Both investing and trading refer to making profit from an asset or in the stock market. Most of the time, they are used interchangeably, depending on the situation and duration at hand. The two terms have several similarities. However, the way they pursue the goal of profit-making is where the difference comes in. In brief, investing is associated with building wealth over a longer period, i.e. medium/long-term. Trading is associated with the generation of profits within a short time.
To remove the dark cloud of confusion between the two terms, especially to the beginners, we have dug into the two terms. We will explain how, when, and where trading and investing differ. We have broken the article into the following topics, for easy understanding:
What is investing?
What Is trading?
The key differences between investing and trading
Investing vs Trading: which is better?
Having given that brief introduction, now let us go straight to the two confusing terms.
What is investing?
Investing signifies the buying and holding strategy that is long term. Here, investors will buy and hold assets for a long-term ranging from years to decades. The secret is to generate substantial profits as the prices of the assets continue rising. Many investors re-invest their previously generated income for more profits. The aim or purpose of one’s investment dictates the duration of the investment. For example, someone investing in real estate might need 3-5 years as opposed to a person investing in a retirement scheme who might have a time horizon ranging from 20 to 30 years.
There is a fundamental principle that applies to investment. It states that, for an investor looking for higher return potential investment, they should expect higher investment risks, otherwise known as “risk-return tradeoff.” In a simpler explanation, it refers to the difference between an investment’s actual and expected returns. The length of the time horizon determines the number of risks on investment that an investor should expect. For an investor who is eying a short-term horizon, they must be conservative on the type of investments to choose to avoid the risk of failing to achieve the set goals. The rising and falling of financial markets in the short-term makes many investors comfortable. This also makes them remain optimistic that even if there shall be periods of underperformance, prices would eventually bounce back and recover from the short-term setbacks.
Types of investing
Active investing: this segment involves active buying and selling of securities to outperform the set investment benchmark index within a period. Here, an active investor can buy forty individual stocks or assets to outperform the 500 largest US companies, also known as the S&P 500 index.
Two main investing styles that are common to most investors including active and passive styles.
Passive investing: this applies where the investor wants to match the benchmark index or market performance for some time. In this cluster, investors avoid securities for funds that are benchmarked, such as index funds and ETFs (exchange-traded funds). Such a move aims at tracking the performance of the market.
What is trading?
Trading is the more active type of financial investment that is short-term based when compared with investing. Here, traders hold trading positions for a significantly shorter time. They mostly buy or sell securities within hours, days, or weeks to capitalise on the price movement within the shortest time possible.
Unlike investors, who majorly benefit from rising stock prices, traders capitalise on both rising and falling prices to realise the profit. Investors focus on long-term asset growth prospects, whereas traders focus on the assets’ price direction in the next position, then strategise on getting profit from that projection. Traders will rely on stop-loss orders to close losing trades automatically at a pre-determined level, hence protecting the trading capital. However, this is not the case with investors, because they ride out on periods of under-performance.
Trading requires more commitment than investing does. Remember, an investor can buy an asset, fund, or stock and forget it for a long time. However, a trader needs to monitor market movements or developments constantly. To achieve this, a trader has various trading styles they can use. We will discuss them briefly.
Swing trading: this trading style focuses on larger price movements, instead of having a start and finish for a price trend. The traders hold positions ranging from days to weeks.
Scalping style: this style aims at capturing small profits that are recurring. It entails holding a trading position for the shortest time possible, from seconds to a few minutes.
Day Trading: it entails a single-day opening and closing of positions. Remember, trades closed before the close of the market minimise the overnight disturbing market news.
Position trading: In this one, a trader stands to benefit from trending dominant prices. A trend is bound to occur when a certain asset’s price has a one-direction movement for a substantial period.
Social trading style: This an additional trading style. The financial industry comprises traders from diverse origins, backgrounds, and skills. Some are well learned, skilled, and more experienced than others. Collaboration amongst the traders is crucial. Just as social networks work, this is how social trading similarly does.
What is Social Trading?
You cannot trade confidently or comfortably if you are not versed in what goes on in the financial markets such as trading forex, or trading metals. As a trader, you cannot afford to walk alone otherwise, you will lose money. That is how social trading comes in, to offer exposure to the inexperienced or beginner traders.
We have talked a lot about this style of trading, but it is important to know what it is. It works exactly like social networking, however, here traders share trading ideas, skills, or expertise instead of selfies, or photos. Here, interaction occurs by watching other professional traders’ trading results, analysing and applying them to your trading. It is simple: once you identify successful traders, follow them and copy their trades. Social trading has several benefits.
