What is the difference between investing and trading?
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.
Both terms could actually be defined very broadly, and I am sure financial professionals could come up with many differences between the two. Here are the basics in my view.
Investing is the act of owning something, it could be an individual stock, a mutual fund, a property, or anything else you feel has less value today than you think it will in the future. Trading is the actual transaction that occurs when you buy or sell investments. If you are an investor, typically it means you are a person who is holding on to something for the purpose of earning a profit when the value increases. If you are a trader, then you are the person creating transactions. You are buying or selling the investments for yourself or others. Traders could be viewed as attempting to take advantage of short term market swings, while investors could be said to take a more long term approach.
Hope that defines it for you. Happy investing. . .or should I say trading? Your choice.
Wyatt A. Moerdyk, AIF®
Chief Compliance Officer
Accredited Investment Fiduciary®
10004 Johns Road
Boerne, TX 78006
Investment Advisory Services offered through Evidence Advisors, LLC, a registered investment advisor. Investopedia, LLC and Evidence Advisors, LLC are not affiliated.
What a great question for Investopedia!
This is really a philosophical question of sorts because there is some blurring between the terms. In a nutshell, however, investing is generally the pursuit of a longer term increase in the value of a security such as a stock or bond. Trading is really not concerned about the long-term prospects of a security--rather a trader seeks to profit simply from the pricing movement of a security. I hope that helps. Good luck!
This is a question that will no doubt receive a number of differing responses! I consider investing to be a process with a relatively known outcome. One example is purchasing an investment grade bond. Barring default, one can expect to receive interest over the life of the bond and principal at maturity. Trading, on the other hand, has outcomes that are more difficult to predict. When one purchases a stock or an equity mutual fund, there is really no way of knowing in advance whether it will go up, down or sideways. For these reasons, one must have specific risk management rules when trading such as position-sizing, stop losses, etc to limit the risk to acceptable levels. Van Tharp has written a very good book on this complex question titled: "Trade Your Way to Financial Freedom." You can find much more information in there.
Think “investing” as a form of planning, and “trading” as the final execution. Ideally you want to have a plan first before any implementations, but in reality, many investors have itchy fingers and are ready to trade as the result of obtaining financial tips from the grapevine. Naturally we all want to get rich faster, and watching or hearing our family, friends, and neighbors doing well financially motivates us even more to catch up. However, your family and friends’ situations may very well different from yours. They may have a big emergency fund set up so they’re comfortable with their investment strategy even if the sky is falling. On the other hand, you may only have one brokerage account, and you may get a double-whammy at the worst time—access your money when the market is down. So, ask yourself, “If I’m a solider on the ground, would I go to a rescue mission without a plan?” If the answer is no, you know you need to consult a professional CFP® to get an investment plan done first before making the trades. Best!