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The difference between trading and investing in the stock market is an important distinction when you’re trying to understand market fundamentals, and working on your personal finance strategy.
If you’re just starting out with understanding the stock market, the economy and all the things that make the system run, it can be overwhelming.
Every time I have a conversation about the stock market, it seems to be under the assumption that there is some form of gambling going on with the markets. A form of gambling that only some elite group of people are able to participate it.
I like to keep up with the stock market, and the world of finance, but I don’t consider myself to be a gambler. I definitely do not have the risk appetite of someone who plays poker at the casino.
Most of my stock market portfolio is invested in good quality companies with strong business models, and great long-term potential. I do have a small portion of money that is set aside for trading. This means that I might be getting in and out of a stock position really quickly, within hours, or days.
Knowing the difference between investing and trading can help you become a more confident investor, while particpating in market returns to grow your wealth.
So what really is the difference between trading and investing?
Trading vs. Investing: What is the difference?
Timing: Length of position
Investors buy stocks to hold long term. Whether 5, 10, 15 years, whatever the time horizon one might have for growing wealth. Investors aren’t usually looking to time the market.
Traders, on the hand, typically look to time the time – buy low, sell high. A trader would be looking to get in and out of stock holdings within minutes, hours, or a few days.
Goal
Investors typically have a goal to invest, and build wealth over the long-term by purchasing small pieces of good businesses. Their mentality is to buy and hold “forever” or at least a very long period of time.
Traders are looking to get in and out of trades as quickly and profitably as possible. They’re always looking for opportunities where they think the market has not fully priced in a stock.
Time required
If you’re investing for the long term, you don’t need to invest a large part of your time in this activity. It should be an automatic part of your financial life.
As a long term investor, you invest periodically, in fundamentally strong companies. You won’t worry so much about daily ups and downs of a stock, as long as they have a strong base to continue working in the future.
As an investor, the mindset is that you are literally investing in the business. You won’t be looking at daily fluctuations of your net worth, but rather focus on overall trend of your positions over weeks, months or years.
A trader, however, look at their holdings daily, or even several times a day. They are trying to profit off the price movement of stocks, and would be getting in and out of trades within minutes, hours, or a few days.
Belief
Investors hold stocks for long term. They believe that the businesses that they have invested in will be around for a long time, and will continue to generate profits in the future which will help increase their stock prices and/or dividends.
A trader would be looking to get in and out of trades very quickly to turn a profit. They are not so concerned with whether a company may be around over the next few years, because they do not anticipate holding the stocks for that long.
Type of knowledge – technical vs. fundamental
Typically, an investor will ask whether the company that they are investing in, is in a position to do well in the future. What are their long term prospects? Is the business in good shape? They might look at company statements, and quarterly filings to determine how profitable the businesses is and might continue to be.
On the other hand, traders typically focus on technical indicators, reading stock charts, and market psychology. Their goal is determine based on market psychology and trends whether a stock will move higher or lower in the short or medium term.
Making money
An investor is looking looking to grow wealth as these businesses perform better. Investors anticipate that businesses will grow their profits, then reinvest their profits into future growth and/or maybe pay dividends. As an investor, you might consider purchasing stocks with dividend income, as a way to increase your wealth.
A trader is typically risking capital for a return in the short term. They are focused on making money from buying low and selling high, and making a return from these short term price movements. A trader would not consider dividend income as part of their strategy, as they don’t intend to hold stocks long enough to realize dividend payments.
What’s right for me?
Now that you have a guide to the difference, it is time to incorporate this knowledge in your financial strategy.
If your goal is to create long term wealth, then investing is definitely the strategy you need.
My Philosophy: Trading is not for everyone; Investing should be for everyone.
On a personal note, I engage in both investing and in trading.
Trading is a semi-hobby for me. But I keep a separate account, with a small small sum of money set aside to engage in riskier trades, where the focus is on getting into stocks at the right price, focusing on the technical analysis and not pay too much attention to the future value of the company (as compared to investing). Majority of my portfolio however is in stable companies, index funds and ETFs, with a focus on slowly growing wealth.
You should make this assessment based on your personal financial situation, level of knowledge, interest and risk appetite. Trading can be a fun hobby or an additional source of income.
But for most people the first thing to focus on is to create a plan to grow your wealth long term, and create a sustainable plan to grow your wealth through investing!
Cheers,
