The terms trading and investing are often used interchangeably amongst investors; however, both have significantly different meanings, consequences, and end results.
While both terms involve putting money into various financial instruments with the goal of earning a profit, the approach, timeline, and goals for each differ significantly. The decision to trade or invest ultimately comes down to an individual investor’s financial goals, risk tolerance, expertise, and investment horizon.
Today, we’ll be exploring the subtle (and not-so-subtle) differences between trading and investment. We’ll delve into the advantages and disadvantages of each to give you an unbiased look at each of these common investing strategies, so you can decide for yourself which is better for your personal investing journey.
What is Trading?
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How to set up your trading screens / Investopedia
Trading involves buying and selling stocks (amongst other financial instruments such as bonds, currencies, cryptos, and commodities) in order to make a profit from market volatility and short-term price movements. Traders typically use a variety of strategies, like technical analysis, to identify opportunities in the markets and execute trades in a timely manner.
There are multiple different kinds of trading strategies, with the most popular being day trading, which involves using various technical analysis tools such as RSI movement, price action, moving averages, and time factors to find companies whose technical charts are showing bullish setups. These traders are looking for short-term profits by purchasing shares before the breakout happens and selling quickly before the price begins to moderate.
Alternatively, swing trading involves holding positions for a few days to a few weeks to capture medium-term price movements. In this strategy, swing traders look for industry trends and positive company catalysts to try and find companies whose share price should rise in the coming days or weeks. For example, an investor attempting to swing trade could focus on a pharmaceutical company that is likely to release positive clinical data results on an upcoming drug.
Swing traders, much like day traders, will also use technical analysis indicators to place trades. However, they also use market-moving events like earnings reports, clinical trial results, and/or inflation data to try and time upward price movements in a company’s stock over a specific period of time.
Scalping is another common trading strategy that involves making numerous trades throughout the day, each with a small profit target. A scalper may purchase 500 shares of a particular stock, aiming to sell them for a profit of just a few cents per share. Although the profit per trade may be small, a successful scalper aims for economies of scale by making multiple such trades throughout the day, which can result in significant profits.
And finally, a much higher risk with higher reward trading tactic is options trading, which involves buying and selling option contracts that give the holder the right to buy or sell an underlying asset at a specific price on or before a certain date. Option traders use various strategies to profit from changes in the price of the underlying asset, such as buying a call option if they expect the price to rise or buying a put option if they expect the price to fall.
It’s important to note that any kind of trading can be a high-risk activity, as traders are exposed to the volatility and unpredictability of financial markets. This unpredictability makes short-term trading extremely difficult to predict with any type of accuracy, which is why finding success in trading can be so difficult.
That said, with proper risk management strategies, a solid understanding of the markets, and a systematic approach to placing trades, it is possible for investors to earn significant profits on a regular basis through various trading methods.
Pros and Cons of Trading
If you’re considering trading as an investment strategy, it’s important to understand the potential benefits and drawbacks before diving in.
While trading can offer the potential for high profits and the flexibility to make quick decisions, it also comes with significant risks and requires a high level of skill and knowledge. In this section, we’ll take a closer look at the pros and cons of trading, exploring the key advantages and disadvantages that you need to be aware of before getting started.
Pros of Trading
Flexibility
Trading allows for a flexible investment plan, as traders can enter and exit positions as they please. This can be beneficial for those who want to take a more active role in their investments.
Potential for High Returns
Trading can be a high-risk, high-reward activity. With the right strategies and risk management techniques, traders can potentially earn significant profits in a short amount of time.
Liquidity
Trading offers high levels of liquidity, meaning that traders can easily buy and sell assets with their capital quickly. This can be great for those who want to ensure they have quick access to their money should they need it for something else.
Cons of Trading
High Risk
Trading involves significant risk, as it exposes investors to the volatility and unpredictability of financial markets. It’s important for traders to realize the risks of trying to find success in the world of trading and ensure they have a solid understanding of financial markets, as well as a well-thought-out risk management plan to help minimize potential losses.
Tax Implications & Trading Fees
Making multiple trades in a day, week, month, and year can have significant consequences for a trader’s tax bill each year. Additionally, trading can also come with significant fees from an investor’s brokerage account, which can make successfully making a profit from each trade much harder.
Requires Significant Time and Effort
Trading requires a significant amount of time and effort to analyze markets, identify opportunities, and execute trades. Traders need to constantly stay up-to-date with market news and trends to make informed decisions. This can make successful trading difficult for those who don’t have the spare time required to spend hours researching each day.
In summary, while trading offers many potential benefits, such as flexibility, high returns, and great liquidity, it also comes with significant risks and requires a high level of knowledge and effort to be successful. Investors should carefully consider their financial goals, risk tolerance, and investment horizon before deciding if trading is right for them.
What is Investing?
Investing refers to the practice of buying and holding financial assets, such as stocks, bonds, and mutual funds, for an extended period of time with the goal of earning a return. Unlike trading, which typically involves buying and selling assets quickly to profit from short-term price movements, investing is a long-term strategy that involves taking a more patient approach to building wealth.
One key aspect of investing is fundamental analysis, which involves evaluating the financial health of a company and its long-term growth potential. This can include looking at financial statements, industry trends, and management performance to determine whether a particular stock or fund is a good investment.
Much like trading, the stock market is a common destination for long-term investors, with many individuals and institutions investing in stocks as a way to grow their wealth over time. While the stock market can be volatile and unpredictable in the short term, historical trends have shown that over the long term, stocks tend to provide higher returns than other types of assets.
Long-term investing can be a great choice for individuals who are still looking to earn a return on their investment but don’t want the added risk and extra time trading involves. By investing in a diversified portfolio of assets and holding onto them for an extended period of time, investors can benefit from the power of compounding, where their returns generate even more returns over time.
