Have you ever wondered which is better, trading or investing? People get into buying stocks for different reasons, so some end up as day traders vs. long term investors.
In this article, we review the similarities and differences between trading and investing.
In a nutshell, investing means:
- buying and holding a portfolio of assets,
- holding on to your securities over a longer period of time,
- all for the purpose of building wealth gradually.
In contrast, trading is:
- engaging in frequent transactions of financial assets,
- with the purpose of generating larger returns over a short amount of time than an investor.
In this article, we explain everything else you need to know about the similarities and differences between trading and investing. Learning these terms of art is an important way to get started on your journey to making money with trading.
Differences Between Trading and Investing
One of the most important differences between trading and investing is the goal of each. Investing aims to build up wealth over an extended period of time by buying and holding on to a portfolio of investments. Investors often take the dividends or profits that they make and reinvest them into their portfolio.
Investing is a technique typically used by folks who aren’t all that interested in the ins and outs of the market, but want to have something to retire on, or are maybe saving up over the long-term for a major purchase, like a house or college tuition for their kids. The long-term nature of investing means that investors are able to ride out individual fluctuations and downturns in the market. Investors are usually more concerned with the fundamentals of the market in order to meet their investment goals.
Whether you know it or not, if you have a 401(k) or an IRA, then you’re an investor! More likely than not, if you have one of these types of accounts, your goal is to grow your retirement savings over the course of several decades. You’re not necessarily monitoring the day-to-day performance of your portfolio, or moving things around. This is a great illustration of the goals of investing.
In contrast, trading requires more frequent transactions, because the goals of a trader vs. an investor are shorter term. Traders aim to generate returns that outperform the typical buy-and-hold investor. For example, while investors might aim to get a return of 10 to 15 percent annually, traders are looking for something closer to a 10 percent return on a monthly basis.
Because their goals differ the timing of traders and investors — in other words, how long they are likely to take a particular position — also varies. Generally speaking, as we’ve already noted, investors purchase assets and hold on to them over the long-term. In contrast, traders will make much more frequent transactions, leading to them holding on to a particular security for shorter periods of time.
That being said, how long a trader holds on to particular securities will depend on his or her trading style. In general, there are four different styles of trading:
- Day traders take multiple position throughout a single day and don’t hold any trades over night.
- Scalp traders work even faster than day traders, often holding a position for minutes or even seconds. They do not hold positions over night.
- Swing traders hold positions slightly longer than day traders, usually over a few days or weeks. They often will hold a position over night.
- Position traders hold on to the same position for weeks, months, or even years. Of all four types of traders, position traders stay invested in the same securities for the longest period of time.
Traders and investors take on different levels of risk. By definition, investors are less interested in taking on a great deal of risk. While investors want their capital to grow, they would rather accrue smaller gains than risk losing it all.
In contrast, traders take on a higher level of risk every day. Because the risk is higher in trading, the returns can also be higher. In this way, trading vs. investing presents a tradeoff.
An Art vs. A Skill
Some say that trading is an art, while investing is a skill. Both trading and investing require a certain amount of knowledge and skill. However, investors tend to be completely analytical, looking at the fundamentals of a business. While traders need to know some analytical skills too, of course, there’s definitely an art to things like knowing the exact moment to make a trade or getting in sync with the psychology of the market and knowing how the game is played.
The cost involved in getting started in investing vs. trading also differs. Long-term investing is better for those who want to make some money over the long term with relatively minimal risk. The cost is also low.
The cost of trading, however, can be higher since you will have to pay out fees including trading commissions.
Similarities Between Trading and Investing
With all that being said, there are a couple of factors that trading and investing have in common.
It’s Better to Stick to Your Plan
Investors stick to one investment plan over a long period of time. Of course, it’s possible to adjust your investment plan between now and retirement, and likely you will make adjustments over the course of your working life depending on how close you are to retirement. But generally speaking, investors are working from a plan.
Trading might seem much more chaotic than investing. But the best traders know that they need to come up with a plan and then stick with it, even when the going gets rough. Lay out for yourself the reasons that you would hold on to or sell a particular stock before hand. That way, you won’t be tempted to make an impulsive decision to change your plan at the last second. Sticking to your plan: it’s one of the hardest parts of being a trader, but also one of the best guarantees of success.
While trading typically brings more gains than investing, at least in the short-term, both trading and investing are better than simply putting your money away under a mattress and hoping for the best. Investing in stocks or other financial assets to save for a major life goal like retirement yields better returns than putting money into a traditional savings account at your local bank or simply holding onto it in cash.
Knowledge is Power
In both investing and trading, knowledge is power. Whether you’re planning to trade an asset quickly or hold onto it over the long run, you’ll need to do your research in order to know which companies to invest in, what the markets look like, and so forth. Metrics like the price-earnings ratio, relative valuation multiples, and the price-to-book-value ratio should be second nature to both investors and traders.
Should You Do Trading or Investing?
Whether you should focus on trading or investing depends on your financial goals, the amount of capital you have to work with, your own skills and proclivities, and more.
You also want to think about how much time you have to devote to your practice. Traders will need to invest much more time on a day-to-day basis in trading, including time spent doing research, making trades, and so forth. Investors have much more leeway to ‘set it and forget it,’ so investing requires less time out of your daily life.
You’ll also want to think about how important your values are to you when it comes to making money on the markets. Say you’re super interested in investing in particular types of companies, because you share their values or you’re interested in their fundamentals. Maybe you love the company that makes your eco-friendly yoga gear and want to support them by buying their stock, or you think a new product is cool and likely to take off.
In this cases, where you want to support particular companies or product types, you can do that through investing. Trading is more about seeing patterns in the market and buying and selling quickly, meaning you won’t be able to invest in companies that you love and want to support and help grow.
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For a limited time, you can get a free copy of our options handbook to start learning more today. Schedule a free training session with one of our expert trainers on your own schedule to start investing to win.