This is a quick read designed to give you a quick and concise understanding of the differences between investing and trading. There are of course many other factors to consider but this article will focus on the main points giving you a firm understanding of the differences between trading and investing.
Ultimately Traders and investors both have a very similar goal: they both attempt to generate profits through participation in the financial markets. Although they share the same goal, they have key differences in how they achieve the goal of profitability.
Investors pursue larger returns over an extended period through buying and holding over long periods of time, taking advantage of a company’s long-term financial performance. Traders by contrast, make smaller and more frequent profits, by taking advantage of both rising and falling markets, to enter and exit positions over shorter timeframes.
Investors are unconcerned with the daily fluctuations of the markets, since these undulations even themselves out over the long term. On the other hand, traders exploit theses market fluctuations, entering a trade to profit from a market misprice and exiting once the market correction is over. Traders do this by buying an asset (long trade) when the price goes up and selling an asset (short trade) when the price goes down.
Trading requires a high level of skill and a deep understanding of chart analysis. Long-term investment accounts are more ‘set-and-forget’, whereas trading accounts are more actively managed. Both paths can achieve the long-term aim of Funding Your Retirement.
Traders use stop loss and target limits to maximise their profits and to minimise their losses, and will do regular analysis of the markets from weekly to daily, and intraday analysis.
Investing, however is putting money into a fund that you can comfortably afford to pay, and leaving it there to generate an income in the distant future. Investments are often applied to retirement accounts.
The effects of compound interest occur much more rapidly for successful traders, whilst investors benefit from compound interest over a long timescale and slower pace.
Traders fall into four general categories:
- Position Trader: Positions are held from months to years (interday trading).
- Swing Trader: Positions are held from days to weeks (interday trading).
- Day Trader: Positions are held throughout the day only, with no overnight positions (intraday trading).
- Scalp Trader: Positions are held for a matter of minutes or even seconds, with no positions held overnight (intraday trading).
There are significant differences between investing and trading, and the following table summarises some of these.
|Short term period.
|Long term period.
|More frequent trades (several per day).
|Less frequent investments (few per year).
|Initial deposit (margin) required.
|Full value of investment required.
|Risk potentially magnified by leverage.
|Risk limited to initial outlay.
|Higher level of skill required.
|Lower level of skill required.
|Smaller investments, smaller returns.
|Larger investments, larger returns.
|More actively managed.
|Less actively managed, ‘set-and-forget’.
|Benefit from market fluctuations.
|Benefit from long term company performance.
|Profit from long and short positions.
|Profit from capital appreciation and dividends.
|Narrow range of stocks and commodities.
|Wide diversification of stocks and commodities.
|Buy when prices increase (long trade), sell when prices decrease (short trade).
|Buy when prices increase.
|Use of stop loss and target limits.
|No use of stop loss and target limits.
|Benefit more rapidly from compound interest.
|Benefit more slowly from compound interest.
|Higher and more frequent transaction costs.
|Lower and less frequent transaction costs.
|Capital locked up short term to medium term and released rapidly as trades are opened and closed.
|Investment capital locked up from medium term to long term until liquidation of funds.
|Traders can exit a risky trade quickly and limit account drawdowns related to unforeseen market events.
|Investors tend to ride out short term market fluctuations, but the accumulated profit will suffer if investment value is down when funds are liquidated. Investors may be penalised for withdrawing funds too soon.
For every trade, you should risk no more than 1% of your capital, so having 10% of your entire capital in a trading account would be reasonable. The question then, is what to do with the remaining 90% which is effectively ‘dead’ money that is not earning you interest. This money can be invested in a long-term investment account to generate an additional income while you are trading. Consequently, it makes sense to become both a trader and an investor to benefit your portfolio.
Is trading better than investing? That depends on factors such as your tolerance to risk, personal style of money management, and your life’s goals. There are pros and cons to both trading and investing. Whatever your money management decisions and long-term goals.
As with most things in life there is never a straight answer, and a combination of the two would be most beneficial in achieving financial self-sufficiency.
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