Two Trading Archetypes: Passive vs. Active

In this chapter, we will explain two approaches that a trader can take when participating in the financial markets: Investing vs Trading. Each necessitates its own way of research, analysis, emotional responses, even lifestyles. Let’s look at the difference between them.

The Passive Investor

The goal of passive investor is to build/accumulate wealth by buying and holding their assets over the long-term, usually at least for one whole year. Most passive investors aim to have their investment portfolio matched, or slightly outperform the market average returns (roughly 5 – 10% p.a.), hence “riding out” the downwards fluctuations of the market cycles in the process.

Starting capital requirement: Medium to large, starting from at least $3,000. Usually requires more than $20,000 to build a well-diversified portfolio. To achieve meaningful results, this archetype requires a substantial capital requirement upfront, since the majority of their investments i.e. company shares are directly purchased over a centralized exchange, without the use of leverage.

Style of analysis: Fundamental analysis, bottom-up analysis i.e. research on company financials such as quarterly statements, half-yearly and yearly financial reports.

Trading Frequency: Low to Medium. For the passive investor, most of his time (~90%) is spent developing investment thesis and dissecting the company financials. Once a investment decision is made, he does monitor the movement of the position, but rather the overall health of his portfolio on a weekly (or longer) basis.

The Active Trader

Active trading seeks to generate returns that outperform the buy-and-hold investment approach. Whilst the investment objective of the passive investor is to achieve a slightly-above-average market returns (~7% p.a.), the goal of the active trader is to outperform the markets by a substantial margin (from 15% to +50% p.a.).

Starting capital requirement: Low to Medium. Starting from anywhere between $200 to $1,000, the active trader takes advantage of leverage offered by the decentralized exchange, usually through a Contract For Difference (CFDs). This allows him to intensely experiment the trading environment in which he trades, providing him a more immediate feedback loop on his decision-making process.

Style of Analysis: Technical analysis, Price action, Support and Resistance levels, Retracement levels, Volume analysis, combined with macro analysis on economics events and thematic investing.

Trading Frequency: Medium to High. In contrast with passive investing, active trading requires a higher level of engagement in the financial markets. Whilst the passive investor “sets and forgets” his position after entering a trade, the active trader constantly monitors (where possible) each movement of the markets to swiftly enter/exit his trades. By doing so, he can take advantage of every opportunity where he sees fit, thereby profiting from both directions of the market.

The Investment Universe

Now we are familiar with the two archetypes of trader, lets explore the investment universe available to all of them. By understanding the nature of each type of markets, one can determine the most suitable asset classes to their unique investment approach.

The Stock Market

One of the most popular financial markets, the stock market consists of the primary and secondary market. In the primary market, a company raises funds through an initial public offering (IPOs) by selling parts of their ownership, in the form of a stocks, or shares. Once listed on a centralized exchange e.g. Nasdaq, NYSE or ASX, these companies shares are then traded between public participants, known as the secondary market. The stock market plays an important role in the economy as both a gauge of the financial health of a country, as well as providing capital gains and dividend income to investors.

Types of exchange: Centralized exchange and OTC market.

Suitable archetype: Both passive investors (medium- to high-cap stocks) and active traders (low-cap stocks, penny stocks).

The Bond Market

A bond is a security in which the buyer pays an amount of money upfront (principle) to the seller with the promise to be repaid in the future. The bond buyer effectively lends money to the bond seller e.g. the government, a company in returns for a fixed interest rate, normally above the risk-free cash rate, plus the principle. Bonds are issued by established entities to raise large sum of capital, thereby carrying less risk than stocks. The bond market is largely opaque, and traded in extremely high volumes; therefore, they are traded over the counter by institutional and sophisticated traders.

Types of exchange: Decentralized, OTC Market

Suitable archetype:  Active Traders, Sophisticated and Institutional Traders (Expert level)

The Foreign Exchange Market

Also known as the currency market, the foreign exchange (FX) market is the largest financial market in the world. It allows participants to buy, sell, speculate, and hedge on the exchange rates between various currency pairs. The forex market attracts the highest level of liquidity i.e. money flow, with consists of more than $6 trillion in daily transactions. The nature of the forex market is decentralized, consisting of an interconnected network of international banks, corporations, brokers, and retail traders. It is also open 24 hours, 5 days, alternating between large markets session such as US, Asia, Europe, and Australia.

Types of exchange: Decentralized, OTC Market.

Suitable archetype: Active Traders, Retail Traders, and Institutional Traders (All Levels).

The Physical Assets (Commodities) Market

Since the beginning of recorded history, physical commodities were considered the first of assets that were traded between people. These include agricultural commodities such as corns, wheat, coffee, livestock; metals like gold, silver, copper, rare earths; even energy products including oil and gas. Most commodities are being traded on derivative and future markets which track the spot price of the underlying asset, such as CFDs. Statistically, since the commodity market has little to no positive correlation with other markets, they are favored by Proprietary Traders, Hedge Funds and Arbitrageurs.

Type of exchange: Derivative Market, OTC Market.

Suitable archetype: Active Traders, Hedge Funds and Thematic Investors (All Levels).

The Cryptocurrency Market

In the aftermath of the 2009 Global Financial Crisis, an anonymous entity invented the concept of blockchain technology and in turn, programmed the world’s first cryptocurrency, also known as Bitcoin. Twelve years later, Bitcoin grew into an asset class of over $1.1 trillion market cap, and a major part of the $2.5 trillion cryptocurrency market. The underlying concept of blockchain technology and cryptocurrency relies on the investment of computer hardware and computing power which derives from the intensive use of electricity.

In the past decade, the return on Bitcoin has outperformed all other asset classes in the world. However, crypto is also considered the most volatile market in the modern world of trading, about at least 5 – 10 times more volatile (riskier) than the traditional stock and forex market.

Type of exchange: Decentralized market, OTC Market.

Suitable archetype: Active Traders, Retail Traders (Intermediate to Expert Level).