Imagine that one day you decided to put all your savings under the mattress for safekeeping. If you then forgot all about that money, and left it alone for a year, it wouldn’t have grown. There would be exactly the same amount of money as you put there in the first place.
In fact, in real terms, it would probably be worth less than when you put it there, because the cost of living is likely to have risen in the interim.
Now, imagine you had instead used that money to buy financial assets such as shares or commodities. Instead of lying dormant, your money would have a much greater potential for growth as the value of those shares or commodities could go up. Though, of course, there’s always the risk they could drop in value as well.
Trading the financial markets is all about balancing that risk with the potential reward, and picking assets likely to move in your favour. As we’ll see, if you do this sensibly and intelligently, the rewards could be much greater than simply letting your money sit in a bank account (or under the mattress).
Investing vs trading
What we’ve described above is called ‘investing’, essentially a long-term form of financial trading which involves buying and holding financial assets over a number of months or years.
In fact, it’s quite likely that you’re already investing in the financial markets in some capacity – possibly only passively. If you have a pension plan, for example, then you’re investing the money you’re earning now with the expectation it’ll grow and be worth more when you retire.
Pension firms generally invest this money for you in return for a management fee. In most cases however, you can have a say in which financial instruments you put your money into. And as the chart below shows, a few simple decisions now could have a dramatic effect in the future.
Looking at the chart, you can see that £100 saved in cash in 1986 would be worth just £38 in 2014 due to inflation. If you’d invested that £100 in the UK stock market you could have received a return of around £1120.
But long-term investing isn’t the only way of participating in the financial markets, there’s also active trading, sometimes known as speculation.
While investors generally focus on the long-term value of assets and attempt to build a portfolio that will perform well in the future, active traders tend to focus on short-term market movements, with some participants placing hundreds of trades per day.
Whether you choose to focus on the long game, making only a few trades per year, or whether you believe that every tiny movement in price represents an opportunity, is entirely down to you, your personality, and how much time you can devote to trading.
We look at this topic in detail in the ‘Planning and risk management’ course, but for now it’s important to note that there are many different ways to trade, and many different types of trader. And whatever your interests, skills or priorities, there’s always a form of trading that will suit you.
One of the main differences between traders is the type of asset that they trade, and that’s what we’re going to start looking at in the next lesson…
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