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Trading vs Investing: What’s the Difference?

TABLE OF CONTENTS

Trading vs Investing: What’s the Difference?

Trading vs Investing: What’s the Difference?

Vantage Updated Updated Mon, 2024 September 23 05:46

The terms “trading” and “investing” are often used interchangeably when discussing activities related to the stock market. While traders are, by definition, investors, not all investors engage in trading. However, both trading and investing share a common goal – that of generating profit from the price action of securities or assets. 

In this article, we will explore the distinctions between trading and investing, and learn about the key characteristics of each activity.  

Key Points 

  • Trading capitalises on short-term market shifts for quick profits, often through methods like short-selling, while investing aims for long-term wealth via asset appreciation. 

  • Traders leverage technical analysis to guide quick transactions, whereas investors use fundamental analysis to select assets for prolonged growth. 

  • The primary distinction between trading and investing lies in their time horizons and risk profiles. 

What is Trading? 

Trading involves the buying and selling of financial assets such as stocks, forex or commodities with the intention of making returns from their price fluctuations. Traders aim to capitalise on near-term price movements by reading the market and correctly placing appropriate trades. Typically fast-paced in nature, trading is commonly performed via strategies such as day trading, swing trading and position trading.  

A key characteristic of trading (compared to investing) is the use of short-selling to capture potential profit when prices go down. This allows traders to expand the profit potential of their trades to include opportunities in bearish conditions, and not just in bullish markets.  

Hence, while an investor may passively wait out a market downturn, an experienced trader would likely be busy looking for opportune moments. In this way, trading can be said to be much more involved than investing.  

One popular instrument used by traders is Contracts-for-Differences (CFDs), as it allows trading on the price action of any market, without having to take direct ownership of the underlying asset. Traders also favour CFDS as they allow both short and long positions, serving their needs more completely. 

Types of Trading Strategies 

Day trading 

Day trading is a short-term trading strategy where traders buy and sell stocks or other assets during the trading day to potentially profit from rapid fluctuations in prices. The intention is to close trades by the end of the day, not holding any assets overnight, so as to over overnight risk – this is when large price movements may occur due to unexpected news or events.  

Day trading often relies on technical analysis, including techniques such as understanding chart patterns, using technical indicators, and analysing price action and volume. By analysing the candlestick chart of an asset or security, traders can better determine an appropriate entry point, where to place a stop-loss order, and anticipate where to exit the trade (or set a take-profit order) to gain potential profits. 
 
Technical analysis is used to study past price action, primarily price levels and trading volume. By establishing patterns based on historical data, the trader aims to forecast future price movements, working under the assumption that trends tend to repeat themselves. 

To help them analyse price charts, traders make use of technical indicators, ranging from simple ones such as trend lines and Relative Strength Index (RSI), to more sophisticated indicators like Moving Average Convergence Divergence (MAD)

It’s important to realise that while technical analysis is widely practised in the trading world, it is an advanced skill that requires experience and practice to fully unleash its potential.  

Swing trading 

Swing trading takes place over a longer time period than day trading, with trades lasting anywhere from days to weeks or months. The main focus of this trading method is to identify and capture the upswings and downswings inherent in the price of a security; as such, the length of trade is determined by how long the swing carries on for.  

The key to succeeding in swing trading is being able to spot incoming trend changes, and then setting up the right trades to capitalise on them (going long for upswings, and going short on downswings).  

To help them in this task, swing traders make use of technical analysis to chart and confirm price trends. They may also perform fundamental analysis to keep on eye on announcements or events that might inspire a bull or bear run.  

Fundamental analysis involves evaluating the intrinsic value of a financial asset by examining related economic, financial, and other qualitative and quantitative factors surrounding the financial asset. 

Position trading 

Position trading is a strategy that involves holding a trading position for an extended period, typically spanning weeks or months, to potentially gain returns. The core idea is similar to swing trading, where the trader identifies a long-term price trend, and takes a corresponding position to capitalise on it.  

However, position traders tend to hold their trades open longer than swing traders; they are more focused on long-term trends rather than short-term price movements. This strategy also allows position traders to ignore near-term price volatility (and the anxiety that can arise from it). 

Because position traders aim to benefit from favourable price changes driven by underlying factors that impact the asset’s value, they tend to pay great attention to fundamental analysis. Technical analysis may also be deployed to confirm or clarify market conditions.  

What is the difference between day trading, swing trading and position trading? 

