Many people assume that trading and investing are two synonymous terms but there are very fine differences between them.
Why the confusion?
Trading and Investing creates confusion because they are very similar for a beginner on a few points.
- Trading means simply buying and selling of any financial instrument, i.e. share, stock, bond, commodity, etc. Now, investing is also the same in that way.
- A trader trades. Here trade means, first he buy and then go for selling a stock. Again, an investor also does the same which is making a trade. Therefore, does an investor become a trader by this logic?
Now, if someone is buying and selling any stock or any other financial instrument to earn profits, how do we know if the person is a trader or an investor?
Let’s clear the confusion
Trading and investing serve the same purpose: capital appreciation. But they are very different methods of generating profits in the stock market. After buying a stock, a trader may not hold or may hold it for a long time. Actually, it depends on the performance of the stock. In another side, an investor buys a stock with the clear intention of holding on to the stock for a long time horizon.
Before discussing in brief about the key differences in investing and trading, let’s have a quick glance about trading and investing. So, the picture will be clearer especially for a newbie in the stock market.
Trading involves the more frequent buying and selling of stock, commodities, currency or other instruments.
The objective of trading is to bring better returns than traditional long-term investing. While investors may be content with a 10% to 15% annual return, their traders might seek a 10% return each month or even weekly basis.
Trading usually involves very close and active monitoring of the market to quickly identify buying and selling opportunities.
So, in trading, traders aim to make a profit by buying at a lower price and selling at a higher price. Sometimes, they also make a profit by short selling, which means selling at a higher price and buying to cover at a lower price when the market is falling.
Another very important factor is the use of stop loss in trading. Traders must make profits or take losses within a specified period of time by using a protective stop loss. Stop loss trigger automatically and close out losing positions at a predetermined price level.
Depending on the timeframe or holding period of stocks, commodities or other trading instruments, traders have categorized four categories.
This style of day trading involves the rapid as well as repeated buying and selling of a large volume of stocks within seconds or minutes. So, the objective is to earn a small per share profit on each transaction while minimizing the risk of volatility of the market.
In this type of trading, traders buy and sell the shares within a day. That’s why it is called intraday trading.
In the swing trading, traders will normally have a slightly longer time horizon than day traders for holding a position in a stock. Traders hold the stock for some days or some weeks.
As in the case with day traders, swing traders also attempt to predict the short-term fluctuation in a stock’s price. Sometimes, swing traders are willing to hold stocks for more than one day, if necessary. It gives the stock price some time to move or to capture additional momentum in the stock’s price
Position trading is very similar to swing trading, but with a longer time horizon. A position trader can hold stocks for months.
In other hands, investing involves much slower and longer time frames. Investors usually enhance their profits through compounding or reinvesting the profits and dividends into additional shares of stock.
The goal of investing is to slowly generate profits over time through the buying and holding of investment and diversified portfolio. Investors hold the shares for a period of years, or even decades, taking advantage of perks like interest, dividends, and stock splits etc.
Investors use fundamental analysis and try to identify the stocks that will be worth in the future. They like to grow their money by making long-term strategic investments.
Depending on the fundamental outlook, investors can stick on the stock even in any downtrend or market crash. They use this price fall as the opportunity of adding more stock to their portfolio. So, they can earn a good profit when the market rebound.
Differences between trading and investing
Here are a few key differences between trading and investing
- The biggest difference between trading and investing is the time horizon. Here time means the period of time for what both investor and a trader buy and hold before selling.
- Trading is the method of holding stocks for a short period of time.
- Whereas, an investor will buy and then hold for years.
- So, an investor aims to make huge profits of a single trade. On other hands, a trader looks for profits in multiple trades.
- If we consider a lap of the year, then a trader makes a lot of trades. Even in a month or day, a trader makes multiple trades. Whereas, an investor makes very few in a year as compared to a trader.
- So, the frequency of trade is more in trading than investing.
- Traders always track closely the price movement of the stocks.
- If the price goes up, most of the time trader book their profit, i.e. sell the stocks.
- But, investing is an art of creating wealth by compounding interest and dividend over the years and holding some quality stocks in the market.
Mode of action
- To earn profits in trading, a trader buys stocks at the low price and sells at a high price. They also go for short selling i.e. selling high and buying low. Missing the right time may lead to the loss for the traders.
- The investors invest for a longer period of time keeping an eye of the stocks they hold in the portfolio. Patience is the key factor in investing. Investors patiently wait till the stock reaches its potential value and earn a good profit at that point.
- The true factor is the trading and investing both implies risk on your capital.
- Trading comparatively involves higher risk and higher potential returns also.
- On other hands, investing involves comparatively lower risk. Actually, daily market cycles do not affect much on quality stock investments and fundamentally strong shares for a longer time horizon.
Tools of selection
- A trader depends on technical analysis. The primary criteria of trading stock selection are the price movement and volume of trading.
- Whereas an investor uses fundamental analysis, company future prospect, business outlook, etc. to select the investment stock.
Psychology (skill vs. art)
- Lastly, a trader and an investor differ on how their mind works. It is related to the psychology of the stock market.
- The trader works smarter than harder. A trader is technical experts who time the market and learn market trends to hit higher profits in the stipulated time.
- Investors on the other hand, first analyze the stocks they want to invest. They have to be patient enough to overlook the market’s fluctuations and noise around to hold their selection. Investing basically includes learning business fundamentals and commitment to stay invested for a longer term.
So, another question that pops up immediately at this point.
What should I be – a Trader or an Investor?
And my answer is the choice is yours.
Trading can fetch you fast money. But, we should not forget that it will lose your money if your move is wrong. Therefore, you need to pay complete attention to the market movement, timing, current economic factors, global issues etc.
The famous investor Warren Buffet quoted:
“When the tide goes out, everyone knows who’s been swimming naked.”
Investment on the other side keeps you on a steady stream. Here you need to research well and chose the right investment options based on the capital and your risk tolerance levels. But, here you have involved constantly to further diversification. Because – change is the only constant.
Please leave your queries in the comment section and let us know your views regarding this article.
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