It is common knowledge that by making the right choices and defining the right strategies, the market can be a treasure trove for wealth creation. However, not all investors make the same choices or define the same strategies to earn profits.
Within the market itself, there are various approaches and strategies that work best for specific groups of investors. The most popular of these are known as Trading and Investing.
Trading and investing both involve seeking profit in the market, but they pursue that goal in different ways. Traders jump in and out of markets within weeks, days, even minutes, with the aim of short-term profits.
They often focus on a market’s factors rather than a company’s long-term prospects. What matters to traders is which direction the market will move next and how the trader can profit from that move.
Investors have a longer-term outlook. They think in terms of years and often stay invested through the market’s ups and downs.
However, more often than not they are used interchangeably. Market entrants not knowing the clear differences between the two apply trading strategies and lose money as a result.
In reality, these approaches differ greatly with respect to attitudes, risks involved as well as time horizons. So, in the debate of trading versus investing, which approach would be ideal for you?
And what exactly are the differences between trading and investing that can help you make your mind? To make this point simpler, let us first look at what is trading and investing, when considered in terms of the market.
Let’s see how they inherently differ, and which approach is better suited to retail investors.
2.0 WHAT IS INVESTING?
Let us review what it means to ‘invest’ in the market. Investment in the market usually refers to the approach of buying and holding of assets over an extended period of time to make long-term profits.
Even as the market keeps fluctuating, investing in the market results in ‘riding out’ the downtrends till the market stabilises. Eventually, the profit and loss margin is determined by the investor after several years, or even decades.
The goal of investing is to gradually build wealth over an extended period of time through the buying and holding of a portfolio of assets and other investment instruments.
Investors often enhance their profits through compounding or reinvesting any profits and dividends. Investments often are held for a period of years, or even decades, taking advantage of perks like interest, dividends, and splits along the way.
While markets inevitably fluctuate, investors will “ride out” the downtrends with the expectation that prices will rebound and any losses eventually will be recovered.
Investors typically are more concerned with market fundamentals, such as price-to-earnings ratios and management forecasts.
Following are some of the attitudes of trader [Buy and Hold]:
- An investor is slow and steady in approach (tortoise)
- Decisions are based on long term consequences hence range from years to decades.
- Do not time the market or get bothered by short term market volatility.
- Selection strategy based on fundamental analysis of a business; value investing
- Is of a more relaxed disposition, information only regarding fundamentals needed.
- Bases all decisions on the conviction he has on the company’s growth prospects
- Possesses lesser risk appetite comparatively, invests for the long haul
- Invests only when his investment objective aligns with a business. Does his own research, and invests only after he completely convinces himself of the potential of a business
3.0 WHAT IS TRADING?
‘Trading’ typically refers to the strategy whereby an individual sells and buys trading assets, commodities or financial instruments within the trading timeframe or session that involves more frequent transactions.
For example, with day trading, the trader determines his loss or profit margin as well as closes all his positions before the market itself closes for the day.
The goal is to generate returns that outperform buy-and-hold investing. Trading profits are generated by buying at a lower price and selling at a higher price within a relatively short period of time.
The reverse also is true: trading profits can be made by selling at a higher price and buying to cover at a lower price (known as “selling short”) to profit in falling markets.
A trader’s style refers to the timeframe or holding period in which stocks, commodities, or other trading instruments are bought and sold. Traders generally fall into one of four categories:
- Position Trader: Positions are held from months to years.
- Swing Trader: Positions are held from days to weeks.
- Day Trader: Positions are held throughout the day only with no overnight positions.
- Scalp Trader: Positions are held for seconds to minutes with no overnight positions.
Following are some of the attitudes of trader [Buy and Sell]:
- A trader is of an impatient personality (Hare)
- Trader takes decisions within minutes, days, weeks, months
- Times the market: missing the right time to enter or exit may lead to loss
- Selection strategy based on technical analysis; momentum trading
- Requires real-time data and information to take buy and sell calls hence is on his toes all the time
- Does not pay attention to what the company does and only focusses on the scrip price and trade volume.
- Has more risk appetite with a penchant for short term gains
- Is more likely to buy based on recommendations by friends, other traders, media and other external resources
Trading and investing both involve taking a position on a market in order to profit from price movements. However, they pursue this goal in vastly different ways.
While investors will physically buy the asset in question, traders will take a speculative position on the underlying market price. Investors will take a longer-term look at markets, assessing the future health and growth prospects of a company over years and even decades.
Traders or speculators will look at rising and falling markets over a shorter time frame in order to profit from volatility. In general, investors seek larger returns over an extended period through buying and holding.
Traders, by contrast, take advantage of both rising and falling markets to enter and exit positions over a shorter timeframe, taking smaller, more frequent profits.
Both these approaches are a successful way to make money from the market. However, if you planning to choose one approach, think about the time that you can spend ‘daily’ on market activities.
If you can daily spend hours in the market, then trading suits you. Otherwise, investing is a better approach for you. Moreover, it also depends on your knowledge.
If you have an interest in reading financials, accounting, news, economy, etc. then investing is good for you. On the other hand, if you are good with trends and charts, trading makes more sense.
Finally, comes your preference. As discussed in the post many people enjoy the game of trading while many want to be relaxed once they invested their money.
Your personal preference has a high weight for selecting your style. In conclusion, trading and investing are both profitable approaches to the market in their own right.
A person’s preference for one approach over the other depends largely on his risk appetite, investment horizon and investment style.