What is the difference between investing and trading?

By Jean Folger AAA
A:

Investing and trading are two very different methods of attempting to profit in the financial markets. The goal of investing is to gradually build wealth over an extended period of time through the buying and holding of a portfolio of stocks, baskets of stocks, mutual funds, bonds and other investment instruments. Investors often enhance their profits through compounding, or reinvesting any profits and dividends into additional shares of stock. Investments are often held for a period of years, or even decades, taking advantage of perks like interest, dividends and stock splits along the way. While markets inevitably fluctuate, investors will "ride out" the downtrends with the expectation that prices will rebound and any losses will eventually be recovered. Investors are typically more concerned with market fundamentals, such as price/earnings ratios and management forecasts.

Trading, on the other hand, involves the more frequent buying and selling of stock, commodities, currency pairs or other instruments, with the goal of generating returns that outperform buy-and-hold investing. While investors may be content with a 10 to 15% annual return, traders might seek a 10% return each month. Trading profits are generated through buying at a lower price and selling at a higher price within a relatively short period of time. The reverse is also true: trading profits are made by selling at a higher price and buying to cover at a lower price (known as "selling short") to profit in falling markets. Where buy-and-hold investors wait out less profitable positions, traders must make profits (or take losses) within a specified period of time, and often use a protective stop loss order to automatically close out losing positions at a predetermined price level. Traders often employ technical analysis tools, such as moving averages and stochastic oscillators, to find high-probability trading setups.

A trader's "style" refers to the timeframe or holding period in which stocks, commodities or other trading instruments are bought and sold. Traders generally fall into one of four categories:

  • Position Trader – positions are held from months to years
  • Swing Trader – positions are held from days to weeks
  • Day Trader – positions are held throughout the day only with no overnight positions
  • Scalp Trader – positions are held for seconds to minutes with no overnight positions

Traders often choose their trading style based on factors including: account size, amount of time that can be dedicated to trading, level of trading experience, personality and risk tolerance. Both investors and traders seek profits through market participation. In general, investors seek larger returns over an extended period through buying and holding. Traders, by contrast, take advantage of both rising and falling markets to enter and exit positions over a shorter timeframe, taking smaller, more frequent profits.

RELATED FAQS

  1. How do I judge a mutual fund's performance?

    Evaluate mutual fund performance utilizing resources such as Morningstar; compare the fund with others in its peer group ...
  2. How do I judge a mutual fund's performance?

    Evaluate mutual fund performance utilizing resources such as Morningstar; compare the fund with others in its peer group ...
  3. What's the difference between alpha and beta?

    Learn about alpha and beta, two very important technical risk ratios that investors use to evaluate relative performance, ...
  4. How can I protect my portfolio from market corrections?

    Learn about some of the types of investment strategies designed to protect an investment portfolio from losing value during ...
RELATED TERMS
  1. Discretionary Investment Management

    A form of investment management in which buy and sell decisions ...
  2. Account Minimum

    The minimum balance required to be maintained in an investment ...
  3. Capital Growth

    The increase in value of an asset or investment over time. It ...
  4. Absolute Percentage Growth

    An increase in the value of an asset or account expressed in ...
  5. Compound Annual Growth Rate - CAGR

    The year-over-year growth rate of an investment over a specified ...
  6. Return On Investment - ROI

    A performance measure used to evaluate the efficiency of an investment ...
Related Articles
  1. What Can The Monte Carlo Simulation ...
    Fundamental Analysis

    What Can The Monte Carlo Simulation ...

  2. Using Normal Distribution Formula To ...
    Investing Basics

    Using Normal Distribution Formula To ...

  3. Swing Trading Indicators: For Those ...
    Trading Strategies

    Swing Trading Indicators: For Those ...

  4. Human Capital, An Important Asset For ...
    Investing Basics

    Human Capital, An Important Asset For ...

  5. Tracking Your Portfolio On Yahoo! Finance
    Investing Basics

    Tracking Your Portfolio On Yahoo! Finance

Trading Center