The growth in the stock market over the years and its potential for growing one’s money makes it the asset preferred by everyone. The stock market has become easy to access since transactions can be done from any corner of the world as long as one has access to the internet. This has led people to wonder, trading vs investing which is better. In this article, we will discuss both to help you understand which one is more suited to you.
Based on the duration of the transaction, you can either trade or invest in the stock market. While both types of transactions are carried out in a similar manner, they are distinctly different with regards to the decision-making factors and the end goal. The stocks that are preferred for trading and investing are different and you must pick the appropriate stock for each activity. Let us first define trading and investing and then understand the differences between the two.
When a stock is held for a few seconds, minutes, hours, days, etc. but for less than a year, it is considered as trading. These short term trades are taken for making immediate profits. Individuals that trade on the stock market are referred to as Traders.
When a stock is held for a longer duration of more than a year, generally 3-5 years, it is considered as investing in the stock. Investments are done with the goal of wealth creation. Individuals that invest in the stock market are referred to as Investors.
While trading and investing in the stock market are pursued with the goal of capital appreciation and making profits, both are done with different intentions and require separate skill-sets to accomplish successfully. Traders will take short term trades and withdraw the profits. Their goal is to take multiple trades in a short period of time and book small profits. Traders can make money in rising as well as falling markets. However, investors park their funds in different stocks and hold the positions for a longer duration so as to create wealth through better returns and to take advantage of the growth in the stock prices over the years. Investors may prefer stocks that give regular dividends and then reinvest the dividend income in the stocks. The mental attitude of traders and investors is different.
The rules you must follow for trading vs investing are very different. The perspective with which traders and investors view the markets differs as well. This makes it difficult to engage in both activities simultaneously. Trying to carry out trading and investing at the same time and trying to keep both perspectives in mind can lead to confusion or analysis paralysis. This makes it difficult to make decisions since the mind is conflicted and thus people fail to execute either transactions. This conflict or confusion can lead to losses and make people unsure of their decisions even when they find a good opportunity to make profits in the stock market.
In order to ensure that you do not get stuck and miss out on good opportunities in the markets, you must evaluate your options and your goals and decide whether you want to be a Trader or an Investor. Once you have made your decision, you can focus your time and efforts on honing the required skills to become successful.
Differences in Trading Vs Investing
As discussed above, let us look through the criteria that will help you decide whether trading or investing is better suited for you and aligns with your goals. We will also discuss the rules you must follow in each case.
- Short Term or Long Term
The first decision you must make before you enter the stock market is to decide whether you wish to trade for the short term or invest for the long term. When a Trader takes a trade for the short term, the frequency of trades is higher as compared to an Investor’s trades. This allows the trader to book smaller profits on a regular basis while investors must have patience and be willing to wait for a long time for wealth creation. They might not see immediate profits but their capital is bound to appreciate in the long term.
A company may not be performing very well in the short term but if it has shown consistent growth and has the potential to grow further, you might not select it for trading but it can still be a good investment opportunity.
- Price Vs Value
The analysis carried out by traders and investors differs greatly. Traders must study price movements through Technical Analysis. This includes studying candlesticks patterns, price action, oscillators, momentum indicators, other volume and price indicators, trading strategies, Dow Theory, Elliot Wave Theory, etc. These studies can be applied on candlestick charts to make them easier to analyze. The trading indicators and strategies give entry and exit signals in bullish, bearish, and sideways markets, enabling traders to generate profits irrespective of the market conditions.
Investing, on the other hand, requires gauging the value of the stock to find the right price. This can be done through Fundamental Analysis. It involves studying the financial statements and financial ratios of the company to judge whether it is a good investment through its performance. You will need to study the Balance Sheet, Income Statement, Cash Flows, etc. of the company and then compares these figures to those of its competitors to decide which is a better investment to grow your money. Most of this information can be found in the Annual Report of the company. Understanding the management and its plans for the future of the company can also assist you in decision-making. The value of an investor’s stock portfolio grows only when the stock prices go up.
- Adhering to Stop Losses or Increasing Investment
When the market goes in the opposite direction of your trade and gives you losses, the nature of your trade will help you decide the next step. When it comes to trading, protecting your capital through proper risk management is essential so that you will have sufficient funds to take another trade to cover up the losses you have booked. Hence, short term trades will hit the stop loss levels and allow the traders to cut their losses and free up their capital to seek other trading opportunities that are more likely to result in profits. However, investors must use this opportunity to buy more quantity of the stocks they own since they are available at lower prices. This will increase their holdings in the stock and lead to higher returns when stock price increases again.
- Generating or Investing Cash Flow
When it comes to trading vs investing stocks, the individual must decide whether they wish to withdraw the profits generated through the trades or re-invest them. When trading, you may wish to book and withdraw your profits and then use them to cover your expenses. But when investing, any profits you book on your long term trades or any dividends received on your investments must be reinvested in the markets. This reinvestment increases your holdings and will contribute to further wealth creation. Thus, what you plan to do with your cash flow can define whether you should trade or invest in the markets.
- Small or Big Returns
While generating profits is the goal for traders as well as investors, the returns involved in both cases differs vastly. Traders seek smaller returns more frequently while investors seek big returns but infrequently.
A trader must not hold the stock beyond the previously decided time frame of the trade since their analysis might not remain valid beyond a certain time and could lead to unexpected price movements which could turn profitable trades into big losses. They must book profits according to their strategies or at least trail their stop losses to safeguard their profits. Furthermore, an investor must avoid the temptation to book small profits and must wait for the stock to reach its full potential. Since the stock was chosen for investment, it must remain in your portfolio provided it still has the potential to grow.
We hope that the above information will help you make the right decision between trading vs investing.
Follow us on LinkedIn