In summary, investing is a long-term strategy that involves buying and holding financial assets with the intent of ignoring short-term price fluctuations and profiting from the extended outperformance of a company’s business. Whereas traders use technical analysis tools to place trades, long-term investors use financial and fundamental analysis to determine where they should invest their capital.
Pros and Cons of Investing
Investing is a popular approach to growing wealth over the long term, but it’s not without its challenges. While investing can provide a range of benefits, including the potential for significant returns and the ability to build a diversified portfolio, it also comes with risks and drawbacks.
Pros of Investing
Potential for significant returns over the long term
One of the key benefits of investing is the potential to generate significant returns over the long term. While there are no guarantees when it comes to investing, historical data suggests that well-diversified portfolios of stocks and other assets have generated positive returns over extended periods of time.
Ability to build a diversified portfolio to reduce risk
Investing in a range of assets can help to reduce the overall risk of a portfolio, as losses in one area may be offset by gains in another. By investing in a range of assets, including stocks, bonds, and other securities, investors can reduce their exposure to any single asset or sector. One popular investment vehicle that has gained in popularity in recent years is the exchange-traded fund (ETF). ETFs offer investors the opportunity to diversify their portfolios across a range of assets, sectors, and markets by purchasing one simple asset.
Can provide a source of passive income
Investing in stocks and bonds can provide a source of passive income through dividend and interest payments. Dividends are regular payments made by companies to shareholders, while interest payments are made by bond issuers to investors.
Opportunity to invest in companies and industries that align with personal values
For some investors, investing is not just about generating returns but also about supporting companies and industries that align with their personal values. By investing in socially responsible funds or individual companies that prioritize sustainability, investors can put their money to work (and earn a return) in ways that align with their values.
Cons of Investing
Investing can be subject to market volatility
One of the key risks of investing is the potential for market volatility and unpredictable swings in asset prices. While historical data suggests that well-diversified portfolios of stocks and other assets have generated positive returns over extended periods of time, there are no guarantees when it comes to investing, and investors should be prepared for the possibility of short-term losses.
Requires significant time commitment
Investing requires a significant time commitment to research and manage investments. Investors must stay up-to-date on market trends, economic indicators, and the performance of individual companies and sectors in order to make educated investment decisions about when to buy and when to sell.
Difficult to choose where to invest
With so many investment options available, it can be challenging to choose the right assets to invest in, particularly for novice investors. The sheer volume of information available on different investment opportunities can be overwhelming, and it can be difficult to assess which investments are most likely to provide the highest return.
Liquidity challenges
Investing in long-term assets, such as stocks and bonds, can tie up capital for extended periods of time, limiting liquidity. This can be problematic for investors who need access to their funds in the short term, as it may be difficult to sell assets quickly without incurring significant losses.
In summary, investing offers a range of potential benefits, including the ability to generate significant returns over the long term and build a diversified portfolio of assets. However, it’s important to understand that investing still involves risk, including market volatility, the need for ongoing research and management, and various liquidity challenges. By weighing the pros and cons of investing carefully, individuals can better understand whether or not active investing could potentially be the right strategy for them.
Key Differences Between Trading and Investing
Trading and investing are two very different approaches to making money in financial markets, each with its own advantages and disadvantages. To truly understand which is best for you, it’s important to go over the key differences between the two.
Perhaps most obviously, and most importantly, is the time horizon difference between trading stocks and long-term investing. Traders are uninterested in holding company stocks for a long period of time and will take losses on certain trades to give them the capital to move on to more enticing setups. Comparatively, those who invest with a long-term mindset will be willing to withstand any bouts of volatility as they’re more interested in where the stock will be 3, 5, or even 10 years from now.
Risk is another important consideration when comparing trading and investing. Trading is generally seen as a riskier activity, as traders often use leverage and may take on more concentrated positions to earn their quick return. Investors, on the other hand, tend to diversify their portfolios across a range of assets to mitigate risk and are more patient with the investments they hold.
The level of involvement required is also a key difference between trading and investing. Trading can be an extremely active and time-consuming pursuit, requiring constant monitoring of market movements and news events. Conversely, investing can potentially be much more passive, with many investors opting to buy and hold a diversified portfolio of assets and ignoring the news/events that move markets on a daily basis.
Finally, the tools and techniques used in trading and investing can differ significantly. Traders often use technical analysis and charting tools to identify short-term trading opportunities, while investors rely more heavily on fundamental analysis to evaluate the long-term prospects of a company or fund.
Trading or Investing, Which is Better for You?
The Difference Between Trading and Investing | Youtube
When deciding between investing and trading, it’s important to take into account factors such as your personal financial situation, risk tolerance, time horizon, and financial goals.
While trading may offer the potential for short-term gains, it can also present the ability to lose (significant) amounts of money and also requires a high degree of skill and discipline. Investing, on the other hand, can offer more stability and the potential for long-term growth but will almost certainly require more patience and a willingness to weather market fluctuations.
Many investors who are still interested in the quick profits trading promises but also want to enjoy the safer returns of long-term investing will split their portfolio between the two strategies, allocating a higher percentage to their long-term investing accounts and limiting how much capital they put towards their higher risk trades.
By doing so, investors can capitalize on the steady upward price movements of overall markets while potentially increasing their total return by entering promising trades.
In truth, choosing between investing and trading doesn’t have to be mutually exclusive, and the right answer between trading vs. investing will vary for each individual investor. The best way to find success, regardless of the strategy you choose, is to determine your own risk tolerance and financial goals and choose the investment plan that you feel most comfortable with.