Trading and investing are two different methods of trying to profit in different financial markets. The end goal for traders and investors is to make profits by participating in the market. Traders take advantage of rising and falling prices.
They enter and exit positions in a short period of time while taking smaller and more frequent profits. Investors, on the other hand, focus on larger returns over a longer time horizon by buying, holding, and collecting dividends.
- Trading involves the use of short-term strategies to take advantage of rising and falling prices in a shorter time frame to capture profits daily, weekly, monthly, and quarterly with frequent entries and exits.
- Investing has a long-term approach and focuses on building returns over an extended period through buying, holding, and collecting dividends, and reinvesting profits.
- Traders take frequent losses and profits, while investors tend to ride out short-term losses and focus on building their portfolios in a diversified manner.
Traders buy and sell securities at a much higher frequency when compared to investing. Traders will buy and sell different securities such as stocks, bonds, futures, options, currencies, commodities, and other financial instruments in a matter of minutes, hours, days, weeks, months, and so on. It all depends on the type of trading strategy they are using.
Trading aims to capture returns that outperform investing.
While standard investing in stocks, bonds, and other financial instruments may yield you modest returns of 10% to 20% per year, trading can yield you returns of 10% to 20% per month or more. While trading can offer higher potential returns than traditional investing, it also tends to carry more risk if you don’t know how to adequately control your losses.
Traders can make money by buying (going long) or selling (short selling) securities in any market. They also tend to trade within a specific period and use technical analysis tools to find trades that are in line with their strategy.
Investing aims to build wealth gradually over a long period of time through buying and holding a portfolio of stocks, bonds, mutual funds, and other financial assets. Investments are held for several years or even decades with the goal of capturing dividends, interest and stock splits to grow the portfolio.
Investors focus on finding high-value companies with strong fundamentals, great products, great management, and strong profits margins to invest in that will produce steady returns for them over a long period of time. They are less concerned with daily, weekly, or quarterly price fluctuations and are more concerned about how a company will perform over the course of several years.
The most common form of investing for most people is through a traditional 401(k) plan or IRA. Investors contribute a portion of their monthly pay to their 401(k) or IRA plan and allocate money to different funds.
Different Types of Trading Styles
There are many different types of trading styles. They will tend to differ based on the traders’ goals and preferred holding period. Traders are most often broken down into the following trading styles.
Day Trading: Positions are held throughout the day without any overnight positions.
Position Trading: Positions can be held from a few months to a few years, typically used for hedging purposes and risk reduction purposes.
Swing Trading: Positions are held from a few weeks to a few months.
Scalp Trading: Positions are held from a few seconds to a few minutes.
HFT Trading: Position frequency is extremely short-term and primarily done with computerized algorithms which take advantage of pricing inefficiencies or statistical arbitrage.
The Benefits of Trading
- Trading allows traders to capture short-term opportunities as they arise in the market.
- Ability to speculate on small prices changes.
- With the advancement in trading technology, you can trade from anywhere in the world.
- Forces you to learn and stay up to date on current and future financial events.
The Cons of Trading
- The fees associated with trading can be quite high depending on your trading frequency and broker.
- Short-term volatility can cause massive swings in your portfolio P&L.
- Traders are subject to more emotional duress due to the frequency of trading.
- Analyzing information and technical factors can be extremely time-consuming.
- Since you will be closing positions frequently, your short-term gains will be taxed higher.
The Benefits of Investing
- One of the primary benefits of investing is that you get to experience much more stable returns.
- Investing tends to have much lower fees when compared to day trading.
- Less time-consuming than day trading.
- Investing can provide a stable source of regular income through dividends.
- Investing allows you to readjust your risk appetite as your needs in life change.
- Holding positions for over a year allows you to tap into the long-term capital gains tax, which can lower your tax rate on your investment gains.
- Historically, stocks have an annualized return of at least 10%, which allows you to stay ahead of inflation.
- Investing can help reduce your yearly tax liability.
The Cons of Investing
- Returns take a longer time to accumulate and build up your portfolio.
- Depending on what kind of funds your investments are in, it may be very difficult for investors to outperform the broader stock market.
- Your investments may be limited to the funds offered within your 401 (k) plan.
- Your investment plan may have maximum contribution limits which can prevent you from growing your portfolio further.
Is Trading Better Than Investing?
Trading is simply different than investing. There’s no way to say that one is better than the other because everyone has a different risk appetite.
Some people might do better at managing and trading their own capital actively. While others are better off investing their money for the long term in stable funds. It will vary based on the individual’s needs, long-term plans, and ultimately risk appetite.
Do Traders Make More Money Than Investors?
There are instances in which day traders make significantly more money than investors and that is highly dependent on the amount of risk that they take. There are also instances in which investors outperform day traders in the long term as they are focused on capital preservation and long-term growth rather than speculation in small short-term moves.