Differences Between Trading and Investing
Trading refers to buying and selling of stock on regular basis to earn profit on the basis of market fluctuations of price whereas investing refers to buy and holding strategy of investments for long period of time where investors can earn on the basis of interest and can reinvestment over a period of time.
You must have surely heard about people making money from the stock market. Although there are a million ways to do so, we have two broad classifications of stock market activities- Trading (who believe in reading charts) and Investing (who believe in fundamentals of valuation over a long term period).
Before we get into the specifics of trading vs. investing, let’s understand the difference by looking at the two most influential people in the world of wealth creation, one is known for his long term investments, and the other is a renowned trader. If you are a follower of the stock market, you might have already guessed the names; they are- Warren Buffet and George Soros. Both have made huge piles of money over their lifetime in the stock market, but differently.
Warren Buffet is worth about US$67 billion, who made his money off long-term investments in companies whose stocks he has held for decades. Let’s look at one of his famous quotes.
Conversely, there is George Soros, whose net worth is about US$24.2 billion, who has made money from a countless number of trades.
Trading vs. Investing Infographics
Let’s see the top differences between trading vs. investing.
- Trading is done generally by the people who do intraday trading and are always looking for growth investment where technical analysis tools are used. They predict the higher or lower movement. While an investor, on the other hand, is looking for value investment, and they stick with their investment for a very long time.
- Risk is very high in trading strategy since there is no hedge against this type of transaction, so money at stake is very high without downside protection. On the other hand, an investor might have a properly balanced portfolio where a downside of a particular asset will be the upside of others to hedge for the losses.
- The movement in the market and the indexes is generally due to large volumes of trading activity, so in this scenario, traders play a major role in moving the market prices as compared to an investor.
- Traders have their perception of upside or downside. They trade accordingly; they have different types of trading strategies like Butterfly, Short sellShort SellShort Selling is a trading strategy designed to make quick gains by speculating on the falling prices of financial security. It is done by borrowing the security from a broker and selling it in the market and thereafter repurchasing the security once the prices have fallen., Long Straddle, Strangle, and many more, while an investor has a simple and vanilla strategy to hold the asset while investing.
- Returns are pretty uncertain and fast in trading since the transactions of buying selling happen daily, an investor has to wait pretty long to get handsome returns.
- A crucial everyday piece of information and quarterly results matter to the trader since those kinds of things bring a lot of movement in the stocks allowing an opportunity for the trader. At the same time, an investor believes in the value and principles of the company.
Pros and Cons
Trading stocks is much more time consuming and frantic compared to making investments. In the case of investments, once you have made sound investments, you can simply relax without buying or selling for months/years.
A quote that signifies this difference-
- Making long-term investments requires knowledge of companies’ financial essentials – like Financial Ratios, understanding Free Cash Flows, DCF valuations, relative valuation multiples like PE RatioPE RatioThe price to earnings (PE) ratio measures the relative value of the corporate stocks, i.e., whether it is undervalued or overvalued. It is calculated as the proportion of the current price per share to the earnings per share. , PBV Ratio.PBV Ratio.Price to Book Value Ratio or P/B Ratio helps to identify stock opportunities in Financial companies, especially banks, and is used with other valuation tools like PE Ratio, PCF, EV/EBITDA. Price to Book Value Ratio = Price Per Share / Book Value Per Share Although you have the opportunity to make piles of money quickly with trading, the risk involved is much higher in trading than in investments. You could lose more money than you actually have in trading. There is a risk of losing money in investments as well, but that could occur because of the vagaries in the business and due to market timingMarket TimingMarket timing is the plan of buying and selling the securities on the basis of decisions made by financial investors. They do security analysis to earn a profit on selling and it is the action plan to cope up with the fluctuations in the market prices..
- The cost involved in trading is usually high, as every time you trade a stock, you will have to shell out certain fees. Hence, your returns need to comparatively higher to cover up those costs. In contrast, you will lower costs since there is less buying and selling, but then the returns will also be comparatively lower.
- Long term investments are for those people who want to make money but avoid huge losses. You could earn a decent return by reinvesting your dividendsDividendsDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity. and leaving your money in the market for the long term.
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What should you do Trading or Investing?
Try answering the following questions for yourself, and you could probably know if trading is the thing for you or investing.
- When deciding between these stock market activities, you need to think about the time you can devote to any of them. If you can spend hours reading charts and graphs daily, then trading would be the thing for you. If not, then you would be better off with long term investments.
- The amount of equity research that will involve in trading is also much more extensive as compared to making investments. A lot of hard work is involved in analyzing the financial statementsThe Financial StatementsFinancial statements are written reports prepared by a company's management to present the company's financial affairs over a given period (quarter, six monthly or yearly). These statements, which include the Balance Sheet, Income Statement, Cash Flows, and Shareholders Equity Statement, must be prepared in accordance with prescribed and standardized accounting standards to ensure uniformity in reporting at all levels., company growth, history, and also future financial projections. Those who would really enjoy putting in energy and doing the technical and fundamental analysis religiously should consider playing the market.
