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Differences Between Trading and Investing
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).
I have seen many people use these words ‘trading’ and ‘investing’ quite synonymously. But in the real world, these two are quite different except for the fact that both of them are a part of the same market and have a common objective of making a profit. There are some fundamental differences between the two and hence here we are discussing trading vs investing. It is important for you to know this as you need to find which one is the right one for you based on your financial goals.
Do check out the difference between – Fundamental analysis vs Technical analysis
Before we get into the specifics of trading vs investing lets 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.
“I will tell you how to become rich. Close the doors. Be fearful when others are greedy. Be greedy when others are fearful.” – Warren Buffett
Conversely, there is George Soros whose net worth is about US$24.2 billion who has made money from countless number of trades.
“Markets are constantly in a state of uncertainty and flux and money is made by discounting the obvious and betting on the unexpected”.-George Soros
Through this debate on trading vs investing we are going to understand the following;
- Trading vs Investing infographics
- Pros and Cons of Trading vs Investing
- What should you do Trading or Investing?
- Problems with being both an investor and trader
- Why trading and investing are both important?
Trading vs Investing Infographics
The below infographics discusses the characteristic differences of trading vs investing.
Pros and Cons of Trading vs investing
Trading stocks is much more time consuming and frantic compared to making investments. In 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-
Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.” – Paul Samuelson
- Making long-term investments requires knowledge of companies’ financial essentials – like Financial Ratios,understanding Free Cash Flows, DCF valuations, Relative valuation mulitples like PE Ratio, PBV Ratio, Although you have the opportunity to make piles 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 timing.
- 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 of the 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 dividends and leaving your money In the market for 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 trading vs investing you need to think about the time you can devote for any of them. If you can spend hours on reading charts and graphs on a daily basis 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 statements, 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 with the goal of growing your portfolio whereas 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 Trading vs Investing
What when the investments don’t go as per our plan? This 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 or the investor has any problem. But what happens when it does not?
Let’s say the stock price starts falling. Here as a trader you would have an escape in order 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. This 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 upon 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 guess. Similarly being an investor you are not supposed to sell off the stock when the prices go down but believe on 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.
Why trading and investing are both important?
Investing vs trading are interdependent wherein without the existence of traders, investors will have no liquidity to buy and sell 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. At the end it is liquidity that tends to smooth out market prices.
If we have to summarize the entire discussion we are 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 stocks.
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 on trading vs investing as much as I did writing it.
Also, do let me know what you like – Trading vs Investing and why?