claims of a person in his role as a financial investor. The assumption that investors, especially the retail kind, need protection is based on empirical evidence that suggests that they are structurally inferior to providers of financial services due to lack of adequate knowledge and experience. Most federal governments have established market regulators, and have empowered them to ensure that –
Market intermediaries like brokers, investment bankers, transfer agents, trustees, portfolio managers, and consultants are registered and regulated.
Investor fees and other charges are periodically assessed.
Major transactions are recorded and monitored.
Frauds and unfair trading practices are kept in check.
Investor awareness and education programme are carried out regularly.
Investment schemes like mutual funds and venture capital funds are registered and regulated.
Activities of foreign investors and credit rating agencies are recorded and monitored

Final Notes

A structured and disciplined investment plan prevents bouts of impulsive buying. An established method for the average investor is “Systematic Investment Plan,” whereby he or she invests a certain pre-determined amount in a single or multiple assets at regular intervals of time. This not only ensures that a person saves regularly, but also obliterates the need for them to “time” their market entries with precision. If you are based in Europe, have a look at the article on leading UK London Brokers.

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