Investment and Trading: Playing the Markets?

It was as a college student in the technical disciplines that I was first introduced to computational finance and investment. My training was primarily related to developing trading systems. In this article I aim to provide a very basic primer on the common types of investment, some principles of trading and the importance of trading systems.

Many of us might have heard of stocks, options and futures. They are the three common types of "trading instruments". Most beginning traders start with stock trading as they are the simplest. These trading instruments can be applied to several "markets" including commodities (rice, wheat) or equity (company stock etc.).

The major types of investment analysis, that inform investment choices are fundamental analysis, technical analysis, trends based (political or economic trending) and the illegal "insider information". Technical analysis tends to be the most popular and analyses market perception using various indicators. Since market prices reflect the perception or opinion of the market towards a stock etc., therefore political and economic trends play an important role and are used as the basis for trading, or at the very least informing trades.

Insider information represents the use of undisclosed (and usually illegal, see Enron executive Jeffrey Skilling) information about a particular stock etc. that when disclosed would cause a predictable change in price. Traders using this method exploit the predictable change to make money. All this does not mean that fundamental analysis, which bases investments on a reasoned study of company financial statements, prospects, industry trends etc. and aims for consistent long-term dividend flow, is not profitable. Many of you might have heard of Warren Buffet, one of the great masters of fundamental analysis and amongst the wealthiest men in the world.

To succeed in any type of trading, the trader or investor needs to have discipline and control over his impulses. Consistent profits can only be made through reason and analysis, not casino style gambling. Traders make trades that reflect their strengths and weaknesses. Therefore, a trading system is recommended.