Investing and trading are two very different ways to make money in the financial markets. Profits from market participation are sought by both investors and traders. Investors generally seek higher returns over a longer period by buying and holding. On the other hand, traders use rising and falling markets to enter and exit positions in a shorter time frame, resulting in smaller, more frequent profits.
The primary distinction between trading and investing is that traders enter and exit stocks within weeks, days, or even minutes in pursuit of short-term profits, whereas investors have a longer-term perspective. As a result, they think in terms of years and frequently hold stocks during periods of market volatility.
Investing
Investing goals are to gradually build wealth over time by purchasing and holding a portfolio of stocks, stock baskets, mutual funds, bonds, and other investment instruments. Compounding or reinvesting profits and dividends into additional shares of stock is a common way for investors to increase their profits.
Investments are frequently held for years, if not decades, taking advantage of benefits such as interest, dividends, and stock splits. While markets will inevitably fluctuate, investors will “ride out” downtrends in the hope that prices will recover and any losses will be recouped. As a result, market fundamentals, such as price-to-earnings ratios and management forecasts, are typically more important to investors.
Trading
Trading entails more frequent transactions, such as purchasing and selling stocks, commodities, currency pairs, and other instruments. The goal is to outperform buy-and-hold investing in terms of returns. For example, while investors may be satisfied with annual returns of 10% to 15%, traders may seek a monthly return of 10%. Trading profits are made by purchasing at a lower price and selling at a higher price in a short period of time. For example, trading profits can be made in a falling market by selling at a higher price and buying to cover at a lower price (known as “selling short”).
While buy-and-hold investors wait for less profitable positions to mature, traders seek to profit quickly and frequently use a protective stop-loss order to automatically close out losing positions at a predetermined price level. To find high-probability trading setups, traders frequently use technical analysis tools such as moving averages and stochastic oscillators.
A trader’s style is the timeframe or holding period in which stocks, commodities, or other trading instruments are bought and sold. There are 4 categories of traders –
- Position Trader: Holds positions for months or years.
- Swing Trader: Positions are held for a few days to a few weeks.
- Day Trader: Positions are only held during the day, with no overnight positions.
- Scalp traders hold positions for seconds to minutes, with no overnight positions.
Traders frequently select their trading style based on account size, amount of time available for trading, level of trading experience, personality, and risk tolerance.
Differences
Investing and trading are the two ways to make money in the stock market regarding wealth creation. However, investing and trading are two very different ways of creating wealth or profit in the stock market.
Here are some key differences between investing and trading in financial markets.
1. Time Horizon
The time horizon can be used to differentiate between investment and trading. Let’s look at an example to better understand this.
- Assume you have some money and decide to open a Kirana shop. Your property’s value rises in two weeks, and you sell it at a profit. Trading is the term for this.
- If, on the other hand, you buy a property because you know it has a high long-term appreciation potential. After all, the area is being developed into a residential area and then held onto it; you are investing.
Trading simply means holding stocks for a short period and profiting by selling them when the price reaches a high. Traders’ consideration periods can range from a single day to several weeks or months. On the other hand, the stock investor chooses stocks based on strong fundamentals and holds them for a longer period, ranging from a few years to decades, to maximise their wealth in the long run.
2. Method
The method used to make money in the stock market differs between trading and investing. Technical analysis is used by traders to make buy and sell decisions, whereas fundamental analysis is used by investors. Fundamental analysis focuses on the company’s financials, industry analysis, and the country’s overall macroeconomic situation.
Technical analysis uses the stock’s market price to forecast future patterns and analyse historical ones, but it does not consider market price factors. Instead, it examines price, volume, and moving average trends over time.
3. Capital Increase
Traders monitor the market’s stock price movement. If the price rises, traders may sell their stocks. Simply put, trading is the skill of timing the market, whereas investing is the art of creating wealth by compounding interest and dividends over time by investing in quality stocks.
4. Risk
Trading and investing both involve capital risk. However, investing is less risky if done over time. Although the returns from investing appear to be lower than those from trading, the power of compounding and the higher probability of success compensate for the lower rate of return.
Meanwhile, Trading is inherently riskier due to the shorter time horizon. It entails forecasting market movements over hours, days, or months, which is unpredictable. Although the risks are high, successful traders earn higher returns due to the short-term volatility of the markets.
Tips for Investing
Investing is a method of accumulating long-term wealth. Remember that ten percent average stock market return? Of course, it can sometimes be lower or much higher, but you must stay invested to reap the benefits.
Here are some things to think about:
- Make a plan for buying, selling, and rebalancing your holdings. For example, some people sell some holdings and buy others to bring their portfolios back to their original objectives after market fluctuations have thrown them off.
- Consider index funds, which do not attempt to outperform the market but rather replicate the performance of a market index, such as the Nasdaq or the S&P 500.
- Understand your investment strategy. This includes knowing your objectives (retirement, college tuition, etc.) and how much risk you are willing to accept.
- Prepare for a long journey. You’ll need patience and discipline to persevere through the market’s ups and downs.
Tips for Trading
- If you want to trade, here are some things to think about to reduce your risk:
- Make a plan for when you will buy and sell. For example, you may decide to sell if the price of a stock rises or falls by a certain percentage.
- Maintain your strategy. Even experienced traders change their minds about holding certain stocks.
- Determine how much you can afford to lose, and trade only that amount.
- Enter with your eyes wide open. The stock market’s long-term average return is 10%, and studies have shown that even professional traders struggle to outperform the market.
- Understand your taxes. You may be able to deduct trading costs from your taxes, but you may also owe taxes. Short-term gain rates range from 10% to 37%. Find out more about short-term and long-term capital gains.
Conclusion
Trading can be an exciting way to make quick money. However, just like gambling, it can quickly lead to large losses. Investing typically results in smaller short-term gains but fewer severe losses.
Trading with a portion of your money can be enjoyable and profitable if you are comfortable with the risks. If reducing risk and exposure to volatility are your primary goals, long-term investing is the way. However, a steady-and-steady investing approach is usually best if you’re saving for a specific financial goal.
