Investing vs trading

by Admin
Updated: August 11, 2018

The key advantage of investing vs trading should be long-term gains with a lower risk-reward ratio

Investing and trading are essentially the same thing: Buy something and hope it goes up in price. The key difference deciding between one term and the other is time frame: Investing is long-term (years), trading is short-term.

A trader expects to realize a profit from buying and then selling, i.e. when the price has gone up by a predetermined amount the trader will sell. An investor will generally continue to hold until the expectation of continued growth & profits is dimished.

Trading

There are different types of trader depending on the timescale, here are some definitions:

  • Close out: To restore to the starting position, e.g. if you started out holding US dollars and bought other currencies, you close out by converting everything back into US dollars.
  • Swing trader: Someone who is prepared to stay in a trade multiple days or weeks to take advantage of a trend.
  • Day trader: Someone who closes out their position within the business day.
  • Arbitrage: Instantaneous buying and selling at a profit (exploiting a difference between two markets).

Following the initial decision to buy, trading can be very time-consuming because it demands intense monitoring.

In principle, the reward for this extra effort is a higher return. Buying low and selling high in a highly active market will produce a return on each transaction even though the price at the end of the day might not have changed.

Traders will generally set a stop loss whereby they will sell if the price drops below a certain level even if it means making a loss in order to prevent an even bigger short-term loss. Large fluctuations in the market can trigger stop losses even if the trend is upwards.

Investing

After the initial decision to buy, investing requires little further involvement because the investor has faith in the fundamentals of the investment and does not get distracted by short-term price fluctuations. Nevertheless, periodic review is essential to make sure the investment is still on track.

Any investment based on sound growth principles should make some kind of gain given sufficient time. Such an investment represents very low risk so the risk/reward ratio will be much lower than for any individual trade even if the rewards are ultimately disappointing.

Investing in trading

While an investor would not be concerned with individual trades, financing a group of traders who are expected to make net gains over time would be an investment. This is essentially the philosophy behind investing in a business.

Income and growth

Making an investment in something that generates an income without necessarily gaining real value is a valid investment, particularly for things like pension funds.

Investing in something that’s expected to gain saleable value in the future, even if it doesn’t produce income along the way, is a valid investment - capital gains can produce some of the highest returns.

Of course, it makes most sense to do both. Investing in real estate that is rented out is the classic example of this. Investing in a business can also qualify depending on the extent to which profits are distributed as opposed to being reinvested in growth.

Transitions

If you buy into an investment and it suddenly increases in value and you sell, then you’ve become a trader.

If you enter into a trade and the price drops and you don’t want to sell, then you’ve become an investor (but really only if you went in on the basis of fundamentals).

Dichotomy

Making good investments when you are very young generally leads to financial security if not great wealth later in life. Unfortunately, when you are very young, you usually have neither the means nor the inclination to invest long-term.

Later in life, when you’ve realized that making good investments when you were very young would have been a really great idea, it often seems like there isn’t enough time left to sacrifice enjoying life for saving.

More info

“Investing vs Trading: Which is better and how to become a good one?” at infimoney.com

“Warren Buffett Tells You the Difference Between Stock Trading and Investing” at fool.com

“How to Know the Best Way to Invest for Yourself” at thebalance.com

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