Trading and investing are different approaches that aim to make a profit from financial markets. But both are very different in their methods and risk levels. Which one is right for you? In this post we will explain the difference between trading and investing. So you can make an informed decision on which method is best for you to use.
Difference Between Trading And Investing
At it’s most basic investing is more long term and trading is short term in nature. Both methods aim to profit from financial markets but both go about this in different ways. We’ll cover the main differences between trading and investing below.
Trading is more speculative in it’s approach, aiming to capitalize from short term events and movements to make high profits. It usually involves more frequent trading of assets such as stocks, cryptocurrencies, commodities and more.
The holding period of an asset is dependent on the type of trader and strategy. Some traders may hold positions for as little as a few seconds. Whereas others may hold for months or years.
Traders usually use technical analysis tools to determine which way an asset or market will move in the near term. They can then position themselves to best take advantage of the expected change in price.
A trader may be more likely than an investor to make a return in a falling market. This is because in addition to long positions, they can also take advantage of short selling. This is the borrowing of a security from a broker. Then selling on the open market and buying back later for less money after the price has dropped. The difference in price being the profit.
Short selling can be risky. If the security goes the other way and increases in value then you will sell at a loss. Remember when betting on something falling in price, it cannot lose more than 100% of it’s value. Whereas hypothetically there is no upside price limit – a stock could potentially keep rising. This means losses are unlimited.
Some investors also take part in short selling as a hedge against their portfolio during falling markets.
Traders may make more use of stop-loss orders to close out losing positions early. This is where a trader sets a price for a trade to be automatically executed, potentially preventing large losses.
Investing differs from trading in that investors are more focused on making profits over a longer time horizon. They prefer to buy and hold positions for years, possibly even decades to benefit from long term wealth building.
As investors are prepared to hold for the long term, they are less concerned with the short term price movements. They do not need to speculate on what price the asset is going to be next. Investors will pay more attention to market fundamentals like price to earnings ratios. This gives knowledge to purchase stocks at good prices that provide returns over time.
Another key difference between trading and investing is found in economic downturns and falling markets. Where we have mentioned a trader is more likely to engage in short selling to profit from falling prices. An investor is less likely to do this. Although some do to act as a hedge against falling investments. Instead they will hold out until market conditions become more optimistic.
In fact, long term investing is at it’s most profitable when investing during bear markets. Purchasing securities at extremely depressed valuations can provide for larger returns when positive market conditions return.
When holding an asset for the long term, there are often many extra perks that come with it. This could include interest payments, dividend payments, stock buybacks and stock splits. Which when re-invested has the potential to create even greater returns through the compounding effect.
Both investors and traders can be further broken down into different categories depending on strategies they employ. For example, investors may focus on growth, value or dividend investing. Traders can be split into either swing traders, position traders, day traders or scalp traders.
Is Trading Or Investing Better?
So now we’ve reviewed the main difference between trading and investing, which one is better? Well that’s really all down to individual preference. Trading has the potential to make very large profits in a short amount of time. But it is riskier and incorrect decisions can easily lead to large losses. It is more suited to those with good investment knowledge and able to interpret technical analysis.
Investing may only produce smaller returns in the near term when compared to active trading. It may also be more susceptible to falling prices in negative financial events. But over a long time frame, investing is less risky as assets have more time to grow. Add in re-investments and compounding and it has potential to grow into serious wealth if invested correctly. It can be a more hands-off approach so is more suited to less financially experienced individuals.
Everybody’s circumstances are different and their knowledge, capital, risk tolerance and temperament will play a factor on which they use.
One more point to mention is that whether trading or investing, trading costs have a big impact on your returns. Whichever method you choose it’s important to select a broker that offers commission free trading. Thankfully there are plenty of quality trading apps that help you keep costs to a minimum such as Public and eToro.
Difference Between Trading And Investing Conclusion
When it comes to trying to make money from financial markets, the two methods are trading or investing. There is a big difference between trading and investing as discussed in this article.
The key difference between trading and investing is the time horizon used. Trading is focused on making as much money as possible in the very short term. Depending on the type of trader and the strategies employed this could be as little as seconds.
Investing on the other hand takes a long term approach to growing wealth over an extended period of time. An investor will often hold positions for many years, riding out the market ups and downs in the process. Over a long time investments may produce dividends and other perks, which if re-invested can help to compound returns.
Both trading and investing are just different approaches to making money from financial markets. There is no right or wrong. It is a matter of personal preference, experience, funds, aims and tolerances.
We hope this article has helped you to understand the difference between trading and investing. Which one are you? Let us know in the comments.
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