Investing vs. Trading: What’s the Difference?
Over the past couple of decades, many people started showing interest in profiting from financial markets, whether through trading or investing. However, it has become evident that a lot of beginners have only a very basic understanding of what investing and trading truly entail, while some don’t even know the difference between these two strategies.
In this article we’re going to look into what trading and investing are exactly, what are the differences between them, and which strategy suits you the best.
- Trading and investing are different strategies that require different amounts of effort, time and capital.
- Trading brings quick and steady profit while investors get their earnings after a certain period of time.
- Traders capitalize on short-term price fluctuation and tend to buy and sell assets within a relatively short period of time.
- Investors put their money in long-term investments to let them grow in value, and then sell them at a later date.
Investing vs. trading: main differences
Let’s start with the basics.
The most obvious difference between investors and traders is the holding period, or the amount of time they keep their positions open. Investors aim to make profit from long-term price changes, holding their orders for months or years at a time, while traders capitalize on short-term price movements, sometimes closing their trades within mere hours or even seconds after opening them.
Another major difference is the size of the initial capital investors and traders need. Since profiting from investments takes quite a long time, it’s more reasonable to invest large amounts of money at once. With trading, however, it’s not necessary to have a huge capital to start trading. Besides, trading is associated with a lot of risk, so pooling a lot of money into short-term trades can leave traders with a large amount of losses.
But what interests beginners the most is the amount of potential profit they can make from trading or investing. Traders tend to earn money in small amounts every day, while investors aim to generate a long-term income off their assets, not trying to actively participate or control the amount of profit they plan to get.
Now that we know the main differences between investing and trading, let’s look into both mechanisms more closely and find out which one suits your goals and abilities better.
What is trading?
Trading is a strategy that involves buying and selling stocks, currencies, commodities and other financial instruments over a short period of time. Traders focus on buying assets at a lower price and selling them at a higher price, capitalizing on short-term price fluctuations. They’re not interested in stable markets. In fact, the more volatile the market is, the more profit traders can make from each trade.
Time is of essence for traders, so they tend to use technical analysis and various indicators to predict the future movement of the price and quickly place orders to catch the price changes and try to profit from them. Traders also need to constantly keep their eyes on the market to identify best trading opportunities and use them to try and earn profit.
Another important thing about trading is that traders need to put in a lot of effort to make noticeable income, if any income at all. The price fluctuations that traders try to catch are usually pretty small, so they have to make a lot of trades to meet their profit targets. As a rule, a lot of traders quit their full-time jobs in order to earn steady income from trading.
Pros and cons of trading
Let’s now look at the advantages and disadvantages of trading. The advantages of trading include:
- Convenience. Being a trader is easy when it comes to buying and selling assets. The procedure for trading on financial markets is quick and easy, allowing you to open and close a trade with a couple of clicks. This is very important as traders often race against time trying to catch the best opportunities.
- More opportunities. Traders don’t get discouraged when the market is volatile or going through a downtrend. They can find ways to profit from any price changes because they speculate on the differences between opening and closing prices. The more the difference is, the larger the profit you get (of course, if this difference is favorable for you).
- Leverage. Traders can use leverage to buy more securities than they could have afforded with their own money. Leverage can increase your profit exponentially, though it comes with some strings attached.
As for the disadvantages, here are some things you should think about before deciding to become a trader:
- Higher risk. With more profit opportunities comes more risk. Trades make short-term trades in volatile markets, but it is difficult to predict correctly where the price will go. It is quite common for beginners to lose their whole capital with one unlucky trade. What’s more, while leverage can increase the profits, it also increases the amount of losses traders can end up with, sometimes leaving them with a hefty debt.
- Unstable income. Traders who quit their full-time job to pursue trading as a career can often find maintaining a stable income quite difficult. Their earnings depend on the amount of trades they’re able to make, but even if they do manage to stick to their trading plan, a couple of unsuccessful trades can bring their total profit down.
