Most casual market observes do not appreciate how widely the various approaches to the stock market can vary. Typically, the view is that people are either long-term buy-and-hold investors like Warren Buffett or they are wild day traders as illustrated by the "hoodies" that use the Robinhood trading app.
The reality is that the great majority of market participants are somewhere in the muddled middle. The best traders and investors develop a unique style that they try to refine as they become more experienced.
It is important to note that no style is inherently superior. What works best is highly subjective and will shift with market conditions. Some folks will do better as long-term investors and some will do better as very aggressive short-term traders.
The factors that will determine the best approach for you are the level of capital you are working with, the amount of time you have to devote to the market, your tolerance for risk, and, most importantly, your emotional makeup.
If you are impulsive and impatient then long-term buy-and-hold investing will be much harder for you than aggressive and active trading. Some folks simply do not have the emotional makeup or mindset to approach the market in certain ways so they need to find what does work for them. There are many choices and you can always find a niche that will work -- but it still requires effort and self-awareness.
There is a hierarchy of investing and trading styles. Since there is far more capital devoted to longer-term buy-and-hold trading that is what we tend to hear about most from traditional Wall Street and the business media. However, because the fastest gains are made in ultra-aggressive short-term trading that is what we will hear about on social media and on many websites.
The general investing and trading styles that exist can be categorized as follows:
1. Long-Term Investing Using Modern Portfolio Theory
Standard financial planning for most individuals is to develop a portfolio that tries to optimize returns by managing risk. It is primarily based on Modern Portfolio Theory that has its basis in a paper by Harry Markowitz developed in 1952. Markowitz was later awarded a Nobel prize for his work. The key to this approach is diversification and asset allocation. Stock selection tends to be S&P 500 names that are less risky and will perform well over the long-term.
2. The Warren Buffett Approach
Warren Buffett's approach is different than the MPT approach because it is focused much more on stock selection rather than portfolio construction. The main goal is to find a handful of stocks worthy of being held for decades. There is a widely held misconception that this is easier than it really is.
3. Mutual Funds and Hedge Funds
The focus of many mutual funds and hedge funds is stock selection that can be used in the context of a portfolio. Funds are just used as a vehicle for exposure to stocks while asset allocation is done at a different level. There are many subcategories within this group such as sector focus or style focus. An example of style focus is "value" where investors seek to buy stocks that are "cheap" based on various financial metrics.
4. Market Timers
There is a very active group of traders that are intently focused on trading market direction. They typical use index ETFs and options and are trying to anticipate what the market will do next
5. Big-Cap Momentum Traders
One subgroup of traders that attracts quite a bit of money is big-cap momentum. This is the group of traders that is constantly pursuing the FAANG names and looking for higher-priced stocks in the best sectors. Investors Business Daily is the bible for those that use this approach.
6. Small-Cap Position Trading
Small-caps tend to move faster but carry higher risk so traders who favor these names tend to be even more aggressive and move even faster.
7. Volatility Traders
A sub-category of big-cap and small-cap momentum trading is volatility trading. These trades look to catch the inevitable ups and downs in the stocks that they favor.
8. News Trading
These traders are constantly scanning the headlines looking to trade the sharp and sudden moves created by news flow. News creates movement and that leads to trading opportunities.
9. Algorithmic Trading
A huge amount of the daily volume in the market is trading driven by computer programs. There are hundreds of different variations. Some use arbitrage approaches, some trade headlines, and some trade technical patterns. There is constant competition to stay one step ahead.
10. Day Traders
The day traders are receiving much attention right now as they have been more aggressive lately and are more aggressive at chasing "junk" and bankrupt stocks. They are more similar to gamblers than speculators as they rely more on luck rather than risk management.
This is just a small sampling of the great number of investing and trading styles that exist. There are many different permutations and combinations and many active market participants will attempt to use a more conservative longer-term approach while also aggressively trading in very short-term time frames.
The important issue here is to be clear about what you are doing. The easiest way to have problems is style drift. Style drift tends to occur when your current style is not working that well and you start treating your trades and investments differently. Suddenly the short term trade becomes an investment or the long-term trade is dumped impulsively as market conditions shift.
One of the great challenges of developing a trading or investing style is that what works best will be highly dependent on market conditions. While you do not want to reinvent your approach every time the market shifts, you also want to be flexible enough to adapt when conditions change. It is a constant battle and is one of the key reasons that market success seems to come and go for so many market players.
Think about your style and how it will evolve as you change and how the market will change. Defining what you are going to do is the first step before you can improve on it.