Strategy Time Horizon Key Characteristics 
Day Trading Minutes to days Frequent, intraday trading to capitalise on market volatility 
Swing Trading Days to weeks Capitalising on short-to-medium-term market swings 
Position Trading Months to years Long-term trading with a focus on greater trends and market cycles 
Table 1: Difference between day trading, swing trading and position trading 

What is Investing? 

Investing, in contrast, is a long-term wealth-building approach. While investors deal in many of the same markets and securities as traders – stocks, bonds, commodities, etc – they have a different mindset and approach. Rather than attempting to generate profits regularly from winning trades, investors focus on acquiring assets with the intention of retaining them for an extended period, ranging from months to decades. 

Another differentiator is that investors almost exclusively take long positions, focusing on buying undervalued securities or those with good growth potential, and benefiting from capital appreciation over time. 

However, there are also some advanced investors who may use derivatives such as options and futures to potentially enhance their returns. 

Investing strategies can vary widely. Some of the more common ones are buy and hold, value investing, growth investing and dividend growth investing.  

Types of Investment Strategies 

Buy and Hold 

Buy and hold is a passive investment strategy where an investor acquires stocks or other securities like ETFs and holds them for an extended period, often several years or decades.  

This strategy is rooted in the belief that the market will deliver a satisfactory rate of return over time, despite periods of volatility. While this approach has merit, as evidenced by the historical performance of popular indices like S&P 500 and NASDAQ, it is important to note that past performance is not indicative of future results. 

While buy and hold may appear similar to position trading, the difference is position trading includes the use of short-selling. Meanwhile, buy and hold investors almost always focuses on long positions – i.e., capital appreciation from prices going up.  

Value Investing 

Value investing focuses on selecting and owning stocks trading below their intrinsic or book value. Investors actively seek out undervalued stocks in the belief that they will revert to their true value once the market catches up. At this point, the stock price would have spiked up, allowing the value investor to enjoy capital appreciation.  

As a simple example, imagine if you had invested in Apple stock 20 years ago as a value investing strategy, and held it till today. Given the stock’s searing performance, you would have achieved your goal of long-term wealth building.  

Growth Investing 

Growth investing shares the same end-goal as value investing: to achieve capital appreciation over time from stock price increases. Although, it has a slightly different approach, where the focus is more on the growth potential of the company, and less on the stock’s current valuation. 

As such, a growth investor may decide to purchase a stock regardless of the current price, based on their conviction that the company is well-poised for significant growth in revenue, customer base, or other relevant metrics.  

Meanwhile, a value investor may come to the same conclusion – that the stock is a worthy investment – but may hold off on purchasing it until the stock price falls under the inherent value. They may also decide to invest in another similar stock that has a better price valuation.  

It should be noted that growth investing tends to favour younger companies that may have the potential to disrupt their sector, but many of such bets may turn out to be speculative at best. Growth investors should pay attention to companies with a proven track record instead of chasing after hype. 

Uncover the right investment strategy for you with our detailed guide on ‘Value Stocks vs Growth Stocks: Which one suits you’. 

Dividend Growth Investing 

Dividend growth investing is a long-term strategy that emphasises acquiring shares in companies known for providing consistent dividend payments to shareholders. It offers the potential for a stable and growing income stream, especially for those looking to supplement their regular income, including retirement planning. 

Here, investors tend to focus on what are known as Dividends Aristocrats, which are companies that have a long history of increasing their dividend payouts over time. Such companies are typically well-established household names with a stronghold on the market, such as Coca-Cola, Johnson & Johnson, and Walgreens [1].  

What are the differences between the different types of investment strategies? 

Strategy Key Characteristics 
Buy and Hold Long-term approach, buying and holding assets 
Value Investing Seeking undervalued assets with growth potential 
Growth Investing Focusing on assets with high growth potential 
Dividend Growth Investing Emphasising dividend-paying assets with proven track record of dividend growth potential 
Table 2: Difference the different types of investment strategies 

Similarities between Trading and Investing 

Both trading and investing share a common objective: gaining financial returns from the financial markets. The ultimate aim of the trader and the investor is to generate profits from securities traded on the stock market, such as: 

  • Company stocks and shares 
  • Dividend stocks 
  • ETFs and index funds 
  • Bonds 
  • Commodities such as gold 

Traders and investors are subject to the same market conditions, as they are participating in identical markets. Both trading and investing can be performed through an online broker that offers access to the desired markets.  

Differences between Trading and Investing 

1. Time Horizon 

Trading involves a shorter time horizon, spanning from minutes to months. Traders are constantly monitoring the markets, making quick decisions to capitalise on short-term price fluctuations. 

