Investing vs Trading - What Is the Difference❓
Investing and trading - which are sometimes, and incorrectly, used interchangeably - are two different methods of attempting to create wealth in the financial markets.
If you are someone who is guilty of incorrectly mixing these terms up, or you simply just want to find out what the difference is, you have come to the right place! In this article, we will take a look at investing vs trading and explain the nuances of both.
Investing and Trading Explained
Investors and traders both approach the financial market for the same purposes: the creation of profit. In this regard, investing and trading are essentially two sides of the same coin, whilst they share a common goal, they differ in how they attempt to achieve that goal. If we could boil this difference down to one main word, that word would be time.
Generally speaking, investing is a long term approach of attempting to make money in the financial markets, whereas trading involves short term transactions. In the following sections, we will look at investing vs trading in more detail.
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Investing: The Art of Long Term Growth
The aim of investing is to build up profit over the long term, most commonly by buying and holding financial instruments, whether these are stocks, bonds or mutual funds.
Investors are not typically interested in short term price movements in the financial markets, but instead take a more holistic approach to the financial markets. They are more interested in the overall growth of their investment and are happy to wait an extended period of time for this growth to take place.
A lot of people reading this will already be making regular investments, or at least will have done so in the past, whether or not you have realised it. Paying money into a pension, either publicly - through National Insurance contributions - or privately, is investing money towards your retirement.
You may not be actively managing your portfolio, or even paying much attention to it, but you are still investing your money with the aim of creating wealth for the future and have merely delegated the day to day management to somebody else.
Trading: The Skill of Short Term Profits
On the other hand, trading is all about exploiting short term price movements in the financial markets. Traders speculate on both rising and falling prices with the goal of smaller, but more regular, profits.
Due to the short term nature of trading, it is a much more hands on experience than that of ‘buy and hold’ investing. Traders spend a lot of time looking at price charts and thinking about their next move, whilst entering and exiting the market on a far more frequent basis.
They analyse the financial markets, seeking the perfect time to both enter the market and to exit it in order to ensure maximum profit or to limit their loss.
Whilst an investor may not be too concerned over a temporary dip in the market, as they are looking at the bigger picture, successful traders tend to cut their losses short quickly.
Fundamental vs Technical Analysis
So far, we have differentiated investing vs trading largely on the basis of the time period involved, but there are other differences we could look at, one being the type of analysis used to make decisions.
When it comes to investing, market participants are generally mainly interested in fundamental analysis. Fundamental analysis will look in detail at macroeconomic factors as well as the performance and results of the company, fund or market in question.
For example, when an investor analyses the stock of a company, they will examine the general state of the economy, how the relevant industry is performing and also scrutinise the company’s past results and current state of affairs.
This analysis is important in being able to choose a suitable investment which will provide the long term growth an investor is looking for.
On the other hand, whilst traders may employ elements of fundamental analysis within their decision making process, their focus tends to mainly be on technical analysis.
Technical analysis is the practice of using historical price data to predict future movements in price. Traders conduct this analysis on an asset’s price chart with the assistance of technical indicators and will have predetermined criteria which need to be satisfied in order for them to enter and exit a position.
Depicted: Admirals MetaTrader 5 - GBPUSD Daily Chart. Date Range: 27 January 2020 - 19 March 2021. Date Captured: 19 March 2021. Past performance is not necessarily an indication of future performance.
Investing vs Trading: Which Is Better?
As with many things in life, there is no right or wrong answer to this question. Neither is necessarily more profitable nor more conducive to success than the other.
Which is better depends entirely on the person in question and what they are looking to achieve from the financial markets. Somebody who wants to be constantly active in the markets whilst attempting to secure short term profits will be better suited to trading.
However, somebody who prefers the idea of taking a more passive route and looking to build up steady profits over a longer period of time will be more drawn to investing.
Is One Riskier Than the Other?
In terms of risk, it is generally accepted that, when it comes to the financial markets, the shorter the time period, the greater the risk.
This is due to the fact that traders, particularly ones with the shortest time horizon, enter and exit the market far more frequently than investors. To put it simply, the more often you enter the market, the more likely you are to lose money.
Moreover, the majority of traders tend to trade on leverage, meaning that they are accessing larger market positions with a lower deposit. These larger positions allow traders to magnify their profits when the market moves in their favour, however, when the market moves against them their losses are magnified to the same extent.
Naturally, that is not to say that investing is without risk, because, of course, that is not the case. Both investing and trading run the risk of loss of capital and both should be approached with caution by people who are new to the financial markets and those who are experienced alike.
Before embarking on an investing or trading journey, it is important to familiarise yourself with the intricacies of the financial markets and to practice on a demo trading account before risking your own capital.
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.