Trading vs Investing
Key Takeaways:
- Trading is considered a short-term market strategy, focused on quicker returns.
- Investing is a long-term financial strategy, that aims to yield steady returns over time.
Trading and investing are two distinct ways to approach the broad financial markets. And, some would say, the only two ways. Essentially, trading and investing can oftentimes be used interchangeably. They hold key differences with each having its own benefits and, to some extent, weaknesses.
In practice, trading is a strategy you can use in the financial markets if you’re looking to make profits in a relatively short time. Investing, on the other hand, refers to a financial approach that envisions staying in the market for a longer period of time.
The timeframe is the foundational difference between trading and investing. Again, trading can take place in the time span of minutes to a few weeks. And investing is a strategy that suggests holding your positions for months and even years.
Let’s dive in and take a deeper look at both financial strategies so you could decide what suits you better.
What is Trading?
Trading is an active financial strategy that refers to holding positions for a short time, from minutes to a few weeks. You can trade virtually everything in the global marketplace, from stocks to cryptocurrencies and commodities such as gold and oil.
Trading is generally considered a riskier approach to markets. Therefore, it is recommended you use a stop-loss order that would protect your portfolio from unwanted risks. On the other hand, the main advantage in trading is the ability to go short, i.e., sell a financial asset and profit from its decline.
Those market participants who practice trading are called traders. Their aim is to ride short-term trends and catch price movements that can yield attractive returns in the near future. Traders usually employ a variety of tactics and techniques when trading in the financial markets.
In order to assess where to jump in next, a trader looks at market news and upcoming reports, as well as chart formations and price behavior. These two, fundamental and technical analysis, are the basics of almost every winning trading strategy.
What are Some Trading Strategies?
Trading strategies differ mainly on two fronts: the analysis used and the time frame of market exposure. Traders can go both long and short, depending on their preferences and views of market developments.
Scalping:
A trading strategy that’s performed in the shortest amount of time possible. Practically, the aim of this approach is to “scalp” small profits from imminent moves in stocks, currencies, or other assets.
Day trading:
This strategy is focused on capturing intraday moves, or those happening in a single day. In other words, your trade should be opened and closed within a single trading day. This is preferred if you don’t want to roll a position into the next day, thus avoiding any unfavorable news.
Position trading:
A strategy for the financial markets that allows you to profit from ongoing trends. Spotting a trend is difficult when you trade in a single day. Position trading, on that note, could be stretched to several days in order to find a trend and ride it out.
Swing trading:
This strategy aims to take advantage of relatively longer price movements. Typically, swing trading is the trading strategy with the widest time horizon. It could span to several weeks of holding, so that once a trend is identified, it could develop and finish.
Trading Pros and Cons
Pros:
- Can go both long and short
- Take advantage of small intraday moves
- You can use high leverage for quick profits
- Diversification through more trading opportunities
- You can enter and exit quickly in every market
Cons:
- You need to monitor your positions almost constantly
- Closing positions early can result in missed profits
- High risk if no stop-loss order is used
- Overtrading can increase fees
- Can be costly until mastered
What is Investing?
Investing is the act of buying and holding financial assets for relatively long periods of time, usually months to years. In practice, investing requires a lot of in-depth research before opening a position. Investing is considered a ‘buy-and-hold’ strategy focused on long-term growth.
In more detail, investing is a widespread financial strategy, popular among institutional market participants, but also retail.
Betting on long-term trends cancels out the intraday noise of the market. In other words, investors disregard the current market state as long as their long-term objectives are still valid. This could mean that if a stock drops 5% on the day, that wouldn’t be a game-changer for an investor with a 20-year time horizon.
To this end, an investment would assume higher risk tolerance so that the position would have enough room to accommodate daily volatility. To better understand investing, let’s divide it into its various strategies.
What are some Investing Strategies?
Investing has many forms and variations but perhaps the most popular ones are these:
1. Active investing:
This is an investing strategy that suggests active management of your positions and funds. More specifically, it implies a significant amount of time in your day is devoted to monitoring and nurturing your portfolio.
This investing style aims to outperform the so-called index investing, or investing in benchmark stock indices like the S&P500. Once your active investing returns more than the S&P500, you get to call your returns ‘alpha’ returns, or superior to the benchmark.
2. Passive investing:
This investment style is suitable for those who only want to put their money into an index and forget about them. The goal of passive investing is to let your portfolio grow without you fine-tuning every little detail of it.
You can just buy an index like the 30-stock Dow Jones Industrial Average and match your performance to its own for a given period of time. Essentially, this style tracks the performance of the broad stock market.
3. Value investing:
A more specific approach in investing, value investing seeks to find undervalued companies with long-term perspectives for catching up to potentially bigger valuations. Warren Buffett is perhaps the brightest example of a value investor. He’s been holding value stocks, or those from relatively old and non-glamorous industries, for decades.
4. Growth investing:
This is a modern investment strategy that aims to scoop up shares of companies with long-term growth potential. Companies that are able to scale infinitely, like technology giants, are considered the best growth companies. Growth companies are the biggest companies in the world with Apple in the lead, worth roughly $3 trillion. This is because they have their future earnings expectations baked into the current price.
Investing Pros and Cons
Pros:
- Capture longer-term trends
- Less worry over positions
- Easier to buy and hold than trade actively
- Opportunities to diversify
- Historically, stocks have provided steady returns
Cons:
- Higher risk of portfolio drawdown
- Short-term fluctuations
- Emotionally challenging
- No guaranteed returns
- Stop losses would most likely not work
The Main Differences Between Trading and Investing
Trading and investing could be engaged in any market:
- Stocks
- Forex
- Indices
- Commodities
- Cryptocurrencies
While a trader may look to profit from short-term movements, an investor would be betting on long-term returns. With this in mind, the main differences between trading and investing are:
Trading is more about price speculation
Investing relies heavily on in-depth analysis
Trading could go long and short
Investing is mostly focused on long positions
Trading aims to capture short-term gains
Investing is focused on long-term appreciation
Trading or Investing: What to Choose?
Whether you choose trading or investing will ultimately depend on your own preferences. You could decide to aim for quick returns by betting on short-term trades. Or you could opt for the long run and focus on future growth prospects.
Of course, you may want to combine these market strategies. Trading and investing could be combined if the market environment allows for both to be employed.
Summary
Trading and investing are the two main ways you can approach the wide financial markets. They can be used in virtually any asset class, from stocks, through currencies, to crypto assets.
What you choose will depend on your own style and character. Nonetheless, both offer valuable techniques and strategies that could get you handsome returns both in the short-term and the long-term.
This said the possibility of combining trading and investing would most likely be more difficult but more rewarding.
The best way to decide whether you want to focus on trading, investing, or using them together, is to first observe the market and try to spot opportunities to enter, this way you can find short-term plays in currencies, and long-term plays in stocks, for example.
To this end, trading and investing could be your way to financial freedom as there are always opportunities in the market. Start acing the markets with TradOwise today!