Benefits of social trading
A trader gets a quick grasp of the trading market. The cost and duration that a trader would have taken to learn are reduced through the social online trading platforms. It is efficient and fast.
You learn as you earn, here you can copy some strategies from experienced traders and apply them in your trading. This means you will not wait until the completion of your learning to earn, but you earn from day one if you copy other traders’ trades and succeed.
Social trading gives birth to a community of traders or investors where you can share, interact, and collaborate in different trading ventures. Since it is an online platform, there is no limit as to where, when, how, and from whom to get information so long as you are connected to the internet. It is a global community of traders.
Finally, getting reliable information is reduced because you get it directly from the main source without third parties. Another aspect is that location does not limit access to information, since it is an online grouping.
The key differences between investing and trading
The two types of strategies attract differences, of course, the main ones being long-term focused for investing, and short-term focused for trading. Below are some key differences.
The first key difference is the type of asset class each strategy uses. For investing, the asset class is mostly stocks or trading shares, as it is often known. These stocks represent a company’s ownership. It can deliver plenty of returns over a period compared to other forms of assets. Investors can add a few other assets along the way to diversify portfolio. Traders have a wide range of asset classes to focus on, such as trading futures, indices, commodities, and currencies, amongst others. Another point of divergence is that investors are involved in buying of assets outright, whereas traders sometimes use financial tools, i.e. CFDs, to access some assets.
How they find opportunities and research their markets is another key difference. Investors overly use fundamental analysis by looking at the information at hand regarding a certain asset to decide whether they can buy or sell the asset. For a stock, an investor will look for the following factors: the balance sheet, competition threat, profit progression, or the economic backdrop to decide on buying the stock. With traders, they focus more on technical analysis by examining the price charts, patterns, trends, or indicators to project the future movement of prices. The historical price data can project the movement of price in the future. Traders use the following technical analysis strategies.
Breakout trading: this applies to assets that have gone past the established resistance or support levels.
Trend trading: the strategy aims at generating profits through the price trend of an asset. A trader will have to trade following the direction of the trend to generate profits.
Support or resistance trading: it supports the generation of profits through the identification of assets support or resistance levels. Support means a price level that a price of an asset has difficulties falling below. Resistance is a level that the price of the asset has difficulties exceeding.
Another key difference is risks and risk management: both investing and trading have unique risks. This means they manage risks differently. For investors, there are two types of risks involved, specific and market risks. Market risks involve the decline of the value of the entire market whereas specific risks involve the decline in value of a particular asset i.e. stocks. Portfolio diversification can minimize the risks. Traders face 2 types of risks: volatility and leverage risks. Volatility stands for the price fluctuations that are short term whereas, leverage involves leverage or borrowing money. To counter the risks, traders employ the strategy below.
Try to avoid excessive leverage by setting a stop-loss order to counter losses and optimal position size determination.
Investing VS Trading: which is better?
The two strategies have their pros and cons. However, experts have proven both investing and trading as viable ways of generating profits from the global financial markets. To determine the strategy that suits you, there are several factors to consider:
Understanding of a certain asset class/market segment
The funds to get started
Time factor: how much time an investor or trader will spend on monitoring their holdings and doing research
It is only after considering such factors that you can decide on which strategy serves your interests better. However, for many people, investing seems to carry the day because of the reasons below. However, before sharing the reasons, we can separate the two terms by referring to trading as active investing and investing as passive investing so that we understand them better. Below are the reasons:
Investing gives you all the time you need to engage in some other actions as you wait for the maturation of your holdings.
The hidden costs of active investing or trading make it less profitable.
Some assets need more time to bring more returns.
Finally, short-term risks are sometimes tricky and fast to tame. Going long term gives you time for a high rate of recovery. Therefore, for long-term and higher returns, investing seems better for most people.
Conclusion From the beginning of this post, three traits have been clear. These include the duration, approach, and risks. Long-term investing involves lesser risks, whereas short-term trading involves high risks. It is important to understand that you can do investing and trading, athough it will depend on your patience or the ability of how much risk you can take. Maybe you have been using the two terms interchangeably without knowing their real meaning, we now believe that through this post, you have familiarised yourself with their key differences. To cap it all, both investing and trading outcomes majorly depend on various underlying market factors. This will require you to invest in learning resources and time to earn profits from your holdings.
This information is not considered as investment advice or an investment recommendation, but instead a marketing communication. FXCess is not responsible for any data or information provided by third parties referenced, or hyperlinked, in this communication