You’re standing at a crossroads: one path is steady progress towards financial security and the other is a wild ride with big highs and potential lows. That’s the difference between trading and investing, where both are long term but very different in strategy, mindset and risk.
Here’s the deal: if you’re an active trader you’re focused on short term price movements, riding trends and making quick wins. Investors are like gardeners – planting seeds and letting them grow over time. So which one are you? Or can you do both to achieve your financial goals?
In this post we’ll compare these two approaches, the risks and rewards of each and why you need to understand them to grow your wealth.
Summary: Investing and stock trading both are for financial growth but they are different in strategy and risk. Active traders focus on short term gains while investors focus on long term growth. We’ll explore which path is for you and how to balance the risk.
For the uninitiated, everything related to the stock market is trading. If you tell an amateur that you invest in the stock market, the first thing which will come to his/her mind is Gordon Gekko in Wall Street (or Jordan Belfort in the Wolf of Wall Street for the youngest). Stock trading and investment are however in complete contrast with each other and understanding the key differences between them is essential for anyone looking to get involved in financial markets, even though both imply opening a brokerage account to buy/sell securities.
The main difference is the holding period. Indeed investors hold stocks for years and/or decades while traders hold them for a few seconds to a week. In other words investors will be into a buy-and-hold strategy while traders into making a short term profit by buying and selling a stock (sometimes multiple times) within the same day/week.
Understanding Investing and Trading
Investing and trading are two different ways to participate in the financial markets. Both involve buying and selling securities but they are different in goals, time frame and risk.
What is Investing
Investing is like planting a tree and watching it grow over time. It’s a long term approach to wealth creation where individuals buy and hold securities such as stocks, bonds, mutual funds and exchange traded funds (ETFs) for an extended period. The primary goal of investing is to generate returns over the long term, usually years or decades by riding out market fluctuations and benefit from compounding. Investors focus on fundamental analysis, looking into a company’s financials, management and industry trends to make informed investment decisions. This systematic approach allows investors to build a diversified portfolio that can withstand market volatility.
What is Stock Trading
Stock trading is more like surfing the waves of the stock market. It’s a short term approach to profit from the stock market where traders buy and sell stocks within a shorter time frame, often using technical analysis tools to identify trends and patterns in stock prices. The primary goal of trading is to generate short term profits, often within a single trading day or a few days. Traders may use various strategies such as day trading, swing trading or scalping to profit from market volatility and price movements. This fast paced approach requires a keen eye for detail and ability to make quick decisions based on market signals.
How do the investors and traders pick their investments in financial markets?
The way to pick good trades is completely different depending if you are an investor or trader. Active investing involves fund or portfolio managers managing an investor’s assets, which comes with higher costs due to professional management. Investors will diversify their portfolio by including exchange traded funds (ETFs) which gives exposure to a broad range of asset classes.
The investor will focus on fundamental analysis. That means reading/reviewing the previous years/quarters financial statements (i.e. Balance sheet, income/cash flow statements) and computing ratios (P/E, P/B, ROE, ROA…). Besides that, investors will estimate or look at the fair value (assess the intrinsic value via the DCF model for instance) of a stock before making any stock investment.
Traders are more into technical analysis. They try to estimate the future price changes of security mainly based on past prices and volume. To see if the price will go down or up, they use technical analysis tools such as moving averages, pivots, fibonacci and momentum indicators.
Which one should you choose?
Time Horizon and Risk
The time horizon and risk levels associated with investing and trading are significantly different.
Time Horizon
Investing involves a long term time horizon where investors hold onto their securities for years or decades. This allows them to ride out market fluctuations and benefit from compounding. Trading involves a short term time horizon where traders buy and sell securities within a shorter time frame, often within a single trading day or a few days.
Which one should you choose? Understanding the key differences
I will direct you to investing but I have however to admit that my opinion is biased as I believe more in investing than trading to make money. When deciding between trading and investing, your risk tolerance will significantly influence your choice, as different approaches cater to varying levels of risk appetite. Making a thorough analysis of the fundamental data of a company and buying a few stocks of this company for the long term is much less risky than day trading, where traders should be prepared to lose money regularly. According to a study published in the Journal of Financial Markets1 in 2014, “Less than 1% of the day trader population is able to predictably and reliably earn positive abnormal returns net of fees”. Besides that, we also have to take into account the required time for investing or trading. To engage in day trading, you will need a trading account and a reliable online trading platform to execute your trades efficiently. Investing only needs a few hours per month (if it is not less specially with ETFs), while trading has to be a full-time job to be profitable. (if trades are successful).
1Article from the journal of Financial Markets
Leave a Reply