- Considering the size of an investor and their goals, if you are a small investor, you would be better suited for long term investments to grow your portfolio. In contrast, if you are a large investor with the goal of short term trading, then you should plan to beat the market.
Problem with Doing Both
What when the investments don’t go as per our plan? It is when some of the biggest errors happen. People tend to confuse the investing approach with the trading one and head towards danger. When the stock price is doing well, neither the trader nor the investor has any problem. But what happens when it does not?
Let’s say the stock price starts falling. As a trader, you would have an escape to avert the small losses becoming big ones. Since, as a trader, you are not emotionally attached to the stock, you will get rid of it at the correct point of time. It is rightly what a trader should do.
But there is a problem in case if you decide to keep the stock and not want to give up on it. So here, the trader has become an alleged investor who does not have enough information on the company to make a decision of holding the stock or letting it go. As an investor, you would be working on the guess. Similarly, being an investor, you are not supposed to sell off the stock when the prices go down but believe in the fundamentals and hold on to the stock.
Regardless of which one of them is a better strategy, you should pick one or the other and stick to it.
|Introduction||Refers to buy and sell as per the price movements||Refers to buying and holding the securities for a certain period of time|
|Investment Period||Generally, in this type of activity, the investment is short term, and there are quick entry and exit.||While here, investment is for a long term and exit if far off from the entry point|
|Capital Gains||There is short term capital gains and only associated with the upside in the security price.||Long term capital gains can be earned not only with the upside but also in the form of dividends and bonus periodically.|
|Risk and methodology||Risk is very high since it is a short term investment.||Risk is lower comparatively as the investment duration is long.|
|Types of securities||Only securities or stocks can be traded since there is quick entry and exit.||Different types of assets can be invested in a portfolio like stocks, bonds, notes.|
|The intention of the investment||The motive is to earn profits and exit the position.||Value investment is made on the company’s functionality, banking on the company’s fundamentals.|
|Profits||Risk is high, so generally, returns are high too.||Limited returns and the profits are reinvestedReinvestedReinvestment is the process of investing the returns received from investment in dividends, interests, or cash rewards to purchase additional shares and reinvesting the gains. Investors do not opt for cash benefits as they are reinvesting their profits in their portfolio. to buy additional stocks.|
|Tools used for analyzing||Technical analysis tools like moving averages and the candlestick method are used.||Financial Ratios and fundamentals of the company are analyzed like P/E Ratio and EPS.|
|Investment Strategy||Traders buy the stock to sell at the upside and short sell to buy at a lower price.||Investors buy the securities to hold and reap the benefits with the company’s growth.|
|Protection from investment||Traders typically follow strict stop losses, which ensure that they are closing out the loss-making positions at a pre-decided price.||Stay put when the prices go down and bank on the company’s performance to do better in the future and recover the current losses.|
|Tax Pattern||Short term capital gains tax is levied on these returns, and the rate is based on your income bracket and is comparatively higher than long term capital gains.||Long term capital gains tax is applied on these returns for which the rate can be as low as zero if the returns are yielded after a long period of time.|
|Investment Products||Stocks and Options, since you can buy and sell easily on an intraday basis and earn the difference.||Stocks, Bonds, Hedge fundsHedge FundsA hedge fund is an aggressively invested portfolio made through pooling of various investors and institutional investor’s fund. It supports various assets providing high returns in exchange for higher risk through multiple risk management and hedging techniques., Mutual funds, Exchange-traded funds (ETF)|
|Cost involved||Frequent buying and selling of these securities mostly happen in the brokerage accountBrokerage AccountA brokerage account is a taxable investment account in a brokerage company where a person deposits its assets and instructs the company to trade in shares or bonds on their behalf. In addition, the company deducts some brokerage or commission., and on every transaction, a brokerage is charged.||With a limited amount of transaction, the brokerage fees are also limited.|
Why Trading and Investing are Both Important?
Both are interdependent wherein without the existence of traders, investors will have no liquidity to buy and sell a stock, and without investors, traders shall have no origin from which to buy and sell. Hence, it is difficult to decide which one is superior.
If everyone was an investor, then no one would be willing to sell or buy in the short-term, leading to an unhealthy market scenario. In the end, it is liquidity that tends to smooth out market prices.
If we have to summarize the entire discussion we had on trading vs. investing, traders are the ones that take advantage of the market conditions to enter or exit their positions on stocks over a short period of time, taking smaller but much more returns, whereas investors strive for larger returns over a long-drawn-out period by buying and holding stocksBuying And Holding StocksThe term "buy and hold" refers to an investor's investment strategy in which they hold securities for a long period of time, ignoring the ups and downs in market price during a short period of time..
It is not much of a concern that you are trading or investing, it’s just that you need to be engaged in a chase that suits your personality traits, capabilities, and philosophies. I hope you enjoyed reading this information as much as I did writing it.
This article has been a guide to Trading vs. Investing. Here we discuss the difference between them, why they are important, along with there pros and cons. You may also have a look at the following articles –