- Time-consuming. If you want to make significant profit from trading, you need to spend a lot of time in front of the screen, looking at the price charts and scanning for trading opportunities. This is why many people turn trading into a career.
What is investing?
Investing is a long-term strategy that involves buying an asset (stocks, real estate, commodities, metals, etc.) and holding it over a long period of time with the expectation that its value will rise significantly.
Unlike traders, investors usually apply fundamental analysis while looking for assets to acquire. As their aim is to generate long-term profit, they are interested to know a company’s current earnings, revenue, and its growth potential. Once they buy an asset, they stick to passively holding the asset for a predetermined amount of time, depending on their goals (retirement, college tuition, down payment for a house etc.).
Since investors tend to hold their assets for long periods of time, they aren’t affected by short-term market volatility. If the market experiences some sort of calamity, investors tend to wait it out until it stabilizes again. However, in order to minimize the risks investors tend to diversify their investments and combine several assets from different markets and industries in a single portfolio. That way, if one of their investments doesn’t work out the way they planned, their earnings will not be strongly affected.
Pros and cons of investing
The advantages of investing include:
- Beating inflation. Money loses value overtime because of inflation. The things you can buy for $100 today will cost more than that tomorrow. Simply keeping the money on your savings account won’t be enough to offset the increase in prices. This is why investing is a smart choice if you want to stay ahead of inflation. The value of your asset will increase, so you’ll be able to sell it for more money in the future.
- Long-term returns. Investment can help ensure you have money in the future. Rather than getting profit right away and spending it, your investments store it for later and allow you to build your wealth over time.
- Dividends. If you invest in dividend-paying stocks, you will get paid a portion of a company’s profit. You can use these payments as an additional income, or you can direct them into your investments and grow your portfolio even more.
- Low effort. With investing, you don’t have to spend much time over charts or analyzing each movement of the market. The only thing you need to do is to check in once a week or even a month to see how your assets are doing and whether you need to change something in your portfolio. Other than that, it doesn’t require you to make any changes to your current lifestyle or quit your job to make more income.
However, investing does have some disadvantages too:
- Slow returns. With investing you’re playing a waiting gain. It can take years for your assets to appreciate in value enough to bring you decent profit. In the meantime, if you don’t get dividends, you won’t be getting any earnings.
- Risk. When you decide to invest in something, you need to be aware that the value of your investments can actually decrease over time. Investments with higher returns, such as stocks, also tend to be more risky as there are more factors influencing the value of a particular company. This is why you have to regularly monitor the state of the market, and if some of your assets aren’t doing as well as you expected, you may replace them with something else or find additional investments for your portfolio to redistribute the risk.
- Opportunity cost. Investing money into assets means you don’t have this money in your active funds. You can’t even spend it when you have an emergency as pulling it out and selling your assets takes time. And if you do end up taking some money out of your investment account, you might lose some benefits and part of the compound earnings that you’ve already accumulated.
Is one better than the other?
As you can see, trading and investing are vastly different strategies that require different amounts of effort and aim to achieve different results. The answer to the question of which one is better for you depends on your personal goals.
Do you want to have a stable income or get your profit at some point in the future?
Are you ready to spend several hours every day in front of the screen? Or would you rather check your assets only once in a while?
Do you enjoy working in a fast paced environment and doing a lot of research? Or do you prefer the laid-back style of investing?
Trading can potentially bring you more money than investing, but it requires more time and effort from you. Plus, the risks from trading outweigh the risks from investing, so you need to carefully research each trade and spend a lot of time developing your trading plan.
But in the end, only you know what you need and what you can do in your current circumstances.
Both trading and investing have the potential to be quite profitable to its users. However, both traders and investors have to face difficulties on their way to earn money. Before deciding on what to do, it’s better to assess your goals and expectations, as well as what resources you have on hand and whether they would be enough to allow you to trade or invest.