On the other hand, investing takes a significantly longer time frame, ranging from months to decades. Investors typically aim to build wealth gradually over an extended period, while ignoring near-term market trends and volatility. 

2. Risk and Reward 

Both trading and investing come with their own sets of risk and reward. 

Trading is centred around short-term market dynamics, which means you will be exposed to the rapid fluctuations of the market. This can lead to both gains and losses, depending on your ability to choose right strategies, and pick the correct entry and exit points.  

Investing, on the other hand, generally leans towards longer-term strategies. Buy and hold is a common investing strategy with the primary goal is to achieve returns over a more extended period, relying on historical precedents to justify the decision to invest. 

In essence, the approach and outcomes differ between trading and investing, with each having its own risk and rewards potential. 

3. Tools and Techniques 

Trading primarily relies on technical analysis, charts, and real-time data. Technical analysts examine historical price patterns and indicators to make predictions about future price movements. They also employ charts and utilise various tools to identify entry and exit points. 
 
Investors prioritise fundamental analysis, delving into the health and prospects of the underlying companies or assets. They assess financial statements, market trends, and growth potential to determine the value of their investments. Investing tends to ignore short-term market dynamics, so investors have less emphasis on technical analysis. 

4. Costs 

Trading often incurs higher costs, mainly due to the frequency of transactions. Traders engage in numerous buy and sell orders, which can add up to significant commission fees and spreads. Additionally, the need for real-time data can incur subscription costs. All these make it imperative to choose an online broker with fair and transparent fees and charges. 

In contrast, investing generally entails lower fees, as fewer trades are made. Lesser transactions translate to reduced costs, allowing long-term investors to benefit from lower overall cost of investing. However, it’s important to note that some investment options, such as Exchange-Traded Funds (ETFs) and Mutual Funds, may charge high management fees, which can impact overall returns. Strive to seek out ETFs and mutual funds that track the same basket of assets, but offer the lowest management fees.  

For a deeper dive into ETFs, read more about ETFs and how to trade them here and learn about the differences between ETFs and mutual funds here

What are the Pros and Cons of Trading and Investing 

Trading 

Pros 

  • Potential for quick returns: Trading offers the potential for gains if market conditions align with a trader’s strategy. 

  • Active engagement with markets: Traders are closely connected to market events and can act swiftly based on real-time data; this can improve trading skills over time 

Cons 

  • Higher risk: Due to the short-term nature of trading, the potential for losses is also higher, especially in volatile markets. 

  • Requires deep market knowledge: Successful trading demands a deep understanding of market dynamics, chart patterns, and technical indicators. 

  • Can be time-consuming: Constant monitoring and quick decision-making can be demanding, often requiring substantial time and attention. 

Investing 

Pros 

  • Potential for steady, long-term growth: Investors benefit from the power of compounding, with the potential for substantial wealth accumulation over time. 

  • Passive approach to the market: Investing allows for a more hands-off approach, making it suitable for individuals with limited time to dedicate to market monitoring activities. 

Cons 

  • Returns may take time: Investors must be patient as the potential returns may only be realised after an extended period, reflecting the long-term nature of investments. 

  • Require patience and discipline: Successful investing demands a disciplined approach to adhere to a chosen strategy even in the face of market fluctuations and uncertainties. 

How to Choose What’s Right for You 

Deciding between trading and investing ultimately depends on your personal financial situation and goals. Here are some ways for you to make the right choice: 

  • Assess your risk tolerance 

Understanding how much risk you can comfortably bear is the first step. If you’re risk-averse, investing may be a better fit. If you’re comfortable with risk and market volatility, trading could be a consideration. 

  • Determine financial goals and timelines 

What do you want to achieve financially, and when? Short-term goals may align with trading, while long-term goals are often best served by investing. 

  • The importance of education and research 

Whether you choose to trade or invest, continuous learning is essential. Stay informed about market trends, strategies, and the assets you’re interested in. 

  • Seeking advice from financial professionals 

Consult with financial advisors or professionals who can provide guidance tailored to your specific financial situation. 

Key Takeaways 

In conclusion, while trading and investing both offer the potential for returns, the choice between the two hinges on individual risk tolerance and financial objectives. 

By grasping the differences between trading and investing, you can embark on a path that aligns with your financial journey, making well-informed decisions that pave the way to a potential prosperous financial future. 

If the risks and rewards of trading sound like they are right up your alley, open an account with Vantage and start trading today. 

References

  1. “Dividend Aristocrats – Nasdaq”. https://www.nasdaq.com/stocks/investing-lists/dividend-aristocrats. Accessed 15 September 2024. 
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