The 4 Big Differences Between Trading and Investing
You’ve probably heard about people making money and winning big in the stock market. Some are traders and some are investors. That might sound like the same thing, but there are differences between the two. In this article, we’ll examine each and show you how to trade and invest wisely.
Trading Stock vs. Investing: 4 Differences You Should Know
1. Traders vs. Investors
First, let’s look at the difference between traders and investors. Traders are generally more focused on short-term gains in the stock market and tend to jump in and out of stocks quickly. Their success relies on outguessing the next trader as opposed to finding a great business to invest in. Traders have differing styles, typically based on their level of experience, risk tolerance, and how much time they can dedicate to trading. Types of traders include:
- Day traders: These traders buy and sell— or sell and buy—the same security in a margin account on the same day, employing strategies to turn a quick profit from short-lived price changes.
- Swing traders: While day traders focus on the trading day, swing traders invest for days or even weeks.
- Position traders: The opposite of a day trader, position traders identify a trend and hold an investment for months or even years until the trend peaks.
How do investors differ from traders? Investing generally means holding an asset for years or longer. Investors use asset allocation strategies to build portfolios that can help them reach their financial goals. These include:
- Income portfolio: As the name implies, this portfolio is made up of income-producing investments, such as stocks or bonds, that pay regular dividends and interest. Portfolio income is taxed at a lower rate than earned income; this approach is used to generate a dependable, steady stream of cash.
- Balanced portfolio: This is a mix of investments that includes stocks with solid growth potential along with bonds for added stability. Investors who opt for this model tend to be more comfortable with short-term market volatility and have medium-to-long-term financial goals.
- Growth portfolio: This strategy focuses mostly on stocks and their long-term performance, therefore, comes with higher risk. It’s best for investors with a long-term investment horizon, who can weather market fluctuations.
2. Short-Term vs. Long-Term
In general, traders focus on short-term profits, following the market closely to determine the best time to buy or sell. On the other hand, investors have a longer-term outlook. They aren’t concerned about day-to-day price fluctuations and think in terms of months or years, patiently holding onto investments as they grow.
3. Business Performance vs. Stock Performance
Traders are focused on stocks that will make them the most money in the least amount of time. They are less interested in a business thriving than they are in whether the stock can make them money. Conversely, investors are more concerned with a business’s long-term trajectory, and they tend to shake off short-term negative market reactions. Those who invest in funds add money regularly and don’t try to “time the market.”
4. Active Investing vs. Passive Investing
Active investing is very much a hands-on approach and involves ongoing buying and selling activity to try and beat the market. Traders continuously monitor the market so they can pick the best opportunities and avoid stocks that are losing value.
Passive investing, on the other hand, is a hands-off strategy that relies on business performance to drive returns higher. Investors using this approach are playing the long game. Instead of simply buying or selling when the market fluctuates, they hold onto their stake.
If you decide that trading is for you, here are some strategies to consider that can help minimize your risk:
- Create a plan: Decide when you’ll buy and sell. For example, your plan may dictate selling a stock if it rises or falls by a certain percentage.
- Stick to your plan: The market can be volatile. Sticking to your plan can help protect you.
- Know your limits: Determine how much money you can afford to lose, and don't trade more than that.
- Don’t forget taxes: Rates on short-term investment gains range from 10% to 37%. Be sure to consult a tax professional so you know the stakes.
If you choose this path, here are some things to consider:
- Create an investment plan: Your plan should cover buying, selling, and rebalancing your portfolio to meet your financial goals.
- Consider index funds: These funds mirror the performance of market indexes, such as the Nasdaq or the S&P 500.
- Set goals and understand risks: Invest with clear goals in mind, such as retirement or college tuition for your children, and determine how much risk you can tolerate.
- Be patient: As an investor, you’re in it for the long haul. That means weathering the market’s ups and downs.
Trading vs. Investing: Which Is Better?
While they both involve assets and financial markets, trading and investing are two different strategies with two different goals. For that reason, comparisons can be difficult.
However, in general, trading is risker for these reasons:
- Speculation: Trading involves educated guesses, quick decisions, and outright gambles.
- Minimal diversification: Because monitoring more than a few trades at the same time can be difficult, traders don’t benefit from diversified holdings.
Choose the Path That’s Right for You
You’ll want to think about your risk tolerance. If you’re comfortable with the risks, trading with part of your money could be profitable. However, if your goal is to reduce risk, long-term investing is a safer choice.
If you’d like help with managing your investments so you can reach your goals, the professionals at our Investment & Retirement Center are ready to assist. Set up a complimentary consultation today and set your financial future on the right path.