Investing vs trading. What’s the difference?
Profiting in the financial market. That’s the aim, whether you’re investing or trading. The two take different routes to arrive at this shared goal. In Investing vs Trading 101, investors seek solid returns over an extended period. So, they buy and hold. On the other hand, traders enter and exit positions over a shorter period, taking potentially higher and more frequent profits.
Let’s define the two in more detail.
Unless you’re a Wolf of Wall Street (or a Jackal on the JSC), and even then, the stock market is a complex place. So, you must understand the basics, let’s clear up any confusion.
1. What is investing?
Investing’s goal is to build wealth over an extended time by buying and holding a portfolio using financial vehicles like stocks, mutual funds, and bonds.
Investments are held for years, or even decades, and, ideally, enjoy growth, compound interest, dividends, and stock splits. As we all know, markets fluctuate, but investors will ride out the downtrends with the expectation that stock prices will rebound eventually. You can often increase your profits by compounding or reinvesting profits and dividends into additional shares or stocks.
A clever investor will do their homework before investing and look at a company’s fundamentals, like its previous financials and industry analysis, as well as a country’s macroeconomic situations.
2. What is trading?
Trading’s goal is to generate short-term returns that outperform buy-and-hold investing. This involves frequent transactions, aiming for buying-low and selling-high instruments like stocks, commodities, and currency pairs.
So, while buy-and-hold investors may be happy with 10% to 15% annual returns, traders might want a 10% return each month.
But, trading is dynamic and volatile. Its high-risk and high-reward nature is at the direct and short-term mercy of the market, so it can incur both hefty profits and losses.
A trader has different homework to do. They need to analyse a company’s performance based on the uptrends and downtrends in the market in a single day. They need to use this analysis to predict changes and trends in volume, price, and moving averages.
What’s the difference between the two?
The key differences between investing and trading are their approaches: appetite for risk and time involved. As we’ve said, investing is lower risk and rewards over a more extended period, and trading is higher risk and higher rewards over a short period. Depending on your profile, you can choose one, the other, or even a combination.
So who earns more profit, investors or traders? Both have the potential to earn profits, but traders frequently earn more profit than investors when they make the correct predictions and decisions, and the market performs accordingly.
Investing vs trading. Which one is right for you?
Your first step is to decide on your investment strategy and goals. Are you saving for retirement? Are you looking for returns today? You also have to establish your appetite for risk, as this is a key differentiator between investing and trading.
Whichever one you decide, let’s look at how to do each wisely.
The clever investor
The smart investor wants to build long-term wealth, and here are some pointers.
- First off, define your investment goal and decide on a strategy. Are you investing for retirement or saving for your kid’s university tuition? And how much risk can you tolerate when it comes to strategy?
- Be prepared for the long haul. Know that successful investing takes longer, so your money will be tied up, and you’ll have less disposable cash.
- Have patience and discipline to stick through the market’s ups and downs.
- Form a plan for buying, selling, and rebalancing your holdings. For example, some investors sell some holdings and buy others to rebalance their portfolio to existing original goals if market fluctuations have thrown it out of whack.
- Think about choosing index funds which don’t try to beat the market but mirror its performance. An example of such a fund in South Africa is the FTSE/JSE Top 40 Index.
The clever trader
The astute trader will always minimise risk. Here’s how you can do it.
- Go in with wide-open eyes. The stock market’s long-term average return is 10%, and many studies have shown that it’s difficult for even professional traders to beat the market.
- Plan when you’ll buy and sell. So, sell if a stock rises or falls by a predetermined percentage.
- Stick to that plan. Even the most experienced traders change their reasoning for holding stocks and shares, and that’s not always wise.
- Work out how much money you can afford to lose, and don’t trade more than that.
- Take tax liability into consideration. Tax rates differ between short- and long-term capital gains.
So before you choose to invest vs trade, sit down, and think carefully about your goals and appetite for risk. Your future self will thank you for it!