Differences Between Trading and Investing
Trading refers to buying and selling to 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).
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 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.
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.
In this article, we are going to cover the following topics-
- Pros and Cons
- What should you do Trading or Investing?
- Problems with being both an investor and a trader
- Why are both important?
Trading vs Investing Infographics
- Trading is done generally by the people who do intraday trading and are always looking for growth investment where technical analysis tools are used, and they predict the higher or lower movement. While an investor, on the other hand, is looking for a 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 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 to move the market prices as compared to an investor.
- Traders have their own perception of upside or downside and they trade accordingly, they have different types of trading strategies like Butterfly, Short sell, 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 on a daily basis, an investor has to wait pretty long to get handsome returns.
- Everyday crucial 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, while 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 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 Ratio, PBV Ratio. 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 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 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 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
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. 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 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 entry point|
|Capital Gains||There is short term capital gains and only associated with the upside in security price||Long term capital gains can be earned not only with the upside but also in the form of dividends and bonus on a periodic basis|
|Risk and methodology||Risk is very high since it is 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|
|Intention of the investment||The motive is to earn profits and exit the position||Value investment is done 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 reinvested to buy additional stocks|
|Tools used for analyzing||Technical analysis tools like moving averages and 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 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 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 intraday basis and earn the difference||Stocks, Bonds, Hedge funds, Mutual funds, Exchange-traded funds (ETF)|
|Cost involved||Frequent buying and selling of these securities mostly happen in the brokerage account 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 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 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 as much as I did writing it.
This has been a guide to Trading vs Investing. Here we discuss the difference between trading and investing, why they are important along with there pros and cons. You may also have a look at the following articles –