Trading vs Investing: How Are They Different?
Trading vs investing: two terms that might seem synonymous to many people. Both refer to ways of buying and selling shares in the stock market. Both seek to gain maximum profit.
However, trading and investing do differ. Trading is all about the short-term, with stocks and shares being bought and sold in a matter of weeks, days, or even minutes. Trading aims to take advantage of even the smallest fluctuations in price to make profit. Investing, on the other hand, generally takes a longer view, with investors often holding onto their stocks for months or years even throughout short-term volatility. These guys think long term.
In this article, we’ll take a look at the difference between trading and investing. It’s not solely about these timescales. Yet, this is the crucial element that determines how the rest of these activities unfold.
What is Investing?
The aim of investing is typically to build wealth over time, by buying and holding stocks that are expected to increase in value across years. Imagine buying a house and selling it a decade later once its value has increased. Investing in the stock market works on exactly the same principle as investing in property, jewellery, or even whisky – but investors will be doing this with shares of different companies.
This comes with a risk. Whilst you could keep your cash in a savings account to obtain interest, investing gives you the chance to potentially earn bigger returns. For example, if you’d bought a single share in Apple when they first floated, in 2020 you’d be sitting on nearly $15,000 from your $22 investment.
However, the flipside of this is that it can result in losses – and the potential for these losses is why investors usually have a diverse portfolio of stocks. This means that, even if a specific company might decline, the others in the portfolio could still make you an overall profit. If Apple hadn’t been such a success, you might have regretted putting your $22 worth of eggs in that one particular basket. When trading or investing, you should also make sure you have enough cash in the bank to cover your needs as well as any emergencies. Always remember, you should not risk what you cannot afford to lose if things go wrong.
What Do Investors Invest In?
When looking for companies in which to invest, investors typically look at a specific company’s potential for long-term future growth. Whilst this can be a game of patience, investing successfully also requires a knowledge of what makes a company worth investing in.
Usually, the signs of this are the rate at which that company’s earnings are growing, or how stable their income is, for example. If a company’s profits increase and decrease rapidly, it might not be a good long-term investment. However, this might not be enough to turn short-term traders off.
What is Trading?
If investing tends to use a strategy of “buy and hold” i.e. buy and retain the shares for the longer term, trading is defined by “buy and sell”. Trading, as the term suggests, is all about the quick transaction, taking advantage of even the tiniest market fluctuations.
Trading, therefore, is something more of a full-time job. If you invest, you are aiming to make an investment decision then sit back and with any luck watch your profits grow over time. Traders, however, need to be constantly vigilant for changes in prices.
Whilst investors typically look at the prospects of a company to increase in value over time, traders are generally more interested in the technical elements of the stock. They care more about the current and possible future value of the stocks they trade than the company itself, as an entity.
So, if political instability briefly reduces the value of a given company’s shares, traders will typically exploit this temporary reduction. Investors, on the other hand, will often ride that out with the expectation that the company’s value will return to what it was.
Who Makes More Money, Traders or Investors?
For those interested in the basics of trading vs investing, one of the more common questions is a simple one: do you make more money from trading or from investing?
Yet, the answer is not really so simple, as each of the activities has its own advantages and disadvantages.
To start with, whilst traders can make large gains on their capital, there are also big risks. Not every judgment on the market’s possible fluctuations is going to be correct, and, if you’re doing something like short selling, you can stand to lose a lot of money from one wrong call. As a result, for every trader that makes potentially large returns, there is another for whom it doesn’t end so well and ultimately as with an investment – they could lose all of the amount invested.
Investing, on the other hand, does not guarantee profit, far from it. Yet, it is generally viewed as being less risky than outright trading. With the right knowledge of what makes a company’s prospects look good, investors can be perhaps more confident over the longer term that it’s possible to make a reasonable profit on their investment. Although of course, this is not guaranteed.
Investing Your Time
At the same time, something to consider is the amount of time you have to spend managing your investments and how active a role you want to play, Investing tends to allow individuals to put their money into an investment portfolio, which they can hopefully watch grow whilst getting on with the rest of their life – where they may well be making money too.
This is not typically true of trading, however. Trading can be a full-time job in itself, as the fluctuations in stock prices require constant attention. In return, however, the profits that can potentially be made may be realised more quickly. So a key difference is that investors tend to expect their cash to see growth over years or decades, not days or minutes.
Trading vs Investing: The Key Differences
To conclude, trading and investing are both ways of buying and selling shares in the stock market. However, they differ in key ways...
The first difference between investing and trading is a difference in the timescale of anticipating holding the shares. Investing is generally a long-term activity, in which returns are expected over a matter of years or decades. Meanwhile, when trading, stocks are bought and sold in minutes – or even seconds.
And trading can be riskier than investing depending on the trading strategy. While investors can lose all the money they have invested, they typically aim to hold a portfolio of stocks across different sectors (diverisifcation) that aims to offer some degree of overall capital protection against individual fluctuations. Traders, however, are continually seeking opportunities to exploit market volatility. Short selling, for example, is a highly risky trading strategy – which can lead to losses greater than the initial capital investment.
Thirdly, returns can differ hugely. If you are seeking short term profit (understanding the risks) and want to feel a return on your investment more quickly then trading could potentially give you that – though it’s never guaranteed. However, if you are aiming to try to seek a longer-term investment, say for retirement, then a diversified portfolio of long-term investments might be one way to achieve this goal – but again, you can’t bet on it. In summary, investment typically requires less day-to-day attention than Trading, and risk is typically more evenly spread across a diversified pool of assets.
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