What is the difference between trading and investing? For a beginner, these two terms may seem synonyms, but it’s not exactly so. Investing and trading represent two distinct approaches to wealth creation, each having its pros and cons. In this article, we will consider 5 major differences between trading and investing.
Differences Between Trading and Investing: Overview
To understand the core difference between trading and investing, let’s answer the questions “What is trading?” and “What is investing?”
- Trading is a stock market activity that consists in buying and selling assets within a short time period. The goal of any trader is to make a quick profit. The meaning of “quick” and “short” may vary, but normally we talk of hours or days.
- Investing means buying assets and holding them in the hope their price will increase over the years or decades. Unlike a trader (who is an “express” investor), you are interested in the long-term outlook.
Now, we will break it all down to 5 key differences.
5 principles to remember if you do short-term trading. Image source: IIFL
Difference 1: Long-term vs Short-term
As we already mentioned, a trader holds assets for hours or days. Very often, they operate within a 1-day frame (this method is called day-trading). The rule of thumb looks like “Buy low, sell high”. When the price of an asset reaches a certain mark, you sell it. Often, you use special trading software to automate such actions.
An investor’s main principle is “Buy and hold”. They invest their funds in something and then leave it alone for several years or even decades. Under this scenario, you don’t have to open trading charts every day to see how your asset is doing. Short-term market fluctuations are not important. A bigger picture is.
Difference 2: Timing vs Planning
This difference deals with the way traders and investors create wealth. The key skill of a successful trader is the ability to determine the best time to buy and sell a certain asset. For instance, if you miss the right moment to sell, you may lose the potential profit when the price of the asset goes down. If you miss the chance to buy at the lowest price, you will pay more when it goes up. The rule looks simple, but it’s easier said than done. Within a short period, prices may go up and down as supply and demand changes. And, since there are many factors that influence the mood of the trading community, it’s hard to predict what will happen next.
The task of an investor is to buy productive assets capable of generating passive income. You accumulate some money, then you select the assets with the good potential to grow, buy them and wait. Your success in investing does not depend on how good your reflexes are. Rather, it’s a question of effective planning, patience, and networking.
Trading and investing pros and cons largely depend on your risk tolerance. Image source: Equidious Research
Difference 3: Risks and Returns
Naturally, both types of market activity put your capital at risk.
Speaking of trading, it involves higher risks but promises higher returns, especially if you deal with volatile assets like cryptocurrencies. You may see trading as a game of action where speed, coolness and positive daring put you on top. That’s why traders prefer assets with a high level of liquidity, as they can be sold very quickly.
Investing may be seen as an art or even childbearing. In this case, your assets may be harder to liquidate at any moment, as they need time to grow, develop and get appreciated. In the short run, investors don’t expect high returns. As for the level of risk, it depends on your objectives and risk tolerance. Normally, investors prefer to diversify their portfolios to balance low and high-risk assets.
Difference 3: Taxation
Investing and trading may also be different from the point of view of taxation.
Many people see trading as a fine way to get rich in the immediate future until they have a closer look at this taxation issue. Any profit a trader makes is seen as a short-term capital gain. It stands for a profit you get through the sale of your personal or investment property that has been held for less than a year. This life-cycle begins when you buy an asset and ends when you dispose of it. Active trading involves many such cycles. So, when you sum up all the taxes you must pay, you may be unpleasantly surprised.
In investing, you deal with long-term capital gains. The term applies to the situation when you have been holding an asset for more than a year. Long-term capital gains are taxed in a different way. In most cases, you pay much less.
Difference 5: Commitment
For a day trader, this activity is a full-time job and not a hobby. To be successful, you have to stay constantly updated on how the market is doing and be ready to grasp an opportunity at any moment. You should follow today’s news, as they can impact the price of your assets tomorrow. Also, you should invest in all these multiple monitors we see on the photos with professional traders. For some people, this stressful and highly competitive environment is too much; others thrive in it.
An average trader is more tech-savvy than the average investor, as his success largely depends on technical tools. On the other hand, he or she lacks interest in the company behind the stocks — it makes no sense to get personal.
By contrast, an investor is likely to have a main job that allows him to make savings and then invest them. An investor has no need to stare at three monitors all day long, as small price movements are invisible on the broad panorama he is focused on. Such people would rather spend a lot of time to learn more about the company they invest in. It helps evaluate its potential and make the right decisions. Very often, investors understand what the company does and share its vision of the future.
Differences Between Trading and Investing: Conclusion
These were the key differences between trading and investing.
Note that we are not trying to persuade you to choose investing over trading or vice versa. Each option has its pros and cons, depending on your character and circumstances.
Our goal was to make you aware of the factors that will be influencing your potential profits.
