Trading vs Investing – Which Approach is Better for You?May 16, 2022
When it comes to the small matter of entering positions and generating a return on the financial markets, it is vital that the basics are properly mastered. These include properly distinguishing between key terms and clarifying even the most simple of phrases.
The markets can often seem a complex world, especially in terms of stock prediction and choosing a suitable plan of action. However, before all that, it is important to clear up any confusion people may have about trading vs investing, two words that are often used interchangeably without sufficient differentiation.
In this article, we will be distinguishing between stock trading vs investing, offering up definitions of each term, as well as highlighting some of the biggest similarities and differences between the two, so you don’t fall into the trap of thinking they are the same thing.
Defining Trading vs Investing
Trading is essentially a short-term approach to the markets, with the principal aim of maximising returns on a daily, monthly, or quarterly basis. It involves frequent transactions, such as the buying and selling of a range of assets, including stocks, commodities, currency pairs, and other tradable instruments.
It is often a volatile and dynamic process, featuring market moves that are often made as a result of day-to-day fluctuations. Consequently, trading offers up a higher level of risk, as it is a money-making process whereby market trends have a direct impact on trades, meaning that it can incur both hefty profits and losses.
Investing is a long-term strategy, where the main goal is to acquire and build wealth gradually, using a number of investment methods, including through bonds, mutual funds, baskets of stocks, or by means of buying and holding of a portfolio of stocks.
Investments can be held over an extended time period, sometimes stretching across a number of years, or even decades. There are also several perks associated with investing, such as interest, dividends, and stock splits. Investors tend to be more focused on the market fundamentals, rather than daily upward or downward market trends.
Trading Pros and Cons
- Growth potential: Traders stand a chance of making money faster by actively participating in the market and trading on a stock’s growth prospects.
- Trading control: Buying and selling a stock within such a short time period can give a trader more control over their money, by reinvesting capital quickly elsewhere.
- Closing positions: Risk-averse market movers can close positions overnight to prevent unexpected market changes from significantly affecting profits.
- Risk/volatility: Day trading carries with it a lot of risk, as a volatile stock market can dramatically affect an investment and lead to big trading losses.
- Unpredictability: Despite technical charts and analytical tools being available, the markets can change in a flash, something which is very hard to spot in time.
- Attention required: Short-term trading is demanding and requires regular attention, with some traders spending many hours each day tracking often complex technical charts.
Investing Pros and Cons
- Low maintenance: Long-term investments are good for those who don’t have the time to constantly monitor the charts, or track them on a daily or weekly basis.
- Fact based: A buying and holding strategy is generally based on fundamental analysis, with balance sheets, income statements, and cash flow data being less subjective.
- Tax benefits: Investments that are held and sold for more than a year are eligible to be taxed at a more favourable, long-term rate, as opposed to an increased short-term rate.
- Tied-up capital: A drawback to this trading method is FOMO – fear of missing out. Here, an investor must avoid the temptation to chase other potential investment opportunities.
- Not infallible: Despite a trader holding on to a stock for many months or years, this doesn’t mean that it won’t be affected when the markets crash or experience a downturn.
- Slow growth: Long-term trading plans are a particularly slow way of generating a return on an investment, with traders having to exercise a high degree of patience.
Trading vs Investing – Which is Better?
It is difficult to make direct comparisons and generalisations on the matter of trading vs investing in stocks, as, while they both involve the financial markets and assets, they really are two very different activities, with distinct aims and objectives.
However, it is possible to conclude that trading is riskier than investing, on the whole. This is because it involves a great deal of speculation, with quicker decisions being taken, usually with a higher heart rate.
Trading involves less diversification, as monitoring more than a few trades at once is both unwise and extremely challenging for a trader of any experience level. A diverse, long-term portfolio could offer the opportunity to even out bad-performing stocks and mitigate the ups and downs.
Despite this, trading can lead to higher returns much more quickly, and although speculative trading carries risk, it can be suited to traders with a certain lifestyle. Investing is the long game, and is better matched with more cautious individuals, who have a higher patience threshold over a drawn out period of time.
As a result, it is hard to classify either strategy as the best way to approach the stock market. For those with a low risk tolerance and wish to avoid volatility, investing is the way to go. But for traders who like to take more of a risk and like the chance to earn quicker and bigger returns, trading could be the method of choice.