The terms trading and investing have become somewhat of an umbrella term, with many people using the two interchangeably.
But are these two terms really that similar?
And does it matter what you call what you do if you’re trying to earn money?
Before you decide whether to start trading or investing, take some time to learn about the distinction between these two practices and why it matters.
Here’s everything you need to know about the difference between trading and investing and how it can affect your financial future.
What is the difference between Trading and Investing
The most significant difference between trading and investing is in their objectives.
Investors buy a portfolio of different investments over time to help them reach financial goals, including retirement.
On the other hand, traders buy securities with an intent to resell those same securities at a higher price within a short period of time.
Another key difference between trading and investing is how both investment strategies are taxed. While most long-term investments in stocks or bonds are taxed at 15 percent for capital gains, traders must pay taxes every year on trades based on their annual income.
For example, if you make Rs 1000 in profit from your Rs 100,000 investment (excluding fees), you will owe taxes on that Rs 1000 as if it were regular income.
It’s also important to distinguish between investors and traders when it comes to risk tolerance: Traders need more flexibility than investors because they’re operating under short timelines—many day traders close out their positions by 5 p.m. before some markets have even opened.
And unlike an investor who wants his money back someday (or maybe not), a trader needs zero concern about getting out of his position completely or having enough money left over for any rainy days along the way.
With that in mind, traders typically find that keeping tight stop losses on their investments is very important to success.
Many investors, however, think that stops are considered bad trading since they can lead to taking large losses too early if you happen to be wrong. But if you don’t use stops, then your average loss per trade could be much greater than 2 percent — adding up with every stop-less trade over time.
If you’re considering becoming a trader, we recommend exploring your own comfort level by using stops as one strategy for managing your trades effectively. I hope these examples help clarify some of the differences between trading and investing.
Few general Rules for Trading and investing
There are plenty of ways to differentiate between trading and investing. The following are a few general rules:
- An investor puts money into assets in hopes that they will rise in value over time.
- A trader buys assets with short-term goals, like hoping to make a profit on fluctuations in price during any given day or week; trades can last for minutes, hours, days, or weeks. – An investor wants long-term gains; a trader looks for quick profits.
- The primary motivation of an investor is to earn money; an investor is focused on taking less risk rather than looking for high returns (although gains are appreciated).
- A trader does not have to think about managing assets because he or she doesn’t plan on holding assets for long periods of time. A trader can end up being rich, but most traders lose money. If a trader has a negative experience with one asset class, such as stocks, he or she can shift focus to another. An investor must stick with investing until their goals are met or retirement approaches.
- When investing, you try not to sell at a loss; when trading, selling short may be part of your strategy.
- An investor buys assets based on fundamental data like annual reports and balance sheets.
How to Decide if you are a Trader or an Investor
Before you can decide if you are an investor or a trader, you need to determine if investing is right for you. To do that, ask yourself some questions:
- Do I want to invest with a long-term goal in mind?
- Would I be comfortable with not knowing exactly when my investments will pay off?
- Can I live without frequent trading?
If your answer to all three of these questions is yes, then you’re probably an investor. If not, chances are good that being a trader might be right for you.
However, remember that either type of investing will require patience—with both waiting on market conditions to improve and waiting on time to pass so your investments can mature.
What trading really means
Understanding the difference between trading and investing is important. Strictly speaking, both involve buying or selling something with an expectation that it will appreciate in value.
Investors tend to be optimistic about long-term prospects for their investments, hoping for growth in a company’s earnings or profits over time—while traders may have no interest in a company’s fundamentals at all. Their goal is to generate returns from short-term fluctuations in price.
The bottom line: While traders are buying and selling stocks with an eye toward short-term gains, investors are looking further down the road for profit potential. For most people, investing makes more sense than trading as a way to build wealth.
By purchasing shares of solid companies and holding them over time, you can realize greater returns while taking less risk than day traders do. That’s why professional money managers frequently choose to invest rather than trade themselves.
And don’t forget: Don’t try to go against the Stock market—or your broker/advisor—if you’re investing for longer-term goals such as retirement. You could get hurt financially if you trade on your own without thoroughly researching investment options first.
Common trading mistakes people make
Trades are sometimes made for reasons that have nothing to do with investing. Many investors make decisions based on fear, greed, envy, or hope — not logic.
If you’re looking to buy something because you’re confident it will go up, you’re speculating.
If you’re buying something because you really need it (for example, a car), or because someone convinced you there’s no way it can lose value in your lifetime, then you’re probably investing.
While both trading and investing involve putting money into assets in an attempt to make a profit, speculation has less to do with fundamentals than with emotions; investors look at factors like earnings reports and balance sheets.
Common investing mistakes people make
Not diversifying their portfolios. Most people think investing means buying several stocks of different companies, but that’s called stock picking.
This is because an individual stock can experience extreme volatility—if a company experiences bad news or worse-than-expected earnings, even if it doesn’t go bankrupt, its stock price can plummet.
Not understanding investment fees. Brokerage firms generally charge some form of fee for investing.
It can be expressed as a percentage of your assets under management, or it can be an annual percentage. This cost should be included in your overall investment costs because it reduces your returns over time.
The lower these fees are, the better off you’ll be. Because most investment companies don’t always provide a clear breakdown of their fees, it’s important to do some research before choosing a company with which to work.
Tips for both traders and investors
1. Have a clear understanding of your goals, otherwise known as your why. If you don’t know why you’re doing what you’re doing, odds are it won’t be worth it in the end.
2. Don’t try to predict when a market is going to do anything; instead, focus on determining what it is already doing by looking at technical and historical information from companies. Markets aren’t entirely unpredictable and there’s always an easy way to make a profit; whether or not that’s for you depends on your tolerance for risk.
3. Be realistic about how much work really goes into investing, investing wisely takes discipline and some people just aren’t ready for all that—including profits—investing brings.
4. Don’t let anyone tell you what kind of portfolio makes you more successful or any other nonsense like that (exaggeration aside, but only slightly).
5. Check out investing blogs and read books about trading and investing.
6. Most importantly: START! You’re never going to get rich if you keep trying to get rich.
The main difference between trading and investing is that one is active while the other is passive.
While investors buy stock in companies they believe will make money over time, traders trade stocks in hopes of cashing in on short-term price changes.
As mentioned above, both ways can make you rich if you do it right.