Key Differences Between Trading vs. Investing
Financial markets offer two philosophically opposed approaches to making money, and they pose significant differences that allow preferences to influence decisions. Both trading and investing share a common goal of outperforming inflation as well as the market, but their primary difference lies in the approach to conducting in the market. Each method has benefits and disadvantages, and neither discipline offers the perfect strategy.
Understanding the Differences
While both approaches to accumulating wealth on the market involve executing financial transactions, the similarities end there.
An investment represents a pledge of capital to an asset to obtain a positive return at an undefined point in the future as a “buy and hold” strategy. Investments may take decades to mature, and investors readily accept that condition. Most investors execute transactions only a few times each year, basing decisions over a long timeline. A return of more than 6% on capital generally meets investors’ expectations.
Working on a shorter timeline than investors choose, traders focus on generating “an immediate and regular cash flow” through daily exposure to capital risk. Traders seek to gain maximum returns in single trading sessions. While traders may select some of the same securities that investors choose, they may also prefer derivative products as well. Price fluctuations allow traders to capitalize on short-term gains in trades that may take only a few seconds each to execute in hundreds of transactions in a single trading session.
Traders expect a gain of 10% each month.
Considering the Pros and Cons of Investing
The differences between trading and investing pose no challenge for the advocates of each. They know which approach suits their preferences, as well as the advantages and disadvantages, and it cannot dissuade them. Even so, they evaluate the plus and minus aspects as they find ways to make their money work for them. On the plus side, these factors contribute to decision-making:
- Compounding: Assets can become more valuable over time as revenue from interest rates allows reinvestment that increases “debt instrument valuation.”
- Limited Short-term Liability: By “riding-out” tough markets instead of reacting to periodic volatility, investors limit risk with products that return value to an investment over time.
- Transaction Costs and Tax Liabilities: Investors can avoid transaction costs by limiting the number that they choose to pursue, and some accounts qualify for “tax breaks on realized profits.”
- Unexpected Capital Gains: Investments may increase over time with unanticipated stock splits or dividend payments.
On the negative side, investors may not have access to available capital until liquidation can occur, and market timing can affect the value of an investment when an investor decides to sell it. Low rates of return can occur when the market turns downward.
Evaluating the Pros and Cons of Trading
Positions open and close rapidly, avoiding risks of a “total market collapse” through an active trading philosophy
Protection from account drawdowns
A series of positive trades can build up a reserve of funds
Traders who use leverage can risk smaller amounts of capital to gain profit
Exposure to short-term volatilities can severely draw down a trading account
Fees and commissions can cut into a trader’s profit picture
Tax liability on short-term capital gains can affect the financial outcome
Reliance on technology for internet and information systems
Traders consider it a plus to achieve liquidity by opening and closing positions rapidly, and they avoid risks of a “total market collapse” through an active trading philosophy. The ability to exit an undesirable position quickly provides protection from account drawdowns, and a “series of positive trades” can build up a reserve of funds. Traders who use leverage can risk smaller amounts of capital to achieve the profit that they desire.
Traders consider exposure to short-term volatilities a minus as they can occur at any time and severely draw down a trading account. Fees and commissions can cut into a trader’s profit picture, and the tax liability on short-term capital gains can affect the financial outcome as well. The support of technology for internet and information systems can impose a capital investment from traders for “equipment and infrastructure updates.”
Knowing When to Sell Stocks for Short-term Profit
The stock market offers some guidelines that become easy-to-remember slogans such as “buy low and sell high.” Market performance shows that Investments become worth more than the purchase price over the long run of at least 10 years. When an investment becomes worth more than an investor initially set as an exit point, it needs to go. A requirement for cash can motivate an investor to liquidate an asset and invest elsewhere, a good reason for selling. In some cases, an investor may want to rebalance a portfolio by taking short-term profits on a stock that performed well.
Focusing on Stock Share Prices for Long-term Gains
The slogan that guides a decision to sell stock shares applies as well to buying them. However, the ability to identify a low price depends on variables that present challenges. Technical indicators such as trade volume may provide some guidance, but many experts consider the practice risky. Other guidelines include analyst reports and consensus price targets that present an average of opinions from all analysts. Knowledge of how to determine when a stock price reaches its lowest point provides one of the most sought after aspects of investing.